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In both Chrysler and General Motors, the government was, among other things, a large creditor exercising control over its debtor and pushing for a speedy sale of the assets. Together the two cases capture the issues central to large Chapter 11 cases today. The debate over speedy sales of businesses in Chapter 11 is over. Sales are now the norm in large reorganizations. Instead of asking whether there should be sales in bankruptcy, we need to ask how to police various forms of abuse. Three years after the fact, we can begin to draw some conclusions about the reorganizations of Chrysler and General Motors. The government’s use of the bankruptcy laws to inject tens of billions into two of the country’s largest automobile companies had its intended effect. At the start of 2009, General Motors and Chrysler were bleeding to death. 2 Maintaining either business as a going concern required a massive infusion of capital no one in the private market was willing to provide. As a result of the government’s intervention, the basic structure of the American automobile industry was preserved.

Fraudulent transfer law in the United States provides a safety net for corporate creditors. It prohibits insolvent debtors from making transfers or incurring obligations for less than reasonably equivalent value. Moreover, it reaches any transaction that lacks economic substance and that is designed merely to make it hard for creditors to monitor the debtor. The distinctive shape of fraudulent transfer law in the United States is not replicated in the other common law or in civil law jurisdictions. Nevertheless, the functions it performs are likely to be part of any legal regime that protects the rights of creditors and other investors.

A meeting of international finance and insolvency experts was held on November 2, 2013 at the Annenberg House in Santa Monica, California. The meeting was co-hosted by the USC Law School and the Annenberg Retreat at Sunnylands. The goal was to solicit the views of experts on the implications of the IMF’s April 26, 2013 paper captioned “Sovereign Debt Restructuring -- Recent Developments and Implications for the Fund’s Legal and Policy Framework”. The April 26 paper may signal a shift in IMF policies in the area of sovereign debt workouts. Although the Expert Group discussed a number of the ideas contained in the April 26 paper, attention focused on paragraph 32 of that paper. That paragraph states in relevant part: “There may be a case for exploring additional ways to limit the risk that Fund resources will simply be used to bail out private creditors. For example, a presumption could be established that some form of a creditor bail-in measure would be implemented as a condition for Fund lending in cases where, although no clear-cut determination has been made that the debt is unsustainable, the member has lost market access and prospects for regaining market access are uncertain.”This Report summarizes the consensus views of the Expert Group on the practical implications of the suggestions contained in paragraph 32 of the April 26 paper.

American bankruptcy law provides creditors of a corporate debtor with an alternative way of sorting out their claims to the debtor’s assets. Bankruptcy differs from ordinary avenues of debt collection in that all claims against a common debtor are determined at one time and in one place. Creditors are forced to give up their right to seek repayment on their own. Each creditor must stay its hand while decisions are made about what to do with the firm’s assets and how to recognize the different claims against it. Some creditors who might have been paid in full if bankruptcy had not intervened are worse off. Others, who might have been unaware of the debtor’s financial straits, may be better off. The premise of American bankruptcy law is that sometimes the creditors and others who contributed capital to the firm are better off as a group than they would be if this avenue of debt collection did not exist and creditors had to depend upon their individual remedies under nonbankruptcy law.’ This premise-that the collective interests of the group can be put at risk when individual creditors exercise their rights-brings with it a problem that other legal regimes do not face. Ordinarily, one can depend upon the party that benefits from a particular legal rule to invoke it. Bankruptcy is different. The beneficiaries of bankruptcy law are the creditors as a whole, not individual creditors within the group.? One wants a bankruptcy proceeding to begin when it is in the collective interest of the group, but one must still depend upon someone to initiate it. One must somehow ensure that when a bankruptcy proceeding is in the collective interest of the creditors, it is also in someone’s individual interest as well. Existing bankruptcy law allows creditors to trigger the collective proceeding when three of them with unsecured claims totaling more than $5,000 join in a

WHEN the managers of RJR-Nabisco announced that they wanted to take the company private, the value of its bonds dropped by $500 million in a single day. The manager's plan, as in most buyouts, called for dramatically increasing the debt-equity ratio of the firm. Instead of holding a senior interest in a firm that had assets greatly in excess of its liabilities, the bondholders found that they would be left with an interest in a firm with the same assets but encumbered with much more debt. They would have claims against a firm with a greater risk of becoming insolvent and of being unable to pay its creditors in full. The same promise from a riskier debtor is worth less-in this case, it might seem, $500 million less. Transactions in which a firm is sold and becomes substantially more leveraged were commonplace in the late 1980s. They accounted for over 20 percent of takeover activity in the United States and totaled almost $50 billion a year.' The legal rights of prebuyout creditors will be a focal point of litigation in any of these transactions that unravel in the 1990s, as some already have and more inevitably will. Before they lend, creditors can insist on a variety of event risk covenants such as "poison puts" that allow them to accelerate the firm's obligations to repay in the event that the firm dramatically changes its capital structure. Poison puts and other clauses, however, aid only those who have them. Those parties who do not, like parties to any other agreement, must look to the background legal rules to flesh out their obligations. The rules governing the rights of the bondholders fall within

