Bankruptcy Related Contracting and Bankruptcy Functions

A bankruptcy system is believed necessary to solve a coordination problem among the creditors of a distressed firm. The firm should survive if its going concern value exceeds its liquidation value, but each creditor, who is assumed to hold debt that is small in relation to the total, has too little at stake to coordinate a restructuring, and so pursues its individual collection remedies. In the likely equilibrium, all firms are liquidated, whether they are viable or not. Bankruptcy law restricts the ability of creditors and the debtor to contract about bankruptcy procedures in order to preserve the viability of a law that solves the coordination problem. These restrictions are broader than the assumed need for them requires. More importantly, there seldom is a coordination problem. The standard story assumes that the typical capital structure has equity and a set of symmetric small creditors, whose dispersion and stake are such that private restructurings are impossible. To the contrary, both theory and data show that common capital structures concentrate creditors for the purpose and with the usual result that viable debtors are privately restructured and unviable debtors are privately liquidated. Consistent with these outcomes, a very small percentage of insolvencies eventuate in proceedings under the bankruptcy code. Theory and data thus raise two related, and largely novel, questions: Empirically, are the debtors that use the bankruptcy code, or the circumstances of those debtors, systematically different from the debtors and circumstances that obtain when the code is not used? Normatively, if there is no coordination problem, what problems should a bankruptcy law solve? This Essay introduces these questions but does not attempt to answer them, though it speculates briefly about the normative query. Rather, the Essay's central claim is that bankruptcy scholarship should expand to consider what functions it is necessary for a corporate bankruptcy system to perform in light of the capital structures that actually exist