Bankruptcy Process for Sale

71 Pages Posted: 27 Aug 2020 Last revised: 27 Feb 2021

See all articles by Kenneth Ayotte

Kenneth Ayotte

University of California, Berkeley - School of Law

Jared A. Ellias

UC Hastings Law

Date Written: January 5, 2021

Abstract

The lenders that fund Chapter 11 reorganizations exert significant influence over the bankruptcy process through the contract associated with the debtor-in-possession (“DIP”) loan. In this Article, we study a large sample of DIP loan contracts and document a trend: over the past three decades, DIP lenders have steadily increased their contractual control of Chapter 11. In fact, today’s DIP loan agreements routinely go so far as to dictate the very outcome of the restructuring process. When managers sell control over the bankruptcy case to a subset of the creditors in exchange for compensation, we call this transaction a “bankruptcy process sale.” We model two situations where process sales raise bankruptcy policy concerns: (1) when a senior creditor leverages the debtor’s need for financing to lock in a preferred outcome at the outset of the case (“plan protection”); and (2) when a senior creditor steers the case to protect its claim against litigation (“entitlement protection”). We show that both scenarios can lead to bankruptcy outcomes that fail to maximize the value of the firm for creditors as a whole. We study a new dataset that uses the text of 1.5 million court documents to identify creditor conflict over process sales, and our analysis offers evidence consistent with the predictions of the model.

Keywords: bankruptcy; corporate governance; distress; chapter 11; contracts; finance; corporate finance

JEL Classification: K22; G33; G30; G34; K41

Suggested Citation

Ayotte, Kenneth and Ellias, Jared A., Bankruptcy Process for Sale (January 5, 2021). UC Hastings Research Paper No. 382, Yale Journal on Regulation, Vol. 39, No. 1, 2021, Available at SSRN: https://ssrn.com/abstract=3611350 or http://dx.doi.org/10.2139/ssrn.3611350

Kenneth Ayotte (Contact Author)

University of California, Berkeley - School of Law ( email )

215 Boalt Hall
Berkeley, CA 94720-7200
United States

Jared A. Ellias

UC Hastings Law ( email )

200 McAllister Street
San Francisco, CA 94102
United States

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