The Creditors’ Bargain Revisited

The Creditors’ Bargain Revisited

Thirty‐six years ago, Tom Jackson suggested that corporate bankruptcy law can best be explained and defended as the terms of an implicit bargain among creditors. This assertion is founded on a belief that creditors, as a group, prefer bankruptcy’s collective process to a grab race among themselves, particularly when such a race may cause the demise of a viable going concern.

Since Jackson’s article, scholars have discussed and debated whether creditors need to rely on bankruptcy’s bargain for collective action. Some have contended that creditors could in fact contractually arrange for a collective process and that the law should permit them to do so. Others have argued that the impediments to such a contractual arrangement would be too daunting. With rare exception, though, participants in this dialogue assumed that creditors desire some form of collective process, whether provided by statute or contract. That is, while implementation was debated, the collectivization premise went mostly unchallenged.

The recent transformation of the bankruptcy process from a forum of reorganization to, largely, an auction block further supports the collectivization premise. A collective process may not seem attractive when it features the contests inherent in reorganization, described colorfully by Sol Stein as a feast for lawyers. But the bankruptcy process may appear in a more favorable light when it is used simply to conduct an orderly sale of the debtor’s assets, including a sale as a going concern if that configuration of assets garners the highest bid.

All may seem well, then, in the world of bankruptcy, where the apparent confluence of theory and practice led Douglas Baird and Robert Rasmussen to declare the end of bankruptcy, by which they meant that bankruptcy has evolved to its ideal. But there is a fly in the ointment.

At a series of recent conferences attended by academics and practitioners, the latter have suggested, sometimes expressly, that if freed from legal constraint, creditors they know would not only contract out of bankruptcy but out of any collective proceeding. That is, at least some practicing lawyers—presumably not immersed in Jacksonian orthodoxy—seem to believe that their clients would like to engage in a grab race after all, consequences be damned.

Do these lawyers, who represent sophisticated lenders, simply mean that their clients favor a competition in which they would occupy a privileged position? Perhaps. But this seems unlikely because in a functioning capital market, creditors are mere stakeholders who are forced by the market to pay for any privilege in the form of lower interest rates. Sophisticated lenders, along with their lawyers, well understand this.

But perhaps a better explanation for why lenders might forgo collectivization exists: debtors would insist on interest rates possible only if the debtor obtained funds within a capital structure designed to throw the firm to the creditor wolves in the event of an uncured default. This conjecture is not new. I first raised the idea years ago in dissent to the collectivist hegemony. What is new, and the focus of this Article, is the extent to which the conjecture is supported by recent developments in bankruptcy practice and creditor activism.