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The Uneasy Case for the Priority of Secured Claims in Bankruptcy

93 Pages Posted: 19 Jun 2003 Last revised: 7 May 2009

Lucian A. Bebchuk

Harvard Law School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Jesse M. Fried

Harvard Law School; European Corporate Governance Institute (ECGI)

Date Written: 1996

Abstract

This paper reexamines a longstanding principle of bankruptcy law: that secured claims are entitled to be paid in full before unsecured claims receive any payment. There is a widespread consensus among legal scholars and economists that according full priority to secured claims is desirable because it promotes economic efficiency. Our analysis, however, demonstrates that full priority actually distorts the arrangements negotiated between commercial borrowers and their creditors, producing various efficiency costs. We show that according only partial priority to secured claims could eliminate or reduce these efficiency costs - and that such an approach might well be superior to the rule of full priority. The analysis also suggests that a mandatory rule of partial priority could be effectively implemented within the framework of existing bankruptcy law, and that such an approach would be consistent with fairness and freedom of contract considerations. We therefore present two different rules of partial priority that should be considered as alternatives to full priority.

Keywords: Secured debt, bankruptcy, reorganization, chapter 11, priority, creditors, debtors, security interests, collateral, unsecured debt, lenders, borrowers

Suggested Citation

Bebchuk, Lucian A. and Fried, Jesse M., The Uneasy Case for the Priority of Secured Claims in Bankruptcy (1996). Yale Law Journal, Vol. 105, pp. 857-934, 1996; Harvard Law and Economics Discussion Paper No. 166. Available at SSRN: https://ssrn.com/abstract=417960 or http://dx.doi.org/10.2139/ssrn.417960

Lucian A. Bebchuk (Contact Author)

Harvard Law School ( email )

Cambridge, MA 02138
United States
617-495-3138 (Phone)
617-812-0554 (Fax)

HOME PAGE: http://www.law.harvard.edu/faculty/bebchuk/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Jesse M. Fried

Harvard Law School ( email )

1575 Massachusetts
Griswold Hall 506
Cambridge, MA 02138
United States
617-384-8158 (Phone)

HOME PAGE: http://www.law.harvard.edu/faculty/directory/10289/Fried

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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