Law & Economics Workshop
presents
Douglas G. Baird
University of Chicago Law School
Financial Innovation and the New Chapter 11
(co-authored with Robert K. Rasmussen)
Wednesday, March 5, 2008
12:30 – 2:00
Solarium (room FA2)
84 Queen’s Park
When the next wave of corporate bankruptcies crests, corporate reorganization law will be put under new stress.[1] Since the last round of large Chapter 11s, financial markets have undergone a revolution. Financial innovation has allowed investors to slice and dice cash flow rights and control rights into smaller and smaller pieces. Those charged with shepherding the business through the reorganization face a daunting challenge in trying to bring together the various stakeholders and accommodate the interests of each.
The players in the next round of reorganizations will be sophisticated distressed debt investors, each of whom holds novel and competing long and short positions, positions that are constantly shifting throughout the course of the case. Unsecured debt may exist in many flavors or be entirely irrelevant. The relative positions of the parties cannot be reconciled with the traditional neatly hierarchical capital structure, nor do the parties know the position of the other players. Those with a voice in the reorganization may have no economic stake, and those with a stake may have no voice. The strength of the desire of one to work towards a successful reorganization cannot be gleaned from knowing into which class their claim falls. Various investors may or may not participate in the reorganization process, may or may not want to act in concert with others, and may or may not care if the reorganization succeeds.
The challenge the legal system faces is much like assembling a city block that has been broken up into many parcels. This is quite at odds with the standard account of corporate reorganizations—that it deals with a tragedy of the commons, a world in which general creditors share dispersed, but otherwise similar interests. Instead, we face an anti-commons problem, a world in which ownership interests are fragmented and conflicting.[2] Senior creditors used to press for a sale; now they often favor a reorganization. Junior parties who used to fear sales now see it as way to protect their interests. In the past, creditors wanted a prominent seat at the bargaining table; now many large players want to stay in the shadows. Bankruptcy has become anti-bankruptcy. In this article, we take stock of the recent changes and show how they will come to the fore when reorganization activity increases.
A light lunch will be provided.
For more workshop information, please contact Nadia Gulezko at n.gulezko@utoronto.ca
[1] The last few years have seen a dramatic decline in the number of large companies that file for bankruptcy. In 2006 there were only 14 filings of large, publicly held companies, while in 2002 there were 120. Some of this downturn is cyclical. Hence, we can expect the number of cases to increase if credit markets dry up and distressed firms cannot find refinancing as easily as they can today. Nevertheless, the long-term trend is decidedly away from the traditional reorganization. For reasons as to why this is so, see Douglas G. Baird & Robert K. Rasmussen, The End of Bankruptcy, 55 Stan. L. Rev. 751 (2002).
[2] On too small property rights creating an anticommons problem, see Michael Heller, The Tragedy of the Anticommons: Property in the Transition from Marx to Markets, 111 Harv. L. Rev. 621 (1998).