Bankruptcy law does not exist in a vacuum, yet one cannot spend much time reading in the field without noting that few judges or scholars have taken this observation to heart.' Too many seem to think that a bankruptcy proceeding provides, in the main, an essentially unlimited opportunity to do what appears at the moment to be good, just, or fair without regard to the reasons for having a system of bankruptcy laws in the first place.2 A close study of the present controversy over the adequate protection of secured creditors illustrates the shallowness of much of the recent discussion of bankruptcy law and the consequences of a failure to

This paper shows that the dynamics of Chapter 11 turn dramatically on the size of the business. The vast majority of the assets administered in Chapter 11 are concentrated in a handful of large cases, but most of the businesses in Chapter 11 are small, and the smaller the business, the smaller the distribution to general unsecured creditors. For businesses with assets above $5 million, unsecured creditors typically collect half of what they are owed. Where the business's assets are worth less than $200,000, ordinary general creditors usually recover nothing. In the typical small Chapter 11 case, the tax collector is the central figure. In small business bankruptcies, priority tax liabilities are the largest unsecured liabilities of the business. Tax obligations are entitled to priority and are obligations of both the corporation and those who run it. Given the large shadow tax claims cast over small Chapter 11 reorganizations, accounts of small Chapter 11 must focus squarely on them.

In a Chapter 11 reorganization, senior creditors are entitled to insist upon being paid in full before anyone junior to them receives anything. In practice, however, departures from such “absolute priority” are commonplace. Explaining these deviations has been a central preoccupation of reorganization scholars for decades. By the standard law-andeconomics account, deviations from absolute priority arise because well-positioned insiders take advantage of cumbersome procedures and inept judges. In this paper, we suggest that a far simpler and more benign force dominates bargaining in reorganization cases. “Deviations” from absolute priority are inevitable even in a world completely committed to respecting priority as long as asset values are uncertain. Uncertainty accompanies any valuation procedure. Bargaining in corporate reorganizations takes place in the shadow of this uncertainty, and standard models of litigation and settlement show that valuation uncertainty alone can explain many of the departures from absolute priority we see in large corporate reorganizations. Even where rational and well-informed senior investors expect the absolute priority rule to be strictly enforced, they must account for the uncertainty associated with any valuation. The possibility of an unexpectedly high appraisal will cause them to offer apparently out-of-the-money junior investors contingent interests in the reorganized business. The debate over absolute priority, the central principle of modern corporate reorganization law, has been misdirected for decades. It has failed to recognize that a substantive rule of absolute priority does not lead to an absolute priority outcome. A coherent account of absolute priority must incorporate relative priority. It must take account of the option value implicit in the junior investors’ right to insist on an appraisal. This paper offers an explanation for one of the most important and persistent puzzles in corporate reorganizations. In a Chapter 11 reorganization, senior creditors are, in principle, entitled to insist upon “absolute priority.” They have a right to be paid in full before junior investors receive anything. This “fixed principle” has been the foundation of our corporate reorganization laws for decades. In practice, however, departures from ab

In The End of Bankruptcy we detailed the forces that have rendered obsolete traditional conceptions of corporate reorganization. In a response to our article, Lynn LoPucki asserts that our paper lacked empirical foundation. In this response, we draw on LoPucki's data set of the reorganization of large, publicly held entities to show the robustness of our claims, both empirical and theoretical. Looking in detail at the firms whose Chapter 11 cases ended in 2002, most of which concluded after we completed our original piece, we find that in over 80% of the cases the assets of the firm were either sold or the bankruptcy proceeding put in place a restructuring plan agreed to before bankruptcy was filed. The remaining firms evince little in the way of going-concern value. Moreover, equityholders are nearly always wiped out, and the board of directors is usually replaced. Today's bankruptcy practice reveals creditors, particularly the senior lenders, in control. They use their powers to remove managers in whom they have lost confidence, replace the board of directors, put the corporation on the auction block and terminate the interest of equityholders. This paper provides further evidence that issues of control rather than priority dominate modern reorganization practice.

