Bankruptcy & Bailouts; Subsidies & Stimulus: The Government Toolset for Responding to Market Distress

By Anthony J. Casey (The University of Chicago Law School)

Anthony J. Casey

In the spring of 2020, as the Covid-19 pandemic shut down economies around the world, pressure arose for governments to respond to the growing threat of pandemic-related market distress. In the United States, the initial proposals for government action varied in nature and focus. Some proposals targeted the financial system while others targeted small businesses and individuals. Others were intended to bail out large businesses and specific industries. Still other proposals took a more institutional focus. In the context of bankruptcy law, many imagined building up the bankruptcy system as a primary bulwark against a seemingly imminent wave of economic and financial distress.

With the exception of measures related to financial markets, the actual responses formed a chaotic mix of disconnected half-measures that neither stabilized the economy nor provided meaningful relief to those most affected. While that failure may be attributed in part to general government dysfunction and legislative gridlock, a large part of the problem arises from the lack of a clearly identified framework to guide government responses.

The main lesson here is that the appropriateness of tools deployed to alleviate a crisis depends on the nature of the specific problem at hand, and scattershot approaches are unlikely to work. As obvious as that principle may seem, it was largely ignored in 2020. Much of the confusion in the pandemic responses is attributable to using the wrong tools and implementing measures that lacked any clear purpose.

In particular, governments and commentators lost sight of two important distinctions in deciding how to act. The first is the distinction between tools appropriate for addressing economic distress and those appropriate for addressing financial distress. The second is the distinction between a systemic crisis where distress is spreading and an instance of firm-specific distress where the harm—though perhaps large—is contained.

These distinctions present four types of market distress: specific economic, systemic economic, specific financial, and systemic financial. Each type is distinct from the others, and for each there is a category of appropriate government responses (respectively): direct subsidies, general stimulus, bankruptcy proceedings, and financial bailouts. We thus have this matrix:

Systemic Specific
Economic General Stimulus Direct Subsidies
Financial Financial Bailouts Bankruptcy Proceedings

(Chapter 11)

 

The importance of understanding these classifications is most evident in the flawed proposals for pandemic-related fixes to bankruptcy law and in the lack of a centralized economic plan to support failing small businesses around the country.

In a new article, I lay out this framework for identifying the right tools for responding to different forms of market distress.  I describe the relationship between the category of tools and the type of distress. Having presented the framework, I then use it to closely examine the interaction between pandemic responses and bankruptcy law. This analysis is particularly important because efforts to understand the bankruptcy system’s role during the pandemic provide the starkest example of confused analysis of appropriate responses to systemic crises, and because a striking decline in bankruptcy filings in 2020 has puzzled many commentators.

What’s Wrong with Chapter 11?

By Charles J. Tabb (University of Illinois College of Law)

The time has come to cast a discerning eye at chapter 11, the United States corporate bankruptcy reorganization statute, and examine how it is currently broken and what fixes can be made to improve it.

This Article first identifies five core normative goals that chapter 11 should promote: (1) maximize the value of the debtor firm; (2) distribute the maximized value of the firm fairly and equitably; (3) save jobs; (4) minimize the ripple effect of the firm’s failure; and (5) ensure that in pursuing those normative goals, the cure is not worse than the disease.

The Article then examines five critical ways in which chapter 11 in practice fails to achieve the normative ideals: (1) traditional chapter 11 restructurings are largely a thing of the past, and have given way to quick all-asset sales of the company; (2) secured lenders control everything and get a disproportionate share of the firm’s value; (3) a small number of other creditors are able to apply leverage to obtain unfair and inequitable payments on their claims compared to other creditors; (4) venue forum shopping has triggered a race to the bottom; and (5) bankruptcy judges routinely ignore the statute as written and legislate judicially.

The Article concludes by identifying seven possible reforms that could help transform chapter 11 from the current nightmare to the normative ideal dream: (1) making sales once again just sales; (2) resurrecting the “perishability” or “emergency” test for sales; (3) limiting secured creditors to foreclosure value; (4) opening up DIP financing terms and eliminating draconian terms; (5) eliminating all preferential priority-altering payments; (6) curtailing venue choice and forum shopping; and (7) eradicating judicial legislation.

The full article is available here.