Bankruptcy for Productivity

Abstract

The accepted economic function of bankruptcy law is that it resolves collective action problems between self-interested creditors. This article argues that this collective-action-resolving function is only one of a multitude of expressions of an overarching economic motivation of bankruptcy law. Bankruptcy law seeks to avoid productivity-destroying consequences of insolvency. The principal expressions of this policy are more prominent features of the bankruptcy system than its collective-action-resolving provisions. The fresh start policy avoids the destruction of individual productivity incentives. The reorganization chapter avoids misallocations and false liquidations due to credit crunches and disrupted markets. The creation of trust funds for future victims of past torts solves the erroneous liquidation incentive that a vicious cycle of tort-driven insolvencies creates. The priority of tort claims during the reorganization cures wasteful incentives for sub-optimal care. None of these fundamental choices is explained as a solution to creditors' collective action problem. Moreover, the resolution of the creditors' collective action problem prevents the destruction of value, becoming itself one more expression in this group of avoiding the economic distortions that insolvency may cause. Closing, I argue that bankruptcy law must address these concerns because they require a study of the debtor's relations in their totality that state law is unlikely to be able to perform. The desired regulatory competition should be provided in the context of the structure of the federal judiciary.

Keywords: Bankruptcy, Reorganization, Credit-crunch, discharge, fresh start, non-compete, capital gains

JEL Classification: K00, K22, K34, K29