Optimal Deterrence and the Preference Gap

Abstract

It is generally understood that the way to discourage particular behavior in individuals is to punish that behavior, on the theory that rational individuals seek to avoid punishment. Laws aimed at deterring behavior operate on the assumption that increasing the likelihood of punishment or the severity of punishment, or both, will decrease the behavior, and the success of these laws is evaluated by how much the targeted behavior decreases. The law of preferential transfers, which punishes creditors who have been paid prior to the bankruptcy at the expense of other, unpaid creditors, has been defended on the grounds that it deters a race to collect from a struggling debtor. However, deterrence theory indicates that the low likelihood of punishment and the cap on punishment associated with preference law make it a very poor deterrence. Further, empirical evidence drawn from interviews with affected creditors, debtors, and attorneys on both sides demonstrate that in practice, preference law does little or nothing to deter targeted behavior, and in the process imposes significant costs. The weaknesses of preference law call for its significant revision, to place a greater focus on specific categories of creditors to be punished on account of their pre-bankruptcy activities.

Keywords: bankruptcy, deterrence, preferential transfers, chapter 11, trade creditors