40 Pages Posted: 4 Feb 2004
An important purpose of this paper is to build a new model for the analysis and justification of insolvency law. So the first task undertaken here is to demonstrate why prior attempts at doing so might be considered inadequate. Focussing on the paradigmatic role of the automatic stay on unsecured claims in corporate liquidation, the analysis here starts with the Creditors' Bargain, the best-known of these attempts. It is argued that the Bargain model has neither descriptive nor moral force. The model relies on a confused and ultimately meaningless notion of consent. It seeks to appeal to the antecedent self-interest of creditors to suggest they would choose certain principles to decide how their debtor's assets should be dealt with in the latter's insolvency. But it suggests no privileged point of time from which the choice is to be made. Since the self-interest of creditors depends on how effective they would be (vis-a-vis other creditors) in each transaction in collecting what is owed to them in any insolvency regime not marked by the automatic stay, certain types of creditor would benefit but others would be worse off in any given transaction because of the stay. Further, the interest of each creditor would be different depending on when it is calculated. The Bargain model therefore fails to explain why all creditors equally would accept the automatic stay as a generally applicable rule.
What is more, the Bargain is built on the simple preferences creditors would express, based on their individual self-interest. But it provides no reason why preferences expressed at one instant in time ought permanently to be imposed on creditors by being enshrined in the law, when contrary preferences would be expressed by the same parties, based again on self-interest, at other times. The model thus provides no justification for the coercion inherent in insolvency law. And finally, the model allows the parties to be as different from each other during the bargaining process as they are in real life. This means stronger parties would be able to oppress weaker ones. Thus, the rules selected by the model are likely to be exploitative rather than just.
The paper then constructs an alternative contractarian model (the Authentic Consent Model, or ACM) to analyse and justify the principles of corporate insolvency law. This model builds on the assumption that all those affected by insolvency law are to be regarded as equals, with the consequence that their interests must be accorded equal care and concern in the choice of insolvency law principles. The notion of Dramatic Ignorance is introduced to accomplish this result. It is argued that, given the features of the Model, principles approved by the ACM can be regarded as being those that the relevant parties themselves would choose in exercise of their political autonomy, if given the chance to bargain with each other under the appropriate conditions. The automatic stay on the individualistic collection efforts of unsecured creditors, which defines the collective liquidation regime, is argued as passing the tests set by the ACM.
Another important part of the argument in this paper is addressed to defining the proper ambit of insolvency law. This point is made through a contrast of the approach of the ACM, with that of others, most notably of Donald Korobkin. Korobkin's Rawlsian model for the analysis and justification of (US) bankruptcy law seeks to address problems which, it is argued, are not unique to the context defined by corporate insolvency. This means his model would sometimes generate principles for inclusion in bankruptcy law which are inconsistent with the principles enshrined in other branches of the law, even though both sets of principles (bankruptcy and non-bankruptcy) deal with situations identical in all material respects. So some people might be treated differently from each other, depending not on any relevant difference in their situations, but simply because some of them did and others did not become subject to insolvency law. This violates the basic assumption of all reasonable legal systems, that people should be treated alike except when there is a good reason for treating them differently. The proposals of some other scholars in this area, including Elizabeth Warren, Karen Gross, and Venessa Finch, are also open to the same objection. To avoid this problem, the ACM requires a demonstration that a principle proposed as being suitable for inclusion in insolvency law deals only with some situation peculiar to (corporate) insolvency.
JEL Classification: D23, K19, K22, K39
Suggested Citation: Suggested Citation
Mokal, Riz, The Authentic Consent Model: Contractarianism, Creditors' Bargain, and Corporate Liquidation. Legal Studies, Vol. 21, No. 3, Pp. 400-443, September 2001. Available at SSRN: https://ssrn.com/abstract=308120