Get in Line: Chapter 11 Restructuring in Crowded Bankruptcy Courts

By Benjamin Iverson, Kellogg School of Management at Northwestern University

On average, total bankruptcy filings rise by 32% during economic recessions, leaving bankruptcy judges with far less time per case exactly when financial distress is worst.  The inflexible nature of the bankruptcy system coupled with the varying demands placed upon it, leads to the concern that time constraints might limit the effectiveness of bankruptcy when economic conditions deteriorate.

In my paper, “Get in Line: Chapter 11 Restructuring in Crowded Bankruptcy Courts,” I test whether Chapter 11 restructuring outcomes are affected by time constraints in busy bankruptcy courts.  Using the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005 as a shock that decreased caseloads dramatically, I show that as bankruptcy judges become busier they tend to allow more firms to reorganize and liquidate fewer firms.  I interpret this as evidence that busy bankruptcy judges defer to the debtor in possession more often, scrutinizing each case less and thereby allowing reorganization more often.  In addition, I find that firms that reorganize in busy courts tend to spend longer in bankruptcy, while firms that are dismissed from busy courts are more likely to re-file for bankruptcy within three years of their original filing.

Perhaps most striking, I also show that busy courts impose costs on local banks, which report higher charge-offs on business lending when caseload increases.  If time constraints create higher costs of financial distress, it appears that these costs are typically passed on to the creditors of the bankrupt firms in the form of higher losses on distressed loans.

The full-length article can be found here.

 

The Ownership and Trading of Debt Claims in Chapter 11 Restructurings

posted in: Claims Trading | 0

By Victoria Ivashina, Ben Iverson, and David C. Smith

The role that active investors play in Chapter 11 reorganization is hotly debated in bankruptcy circles. In our paper, “The Ownership and Trading of Debt Claims in Chapter 11 Restructurings,” we collect comprehensive data on individual claims for 136 large firms that filed for Chapter 11 protection to empirically test how active investors might influence the bankruptcy process. Our data allows us to observe the identities of over 77,000 claimants and precisely measure both ownership concentration as well as claims trading for these cases.

We find evidence that firms with more concentrated capital structures are more likely to enter bankruptcy with pre-negotiated or pre-packaged bankruptcy plans, suggesting that negotiations are easier when creditors are not dispersed. In addition, even if they do not have a pre-packaged plan, firms with more concentrated ownership tend to exit bankruptcy more quickly and are more likely to emerge from Ch. 11 intact rather than being sold or liquidated piecemeal.

In the second half of the paper, we turn to the question of how claims trading in bankruptcy affects the resolution of the case. We find that trading during bankruptcy tends to concentrate ownership even further, and that the bulk of claims purchasing is done by hedge funds and other active investors. Interestingly, as these active investors enter the capital structure the overall recovery rate for the case tends to decrease, suggesting that perhaps active investors shrink the size of the overall “pie” in their efforts to obtain a larger piece of it.

The full-length article can be found here.