59 Pages Posted: 10 May 2006
This article draws upon data from a large empirical study of business bankruptcy cases to cast serious doubt upon two of the fundamental premises required to support claims that bankruptcy law should be replaced by default procedures established by contract. A number of proposals have been made to privatize the bankruptcy process by contract. The proponents of these contractualist approaches assume that default structures bargained in the marketplace will reduce transaction costs and improve post-default outcomes. Although these proposals necessarily affect materially the interests of third parties, their proponents suggest devices that are claimed to make that process efficient and non-redistributive.
One premise underlying a contractual approach is that third parties can adjust their prices and terms to account for the effects of the proposed bankruptcy contracts. Prior scholarship has cast doubt on this premise by identifying categories of involuntary and maladjusting creditors who could not make such adjustments. This article for the first time quantifies that critique, showing that in most business bankruptcies there are many such involuntary or maladjusting creditors. Second, contractual theories necessarily assume that many or most business bankruptcies involve relatively few claims, because numerous claims, especially small ones, would impose transaction costs that are substantial enough to make individual negotiation or even unilateral adjustment by each creditor impossible. In fact, the data reveal that the typical business bankruptcy case presents many claims that are too small to be adjusting. These data demonstrate that a contractualist system will likely produce substantial inefficiencies, including a redistribution of wealth to the parties to the proposed bankruptcy contracts. The data support the superiority of a model of bankruptcy law that provides a non-waivable, collective infrastructure for the resolution of a multiparty economic problem.
Keywords: bankruptcy, business, contractualism
JEL Classification: K20, K22, G33, G34, K23, K30
Suggested Citation: Suggested Citation
Warren, Elizabeth and Westbrook, Jay Lawrence, Contracting Out of Bankruptcy: An Empirical Intervention. Harvard Law Review, Vol. 118, No. 4, p. 1197, 2005; U of Texas Law, Public Law Research Paper No. 98; U of Texas Law, Law and Econ Research Paper No. 78. Available at SSRN: https://ssrn.com/abstract=901233
By Todd Zywicki