At the time that Enron filed for bankruptcy, it had substantial assets, thousands of creditors, an opaque capital structure, and more than a whiff of fraud. By the traditional account, Enron is a prototypical example of a firm with problems that a law of corporate reorganizations is designed to solve. Like the 19th century receiverships of the great railroads, the reorganization of Enron could have allowed creditors and others to negotiate with each other and find a way to preserve the value of the firm as a going concern at the same time misdeeds are uncovered and losses are allocated among the different players. Negotiations aimed at preserving Enron's value as a going concern never took place, however. As is increasingly the case in large Chapter 11s, Enron's assets were sold quickly, most within a few weeks or months of the filing. The decision as to how to deploy Enron's assets lay not in the court but in the new owners. After selling the assets, the bankruptcy court quickly turned to what courts do best - sorting out complex and perhaps conflicting legal entitlements. This pattern of a prompt sale followed by litigation over the distribution of the proceeds reflects a dramatic change in large firm bankruptcy practice. It suggests that we should no longer think of Chapter 11 as a collective forum in which the interested parties gather to bargain over the fate of the firm.

The law of corporate reorganizations is conventionally justified as a way to preserve a firm's going-concern value: Specialized assets in a particular firm are worth more together in that firm than anywhere else. This paper shows that this notion is mistaken. Its flaw is that it lacks a well-developed understanding of the nature of a firm. Initially, it is easy to confuse size with specialization and overstate the extent to which assets are dedicated to a particular enterprise. Even when such dedicated assets exist, they often do not need to stay in the same firm. As Coase taught us, as the costs of contracting go down, so too does the value of keeping assets in a particular firm. But even when specialized assets must be kept inside a firm, two other forces limit the need for a traditional law of corporate reorganizations. Capital structures are increasingly designed with financial distress in mind. For these firms, control rights shift from one set of investors to another as the firm encounters difficulty. Such firms either never file for bankruptcy, or, if they do, it is only to vindicate the pre-determined allocation of control rights. Even where control rights are not sensibly allocated, a quick sale of the firm restores order. When firms can be sold as going concerns, the need for the traditional negotiated plan of reorganization disappears. The vast majority of firms in financial distress never enter bankruptcy. Today the Chapter 11 of a large firm is an auction of the assets, followed by litigation over the proceeds. To the extent we understand the law of corporate reorganizations as providing a collective forum in which creditors and their common debtor fashion a future for a firm that would otherwise be torn apart by financial distress, we may safely conclude that its era has come to an end.

Elizabeth Warren has presented a view of bankruptcy that, while rarely as well articulated, is widely shared. The virtues of Warren's paper, like those of the rest of her work, are easy to identify. Her style is sharp and penetrating. She writes with insight and wit, and she demands that all analysis be held against the light of empirical data-the brighter the better. Warren has put forward a critique of the work I have done with Thomas Jackson that merits a response both because of its own strengths and because it captures misgivings other traditional bankruptcy scholars have shared about our work. There is much in Warren's view of bankruptcy policy that I admire and agree with. Indeed, to understand our disagreement, it is necessary first to recognize the extent of our common ground. Warren and I agree that, in the main, existing bankruptcy law is consistent with sound bankruptcy policy. The trustee should have the powers of a hypothetical lien creditor; the trustee should be able to set aside voidable preferences and reject executory contracts; creditors (including secured creditors) should be stayed from asserting their substantive claims after the filing of a bankruptcy petition. Warren and I also agree that victims of nonmanifested torts should have their rights against the firm recognized in bankruptcy. On what in my view is a different front, Warren and I also think existing laws do not adequately protect many, such as workers, who are affected when a firm fails. Warren and I both have doubts about whether secured credit brings benefits that outweigh its rather obvious costs. I am more inclined than Warren to think that the institution is one worth having, but we agree that the issue is not clear. Warren's attack on the theory of bankruptcy that I have developed with Thomas Jackson goes to methodology. Jackson and I claim that we can isolate bankruptcy issues (such as whether the

Congress's exercise of the bankruptcy power was far from inevitable. Indeed, for much of the nineteenth century, there was no federal bankruptcy statute at all. That we might live in a world without bankruptcy law or any similar collective procedure is not as far-fetched or as ridiculous as it might seem at first glance to those of us who are immersed in its intricacies every day. This article will take problems that have been the focus of much of the recent debate in bankruptcy law and ask how these issues would be approached if no bankruptcy law existed.

Traditional approaches to corporate governance focus exclusively on shareholders and neglect the large and growing role of creditors. Today’s creditors craft elaborate covenants that give them a large role in the affairs of the corporation. While they do not exercise their rights in sunny times when things are going well, these are not the times that matter most. When a business stumbles, creditors typically enjoy powers that public shareholders never have, such as the ability to replace the managers and install those more to their liking. Creditors exercise these powers even when the business is far from being insolvent and continues to pay its debts. Bankruptcy provides no sanctuary, as senior lenders ensure that their powers either go unchecked or are enhanced. The powers that modern lenders wield rival in importance the hostile takeover in disciplining poor or underperforming managers. This Essay explores these powers and begins the task of integrating this lever of corporate governance into the modern account of corporate law.

