The Control of Wealth in Bankruptcy

Abstract

Nearly every country in the world has a legal regime devoted to the process of recovery and distribution of value following a general default by a debtor in business. In the United States, we have both a public and a private regime that may govern the recovery process. The public regime is bankruptcy and the private regime is secured credit. Any regime governing the recovery process must include two components: (1) control of the process that maximizes value and allocates that value to chosen beneficiaries; and (2) rules of priority that specify the beneficiaries and their shares of the value. The greater sophistication of the modern recovery process means that control of that process crucially influences outcomes, but the theoretical literature discussing bankruptcy and secured credit has been devoted to questions of priority rather than control. Control is the central subject of this Article. New models of secured credit and bankruptcy are proposed, incorporating the concept of control as fundamental to both regimes. The struggle for control is the essential linkage between them. A number of consequences follow from these new models. Development of these consequences is the author's larger project, but only one of them is fully explored in this Article.

"Contractualism" is a term describing a variety of proposals for privatizing the recovery process through contracts between a debtor and its creditors. This Article argues that these proposals cannot be legitimate or efficient unless linked to a dominant security interest encumbering substantially all of the debtor's assets, even though none of the scholars proposing contractual regimes has acknowledged that the contractual schemes require security to be plausible. Because secured-credit law in the United States is in place and highly functional, it represents the only method for resolving the otherwise intractable difficulties presented by these privatization proposals. That conclusion is confirmed by the United Kingdom's experience with a contractualist system based upon a dominant security interest, a system that has served as the core structure of commercial finance in that country for over a century.

Recognition that secured credit is the sina qua non for contractualism presents some serious difficulties for its proponents, including underdeveloped claims of efficiency and substantial conflicts of interest in secured-party management of the recovery process. The abolition of the British system in 2003 demonstrates empirically the serious weaknesses of secured contractualism. This Article concludes that the case for secured contractualism cannot be made. The control models give rise to a number of consequences mentioned here but left for subsequent development, including: (1) the need to introduce valuation of control rights, pre- and post-default, to the long-standing debate about the efficiency of secured credit - a point closely tied to the specific debate about securitization of assets; and (2) the relationship between the control models offered by other recent articles and the models presented here.

Keywords: Bankruptcy, reorganization, control, secured credit, administrative receivership, veto, priority

JEL Classification: G30, G33, G34, G35, K20, P59