Creditor Control and Conflict in Chapter 11

27 Pages Posted: 5 Jul 2007

See all articles by Kenneth Ayotte

Kenneth Ayotte

University of California, Berkeley - School of Law

Edward R. Morrison

Columbia Law School

Date Written: July 5, 2007

Abstract

We analyze a sample of large privately and publicly held businesses that filed for Chapter 11 in 2001. We find that creditor control is pervasive. Equityholders and managers, in contrast to the traditional view of Chapter 11, exercise little or no leverage during the reorganization process. Eighty percent of CEOs are replaced before or soon after a bankruptcy filing, and very few reorganization plans (at most 6 percent) deviate from the absolute priority rule in order to distribute value to equityholders. In sharp contrast, creditors dictate the dynamics of the reorganization process. Senior lenders exercise significant control through stringent covenants contained in DIP loans, such as line-item budgets. Unsecured creditors gain leverage through objections and other court motions.

We also find that bargaining between secured and unsecured creditors can distort the reorganization process. A Chapter 11 case is significantly more likely to result in a sale if secured lenders are oversecured, consistent with a fire-sale bias; it is much less likely when these lenders are undersecured or when the firm has no secured debt at all. A sale is also less likely if unsecured debt is concentrated in the hands of three creditors. Our results suggest that the advent of creditor control has not eliminated the fundamental inefficiency of the bankruptcy process: resource allocation questions (whether to sell or reorganize a firm) are ultimately confounded with distributional questions (how much each creditor will receive), due to conflict between creditor classes.

Keywords: Chapter 11, bankruptcy, creditor control, secured debt

Suggested Citation

Ayotte, Kenneth and Morrison, Edward R., Creditor Control and Conflict in Chapter 11 (July 5, 2007). 2nd Annual Conference on Empirical Legal Studies Paper, Available at SSRN: https://ssrn.com/abstract=998528 or http://dx.doi.org/10.2139/ssrn.998528

Kenneth Ayotte (Contact Author)

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

215 Law Building
Berkeley, CA 94720-7200
United States

Edward R. Morrison

Columbia Law School ( email )

435 West 116th Street
New York, NY 10025
United States

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