The law of corporate reorganizations is conventionally justified as a way to preserve a firm’s going-concern value: Specialized assets in a particular firm are worth more together in that firm than anywhere else. This paper shows that this notion is mistaken. Its flaw is that it lacks a welldeveloped understanding of the nature of a firm. Initially, it is easy to confuse size with specialization and overstate the extent to which assets are dedicated to a particular enterprise. Even when such dedicated assets exist, they often do not need to stay in the same firm. As Coase taught us, as the costs of contracting go down, so too does the value of keeping assets in a particular firm. But even when specialized assets must be kept inside a firm, two other forces limit the need for a traditional law of corporate reorganizations. Capital structures are increasingly designed with financial distress in mind. For these firms, control rights shift from one set of investors to another as the firm encounters difficulty. Such firms either never file for bankruptcy, or, if they do, it is only to vindicate the predetermined allocation of control rights. Even where control rights are not sensibly allocated, a quick sale of the firm restores order. When firms can be sold as going concerns, the need for the traditional negotiated plan of reorganization disappears. The vast majority of firms in financial distress never enter bankruptcy. Today the Chapter 11 of a large firm is an auction of the assets, followed by litigation over the proceeds. To the extent we understand the law of corporate reorganizations as providing a collective forum in which creditors and their common debtor fashion a future for a firm that would otherwise be torn apart by financial distress, we may safely conclude that its era has come to an end. * Harry A. Bigelow Distinguished Service Professor, University of Chicago Law School. Forthcoming in the Stanford Law Review. ** Associate Dean for Academic Affairs and Professor of Law, Vanderbilt Law School. We thank Barry Adler, Marcus Cole, Michael Hilgers, Richard Levin, Alan Littmann, Eric Posner, Mark Ramseyer, and David Skeel for their help. Prior versions of this Article were presented at the University of Chicago Law School and the Annual Meeting of the American Law and Economics Association. For his support and insight throughout this project, we are especially grateful to our colleague Edward Morrison. We also thank the John M. Olin Foundation, the Sarah Scaife Foundation, the Lynde & Harry Bradley Foundation, and the Dean’s Fund at Vanderbilt for research support. Baird & Rasmussen, page 2

A BANKRUPTCY proceeding is a day of reckoning for all parties with ownership interests in an insolvent firm. Ownership interests are valued, the assets are sold, and the proceeds are divided among the owners. Bankruptcy proceedings take one of two forms, depending on whether ownership rights to the assets are sold on the open market to one or more third parties or whether ownership rights to the assets are transferred to the old owners in return for the cancellation of their prebankruptcy entitlements. The first kind of bankruptcy proceeding, a liquidation, is governed by Chapter 7 of the Bankruptcy Code; the second kind, a reorganization, is governed by Chapter 11. A bankruptcy proceeding always involves a sale of assets followed by a division of the proceeds among the existing owners. In a Chapter 7 proceeding the sale is real; in a Chapter 11 proceeding the sale is hypothetical.' An analysis of the law of corporate reorganizations should properly begin with a discussion of whether all those with rights to the assets of a firm (be they bondholders, stockholders, or workers) would bargain for one if they had the opportunity to negotiate at the time of their initial investment.2 Properly understood, a bankruptcy proceeding itself can be

IN 1600,' a Hampshire farmer named Pierce conveyed his sheep to his creditor Twyne to satisfy a preexisting debt. Twyne, however, allowed Pierce to remain in possession of the sheep, to shear them, and to mark them as his own. When a sheriff tried to seize the sheep under a writ of execution on behalf of another creditor, Twyne forcibly resisted, maintaining that the sheep were his. Edward Coke, then attorney general, brought a criminal action against Twyne in the Star Chamber. That court held that because the transfer to Twyne was secret it was fraudulent and therefore void.2 Few principles of Anglo-American law have been so long-lived and so widely held, as the one in Twyne's Case.3 The principle that secret inter

defaults, he will require a higher interest rate from the debtor.' In order to reduce this uncertainty, and thereby to facilitate secured credit, the Uniform Commerical Code normally requires a creditor either to take possession of the property or to make a public filing, if he wants a security interest in his debtor's property that is effective against competing property claimants.2 This requirement, coupled with a simple "first-in-time" rule, enables a creditor who wants to lend money on a secured basis to assume that, if the property in question is in the debtor's possession and if no other creditors have filed a financing statement, his claim to that property can have priority over those of other existing and future creditors. The Code assumes that this benefit outweighs the costs imposed upon secured parties by the requirement that they take possession or file.3