The Costs of Corporate Bankruptcy: How Little We Know
by | posted in: Bankruptcy Administration and Jurisdiction | 0

Author: Stephen J. Lubben, Seton Hall University School of Law

lubben-176x220_1 For almost as long as there have been bankruptcy laws, there have been complaints that the primary beneficiaries of these laws are insiders who administer the bankruptcy system. In recent decades, this line of criticism has carried with it an implicit criticism of bankruptcy courts, which are urged to more aggressively police the costs of bankruptcy. Indeed, at least one recent critic has unkindly suggested that the failure of the courts to control bankruptcy costs is the result of a corrupt bargain between bankruptcy courts and practitioners.

Rarely addressed is why bankruptcy courts regulate professional costs at all. In most areas of American law, a professional is accountable solely to its client. Complaints about excessive cost might result in a separate malpractice action, but a client who thinks they have been overcharged for the defense of their speeding ticket will find little relief in traffic court. Why is bankruptcy different?

This paper begins to look at this question with brief overview of the concept of bankruptcy costs, traditionally divided between direct and indirect costs. I next turn to a consideration of the process for overseeing bankruptcy costs. I briefly trace the history of court control of compensation in corporate bankruptcy, and then detail the current legal structure. The final part of the chapter then surveys the existing understanding of chapter 11 cost, and concludes with a some thoughts on the important questions that remain unanswered.

In short, we know a bit about direct costs, but very little about any other sort of costs. Moreover, what we know is almost entirely lacking in context. This makes it quite hard to understand if the existing system of cost regulation is either useful or justified.

This article is available here.

 

Get in Line: Chapter 11 Restructuring in Crowded Bankruptcy Courts
by | posted in: Bankruptcy Administration and Jurisdiction | 0

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.

 

Activist Investors, Distressed Companies, and Value Uncertainty
by | posted in: Claims Trading | 0

Authors:  Michelle M. Harner, Jamie Marincic Griffin, and Jennifer Ivey-Crickenberger

Hedge funds and other private investment funds often play a key role in chapter 11 cases.  They may hold the debtor’s prepetition secured debt or provide postpetition financing to the debtor.  They also may buy and trade the debtor’s secured and unsecured debt both before and after a chapter 11 filing.  These activities can provide much-needed liquidity to a debtor and foster a robust secondary market for creditors looking to exit the credit.  A fund’s participation in a case, however, sometimes generates litigation and, arguably, both delays the resolution and increases the cost of the case.  Consequently, many commentators and practitioners debate the utility of funds in restructurings.

In our most recent article on funds in chapter 11, we conduct an original empirical study of funds as purchasers of chapter 11 debtors.  Specifically, the study analyzes cases where a fund (individually or as part of a group) acquires control of a debtor through the chapter 11 process by purchasing either substantially all of the debtor’s assets or a majority interest in the reorganized stock.  In the stock acquisition context, we were concerned only with the investment of new capital.

Overall, the data suggest that funds have the potential to provide value in chapter 11.  But neither the participation of funds nor the chapter 11 process itself is a panacea, and more empirical and traditional case studies are needed to understand fully the impact of funds on corporate restructurings.  We hope our study encourages further research.

The full-length article can be found here.