Statutory Erosion of Secured Creditors' Rights: Some Insights from the United Kingdom

Abstract

Concerns about secured creditor capture of Chapter 11 are now part of the corporate bankruptcy reform conversation in the United States. So, for example, the American Bankruptcy Institute’s Commission on Chapter 11, scheduled to report and make recommendations for the reform of United States business reorganization law by the end of 2014, has the issue of secured creditors’ rights in bankruptcy squarely on its radar. The narrative is now well established and oft repeated. Whereas in the past, firms filing for Chapter 11 would come into the bankruptcy process with at least some unencumbered assets, modern firms tend to have capital structures that are entirely consumed by multiple layers of secured debt. And so, according to the prevailing conventional wisdom, Chapter 11 in the general run of cases has become little more than a glorified nationwide foreclosure process through which secured creditors can exit via a quick section 363 sale or an outright liquidation that is far from guaranteed to maximize the welfare of all creditors. But can concerns about the possible downside of secured creditor control of corporate reorganization be converted into effective reforms?

This paper (based on the author’s presentation at a symposium jointly sponsored by the American Bankruptcy Institute and the University of Illinois), offers insights from experience in England and Wales that, it is hoped, will assist reformers in the US to think through the possible consequences of certain types of reform proposal. The paper starts from the premise that lenders that are powerful enough to bargain for superior control and priority rights inside or outside of bankruptcy will be equally capable of adjusting to legal changes that affect, or are perceived as affecting, their interests.

Four ways in which lenders will adjust to “adverse” bankruptcy reform are identified: (i) meta bargaining; (ii) adjustments to pre-bankruptcy behaviour; (iii) transactional innovation; and (iv) shape shifting. The paper then illustrates how lenders in England and Wales have successfully adjusted to statutory attempts to undermine their bankruptcy priority and (via the abolition of administrative receivership) erode their control rights.

Keywords: Bankruptcy, reorganization, secured creditors

JEL Classification: K19, K20, K22, K29