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Whence Corporate Bankruptcy

posted by Bob Lawless

A correspondent and I were discussing the changes wrought by the 1978 enactment of the current U.S. Bankruptcy Code. My correspondent noted that corporate bankruptcy became more salient after 1978 and linked this phenomenon to the 1978 law. My perception is the same: corporate bankruptcy became more salient after the 1978 enactment of the Bankruptcy Code, and my guess would be that many experts would have the same reaction. We all remember big cases like Johns-Manville, Drexel Burnham, most all of the airline cases (Pan-Am, Eastern, Braniff), and many others. These cases all tend to occur after 1978 suggesting that the 1978 law did lead to a boom in corporate bankruptcy filings. Then I wondered whether my perception was backed by empirical fact.

One possibility is some sort of selection effect. There were large corporate bankruptcies before 1978 – Penn Central comes to mind as an immediate example. The New York City financial crisis of 1975 was neither a bankruptcy nor corporate, but it would evoke the same issues as the discussions of today’s municipal financial woes. Maybe these cases are just older and do not come as easily to mind? Because it is increasingly less the case for historical events, I am happy to note that my professional career did not overlap with these cases. Maybe, my perceptions on this topic is just a personal artifact of when I came of age? Relatedly, maybe these older cases just did not command the media attention that modern corporate bankruptcies do?

Another possibility—and I tend to think this explanation is probably correct—is that corporate bankruptcies did become more salient after 1978, but it was primarily for reasons other than the 1978 law. In other words, the 1978 law did not play a causal role in making corporate bankruptcy more salient to the American public. Rather, it was things like the use of bankruptcy to get rid of mass-tort liability by companies such as Johns-Manville and A.H. Robins. Or, in a market with just a few dominant airlines, the bankruptcy of one national airline is headline news.

As you can see, I have more questions than answers on this topic. Despite what I just wrote, it could be that the 1978 law did play a causal role by enabling legal developments, albeit mainly unintentionally. The broadening of the scope of a permissible bankruptcy “claim” was important for the mass-tort bankruptcies. Still, when it comes to the causal role of law in social change, I think it usually is a good bet to think of the legal doctrine as the tail, and the rest of what is happening in society as the dog. If corporate bankruptcy did become more salient after 1978, my hunch would be that it would have happened regardless of whether the law had been changed. For example, the increased use leverage by large corporations surely contributed to the increase in bankruptcies in the 1980s and 1990s. My primary purpose in the post, however, is to get everyone else’s perspectives. I would be interested to learn what others have to say on this topic in the comments.

Comments

Up until 1973, it took some relatively spectacular mismanagement to run a major player into the ground in the US. Then came the first oil embargo, and the game started to change. Net went down and, worse, became less predictable, especially short-term. The economy became more international, first in finance and commodities, then in off-shoring of manufacturing. Then came the 1979 oil shock, and the dominoes really started to fall. Unstable and reduced revenues, unstable and increased costs, increased reliance on unstable foreign markets, and a wave of deregulation mixed in.

Aside: Anybody notice how many of the big BKs we remember were the result of two chickens coming home to roost: nonregulation (asbestos and other haz-mat mass torts) and deregulation (airlines and S&Ls [OK, S&Ls technically weren't BKs, but still.])?

Businesses needed to leverage to paper over bottom lines affected by decreasingly predictable events. The deregulated financial industry made that possible, but just because something is possible doesn't make it a good idea. Unless an economy can expand forever (snort, guffaw), increased leverage yields increased BKs.

One other thing. I DO think that the financial industry BKs are pushing us into truly uncharted territory, real "Here there be dragons" stuff. For example, the seizure of the bullion and treatment of warehouse receipts in the MF Global case. I've posted some thoughts on my blog which are too much for the comment section, but I don't think anyone's even thought about how to think about this.

The Code made several changes that made chapter 11 more palatable to the persons involved in making the decision to file: dramatic reduction of chance of trustee / increased likelihood of board and management staying in place; sharply reduced role of SEC; increased ability to get post-petition financing and to restructure secured debt; increased ability of professionals to be paid market rates.

There would obviously be an economic explanation, given the Code's enactment coincided with a surge in interest rates under Volcker; the equity markets were in a decade long slump; a shock in oil prices was still rippling through the system; the cocoon in which the US private sector, owners and workers alike, had lived free of effective competition post WWII was being rendered.

I don't know how one would isolate the Code's impact from the larger causes.

I do know the views of the American public had nothing to do with it.

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  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless (rlawless@illinois.edu) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.

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