Optimal Deterrence and the Preference Gap

By Brook Gotberg (University of Missouri School of Law)

It is generally understood that the way to discourage particular behavior in individuals is to punish that behavior, on the theory that rational individuals seek to avoid punishment. Laws aimed at deterring behavior operate on the assumption that increasing the likelihood of punishment, the severity of punishment, or both, will decrease the behavior. The success of these laws is also evaluated by how much the targeted behavior decreases. The law of preferential transfers, which effectively punishes creditors who have been paid prior to the bankruptcy has been defended on the grounds that it deters a race to collect from a struggling debtor. However, deterrence theory suggests that the low likelihood of punishment and the cap on punishment associated with preference law make it a very poor deterrence. Further, statements pulled from interviews with affected creditors, debtors, and attorneys demonstrate that in practice, preference law does little or nothing to deter targeted behavior, and in the process imposes significant costs. The weaknesses of preference law call for its significant revision to place a greater focus on specific categories of creditors to be punished on account of their pre-bankruptcy activities.

The full article is available here.

 

Conflicting Preferences: Avoiding Proceedings in Bankruptcy Liquidation and Reorganization

posted in: Avoidance | 0

By Brook Gotberg, J. Reuben Clark Law School, Brigham Young University

GotbergThe law of preferential transfers permits the trustee of a bankruptcy estate to avoid transfers made by the debtor to a creditor on account of a prior debt in the 90 days leading up to the bankruptcy proceeding.  The standard for avoiding these preferential transfers is one of strict liability, on the rationale that preference actions exist to ensure that all general creditors of the bankruptcy estate recover the same proportional amount, regardless of the debtor’s intent to favor any one creditor or the creditor’s intent to be so favored.  But preference law also permits certain exceptions to strict preference liability and gives the estate trustee discretion in pursuing preference actions. This undermines the policy of equal distribution by permitting some creditors to fare better than others in the bankruptcy distribution.  However, these practices are arguably necessary to promote the conflicting bankruptcy policies that seek to maximize the value of the estate for the benefit of creditors and also encourage the survival of struggling businesses.

As a result, the law of preferences is internally inconsistent and controversial, attempting unsuccessfully to serve multiple policy masters simultaneously.  Much of the analysis on preferences up to now has proposed amending preference law generally in an attempt to satisfy these often conflicting demands.  This article recommends a more dramatic approach; returning preference law to a mechanism of equal distribution in liquidation proceedings (Chapter 7) by eliminating true exceptions to the rule, and doing away with preference law in the context of bankruptcy reorganization (Chapter 11).

For the full article see here.

Next week we will be featuring another article on this topic, Professor Daniel J. Bussel’s The Problem with Preferences.