The Evolution of Corporate Rescue in Canada and the United States

By Jassmine Girgis (University of Calgary, Faculty of Law)

Jassmine Girgis

This chapter explores the evolution of corporate rescue in both Canada and the U.S. The timing and specific circumstances surrounding the legislation’s enactment were different in each country, but the underlying concepts and goals within the broader context of bankruptcy legislation were the same. Both countries had experienced the profound effects of business failure on directly impacted stakeholders, as well as on surrounding communities, and they recognized that saving companies would protect investments, preserve jobs, maintain the supplier and customer base, and prevent the wider impact of bankruptcy on society. To that end, both countries devised proceedings to restructure and rehabilitate financially distressed companies, allowing them to re-emerge with new debt or equity structures and continue operating as going concerns.

Historically, traditional restructurings – that is, proceedings in which the debtor company engages in lengthy negotiations with its creditors to restructure its debt obligations and business operations, all under the supervision of the court – were used extensively, dissolving unsuccessful companies while allowing others to emerge and continue operating. But these proceedings were slow, expensive, and cumbersome, and as changes in technology, firm assets, the economy and financial instruments modified the ways companies operated, and globalization altered their business methods and interactions with the community, a different process emerged. Rather than rescuing companies, this new process liquidated or merged them with other companies, and though traditional restructurings continued to occur, they have largely given way to sales or liquidations. Importantly, these emerging liquidation proceedings did not occur under bankruptcy or receivership regimes, but under the statutes that governed restructurings. They also occurred without meaningful consideration as to how this shift affects the public interest goals of the legislation.

The first part of this chapter discusses what happened: the history of these statutes, the reasons traditional restructurings emerged, and the eventual move to liquidations. The second part explores the three broad reasons liquidation plans replaced restructuring. First, an increase in secured debt left secured creditors in control of the financially distressed debtor corporations, and secured creditors typically prefer liquidation over restructuring. Second, the decline in the manufacturing and industrial era and growth of a service-oriented economy impacted firm assets; assets became less firm-specific and more fungible. Finally, increasingly complex financial instruments altered the composition of creditors; creditors at the table now include hedge funds and other non-traditional lenders, and they may be motivated by factors beyond saving the distressed company or maximizing its asset value.

The third part of this chapter addresses the consequences of using rescue legislation to liquidate companies. First, the governing legislation was not meant to be used in this way, and stakeholders in these expedited sales do not have the benefit of the procedural and substantive safeguards that arise in restructuring proceedings. Second, it is arguable that these liquidation proceedings do not fulfil the public policy goals of restructuring legislation. Finally, embedded within public policy is the concept of value-maximization, but what ‘value’ means and how it can be maximized, is not static, and may have different connotations under traditional restructurings than under liquidations.

The last part considers the most feasible way forward for each country: where does corporate rescue go from here? This section examines whether the bankruptcy forum should be abandoned in favour of non-bankruptcy legislation or private contracts, or whether the answer lies in improving the current legislative schemes. Although many do not want to see restructuring legislation overhauled, they do recognize that this legislation was enacted under different circumstances, in a different market, when corporations looked vastly different than they do today, and that to remain relevant, it must come to reflect today’s society and corporations. Doing so requires reconceptualizing how liquidation fits into the public policy goals of the statute and reassessing the concept of value to determine what it should encompass. 

The full chapter is available here.

Bankruptcy’s Cathedral: Property Rules, Liability Rules, and Distress

By Vincent S.J. Buccola (University of Pennsylvania – The Wharton School)

What good can a corporate bankruptcy regime do in the modern economy? The question bears asking because the environment in which distressed companies find themselves is so markedly different from the environment of just twenty years ago—to say nothing of the days of the equity receiverships, of sections 77 and 77B, of Chapters X and XI. The most important changes are well known: increased depth and liquidity of financial markets and, especially, increased capacity of financial contracting to say ex ante how distress will be resolved ex post. Recent efforts to take stock of contemporary bankruptcy practice, most notably the ABI’s Chapter 11 reform project, grapple implicitly with the significance of a changing environment. But by leaving the matter implicit, they underscore a lacuna about what the law’s marginal contribution to the economic order might be.

In a forthcoming article, Bankruptcy’s Cathedral, I hazard a general answer and elaborate its implications for a few prominent uses of bankruptcy in today’s practice.

The characteristic function of bankruptcy law, I say, is to recharacterize the mode in which an investor’s relationship to a distressed firm is governed. In particular, bankruptcy frequently toggles the protection of an investor’s economic interests from a property rule, in the Calabresi and Melamed sense, to a liability rule. It swaps out the investor’s unilateral right upon default to withdraw her investment, when such a right would ordinarily prevail, in favor of a judicially mediated procedure designed to give her the official value of her right. The automatic stay furnishes an example. It extinguishes a secured creditor’s power to repossess and sell collateral, and supplies instead a right only to what the bankruptcy judge determines to be “adequate protection” of its interest in the collateral.

This toggling function can be useful, Property rules are often more efficient during a company’s financial health than during distress. A state-contingent meta rule that switches between the two thus might be optimal. But what about financial contracting? Why can’t investors stipulate state-contingent meta rules if indeed they can maximize surplus by doing so? The short answer is that in some cases contract is sufficient, but in other cases legal or practical impediments are insuperable. The marginal contribution of bankruptcy law, then, is to supply toggling rules where investors cannot practically do so on their own.

One implication of my approach is to index the justifiable scope of bankruptcy to contingent facts about the efficacy of financial contracting. In environments where it is difficult for investors to specify state-contingent toggling rules, whether because of legal prohibition or practical impossibility, the compass for bankruptcy law is wider. As contract becomes more efficacious, bankruptcy’s brief grows correspondingly shorter.

This normative schema can be used to assess one-by-one the many actual interventions of bankruptcy laws. I scrutinize three uses of bankruptcy that are important in today’s practice: to confirm prepackaged plans, to effect going-concern sales, and to take advantage of the automatic stay. I find plausible justifications for a legal institution to bind holdout creditors and to extinguish in rem claims against a debtor’s assets. The automatic stay, on the other hand, is harder to justify. (The curious must read within to find out why.) More generally, though, my approach shows how one can weigh the contributions of a bankruptcy regime against its redundant or even counterproductive in light of contracting innovations.

The complete article is available for download here.