Bankruptcy Law as a Liquidity Provider

68 Pages Posted: 16 Mar 2013 Last revised: 9 Sep 2014

See all articles by Kenneth Ayotte

Kenneth Ayotte

University of California, Berkeley - School of Law

David A. Skeel

University of Pennsylvania Carey Law School; European Corporate Governance Institute (ECGI)

Date Written: 2013


Since the outset of the recent financial crisis, liquidity problems have been cited as the cause behind the bankruptcies and near bankruptcies of numerous firms, ranging from Bear Stearns and Lehman Brothers in 2008 to Kodak more recently. This paper expands the prevailing normative theory of corporate bankruptcy — the Creditors’ Bargain theory — to include a role for bankruptcy as a provider of liquidity. The Creditors’ Bargain theory argues that bankruptcy law should be limited to solving problems caused by multiple, uncoordinated creditors, but focuses almost exclusively on the problem of creditor runs. We argue that two well-known problems that cause illiquidity — debt overhang and adverse selection — are also caused by multiple creditor coordination problems. As such, bankruptcy law is justified in solving these problems in addition to creditor run problems.

With this insight in hand, we argue that many of bankruptcy’s existing rules, including debtor-in-possession financing, sales free and clear of liens, and coerced loans can be seen as liquidity-providing rules that target either debt overhang problems, or adverse selection problems, or both. Using bankruptcy to solve liquidity problems can create costs, however, such as the risk of continuation bias. We suggest rules of thumb for judges to use in balancing the benefits and costs of these rules. We also connect our theory to the use of bankruptcy for financial institutions, where liquidity concerns loom large.

Keywords: bankruptcy, liquidity, creditors' bargain, debt overhang, adverse selection

JEL Classification: G32, G33

Suggested Citation

Ayotte, Kenneth and Skeel, David A., Bankruptcy Law as a Liquidity Provider (2013). University of Chicago Law Review, Vol. 80, P. 1557, 2013, Northwestern Law & Econ Research Paper, U of Penn, Inst for Law & Econ Research Paper No. 13-8, Available at SSRN:

Kenneth Ayotte (Contact Author)

University of California, Berkeley - School of Law ( email )

215 Law Building
Berkeley, CA 94720-7200
United States

David A. Skeel

University of Pennsylvania Carey Law School ( email )

3501 Sansom Street
Philadelphia, PA 19104
United States
215-573-9859 (Phone)
215-573-2025 (Fax)

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels

Do you have negative results from your research you’d like to share?

Paper statistics

Abstract Views
PlumX Metrics