On the Mandatory Stay of Secured Creditors in Bankruptcy
32 Pages Posted: 30 Oct 2017
Date Written: April 1, 2017
Subsidiary legal entities can be used to create a path around bankruptcy's automatic stay, giving a secured creditor a free right to withdraw collateral. In some cases, core assets of the firm are made separable from each other. To fully understand the desirability of subsidiaries as a path around the stay, I take a step backward and ask a fundamental question that has not been addressed formally: why do we need a mandatory stay of secured creditors in the first place? The model generates conditions under which a stay of secured creditors can be valuable. Three conditions are necessary: a) the collateral must be firm-specific, b) debt contracts are sequential and incomplete, and c) bargaining at bankruptcy is imperfect. Under these conditions, a debtor may grant withdrawal rights even when they are less efficient than a stay. I discuss ways that a stay might be made applicable to subsidiary creditors in a way that is targeted at the inefficiencies the model identifies.
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