Breaking Bankruptcy Priority: How Rent-Seeking Upends the Creditors’ Bargain

posted in: Cramdown and Priority | 0

Editor’s Note:  Breaking Bankruptcy Priority: How Rent-Seeking Upends the Creditors’ Bargain, by Mark Roe and Fred Tung, was selected as one of the ten Best Corporate and Securities Articles of 2014. This “10-best” list reflects the choices of academic teachers in this area from more than 560 articles published last year. The article was the subject of a Bankruptcy Roundtable post on April 8, 2014 at its time of publication. It was the only bankruptcy-based article on the “10-best” list. That list can be found here.

By Mark Roe, Harvard Law School, and Frederick Tung, Boston University School of Law

Roe 124tungprofileIn “Breaking Bankruptcy Priority:  How Rent-Seeking Upends the Creditors’ Bargain,” recently published in the Virginia Law Review, we question the stability of bankruptcy’s priority structure. Bankruptcy scholarship has long conceptualized bankruptcy’s reallocation of value as a hypothetical bargain among creditors: creditors agree in advance that if the firm falters, value will be reallocated according to a fixed set of statutory and agreed-to contractual priorities.

In “Breaking Priority,” we propose an alternative view. No hypothetical bargain among creditors is ever fully fixed because creditors continually seek to alter the priority rules, pursuing categorical rule changes to jump ahead of competing creditors. These moves are often successful, so creditors must continually adjust to other creditors’ successful jumps. Because priority is always up for grabs, bankruptcy should be reconceptualized as an ongoing rent-seeking contest, fought in a three-ring arena of transactional innovation, doctrinal change, and legislative trumps.

We highlight a number of recent and historical priority jumps. We explain how priority jumping interacts with finance theory and how it should lead us to view bankruptcy as a dynamic process. Breaking priority, reestablishing it, and adapting to new priorities is part of the normal science of Chapter 11 reorganization, where bankruptcy lawyers and judges expend a large part of their time and energy. While a given jump’s end-state (when a new priority is firmly established) may sometimes be efficient, bankruptcy rent-seeking overall has significant pathologies and inefficiencies.

The paper is available here.