A Normative Theory of Business Bankruptcy

Abstract:     
It is widely agreed that capital cost reduction should be among the goals that a business bankruptcy law should pursue. This Essay argues that capital cost reduction should be the only goal, and that a bankruptcy system seriously committed to this goal would be both smaller and less centralized than the current U.S. Bankruptcy Code. In particular, a bankruptcy law that sought to reduce the cost of debt capital to firms would (a) require the trustee or debtor in possession to maximize the value of the insolvent firm rather than the payoffs of general creditors; (b) permit preferences (but continue to bar fraudulent conveyances); (c) permit suppliers and customers to contract for the right to cease dealing with a firm that has become insolvent; (d) not subsidize the use of expert professionals by junior creditors, but sometimes subsidize expert use by seniors; and (e) permit parties in the lending agreement to induce the debtor to use the bankruptcy procedure, either Chapter 7 or Chapter 11, that turns out to be optimal in the state of the world in which insolvency occurred.

Number of Pages in PDF File: 75

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