Design Flaws in the Bankruptcy Regime: Lessons from the UK for Preventing a Resurgent Creditors’ Race in the U.S.

Abstract

A current trend in U.S. bankruptcy law reflects the predictions of economic theory related to “common pool” resources. According to the theory, without coordinating law to account for and distribute limited assets in an orderly way, creditors race to claim them for themselves. The winners of the race deprive other creditors of value and make corporate reorganization more difficult, a situation economists would describe as a “tragedy of the commons.” Increasingly, secured creditors divert bankrupt companies from the traditional Chapter 11 process, which has protected the interests of junior creditors, and pushed them instead into asset sales under Section 363 of the U.S. Bankruptcy Code. Secured creditors use Section 363 to maximize their recoveries to the detriment of unsecured creditors, as well as others in the community dependent on the companies.

That a similar trend persists in the UK, despite concerted legislative efforts to reverse secured creditor control, indicates the pressure on bankruptcy law to withstand the tendency towards a creditors’ race. It has become necessary to retool the bankruptcy regime to better withstand secured creditor circumvention. The English experience suggests that empowering a neutral regulator that can use soft law to influence the incentives of secured creditors may provide a solution.

Keywords: bankruptcy, common pool resource, creditors' race, tragedy of the common, Chapter 11, 363 asset sale, secured creditors, English administration, London Approach, English Receivership, creditors distributions, prepacks