The Utility of Chapter 11

First, I want to thank Bob Lawless and the other authors of Credit Slips for inviting me to guest blog this week. I am honored to share this space with you, and I look forward to a robust dialogue.

Second, I have to say that guest blogging at Credit Slips feels like coming home to me. Before changing careers, I had the privilege of serving as a law clerk to the Honorable William T. Bodoh, and I practiced as an associate and then a partner in Jones Day’s corporate restructuring practice group for about ten years. I welcome this opportunity to share my passion for everything bankruptcy with others interested in the field.

As you might suspect from my days in practice, I am a strong proponent of the utility of chapter 11 of the U.S. Bankruptcy Code as a restructuring tool. I want to emphasize that I view chapter 11 as a "tool"—not a "fix"—in the context of financial distress. The effectiveness of this tool depends largely on who is using it and how it is being used. Companies do not fail because of chapter 11; rather, companies fail because, among other things, they wait too long to invoke the chapter 11 tool (see here), they do not understand how best to use that tool (see here), or perhaps they simply have outlived their economic utility (see here).

The effectiveness, however, also depends on the construction of the tool itself. So how do we assess its construction? Although there are a number of very useful studies on the topic, I suggest we look back at the origins of chapter 11 and three of its important features: its dual goals of rehabilitation and value maximization (referenced recently here in Congressional testimony); its design to mitigate the collective action problem (see here at pp. 95-98 for an interesting discussion); and its ability to promote negotiation and consensual resolution.

The dual goals of rehabilitation and value maximization require transparency and information sharing to all, and by all, key constituents. The collective action problem merits strong rules maintaining the status quo while constituencies gather around the negotiating table. And negotiation needs a flexible framework and a neutral third party with the discretion and power to adapt the rules to the particular needs of the case. Does chapter 11 currently measure up?

Over the years, chapter 11 has increasingly moved away from its original objectives and, in many respects, been captured by special interest groups. This shift has created weaker rules and less flexibility. It also has limited the contributions of our specialized and very talented bankruptcy bench.

During my time at Credit Slips, I hope to explore the strengths and weaknesses of chapter 11 in its current state, including its role in facilitating obsolescence (see here), creating value and exploiting information asymmetries (see generally here and here). Chapter 11 has changed and perhaps not all for the best. I suggest that we might best move it forward by looking backward.

Comments

[George Kuney]

Nicely put, Prof. Harner.

Strangely, for a statute-based system, Chapter 11 has developed a surprisingly "common law" overlay through the courts' aggressive embrace of the "all writs" powers of 11 U.S.C. section 105 -- far beyond anything that the District Courts have done with their "all writs" statute, 28 U.S.C. section 1625. All done in the service of "benefit to the estate" -- a somewhat vague standard to say the least. In the more accommodating jurisdictions, much of chapter 11 practice is nothing more than a federal unified foreclosure mechanism serving secured creditors (and professionals to the extent of the carve out allowed to them by the secured creditors), followed by a structured dismissal, even.

This is not to say that such a result is not the right one, but to ask that we examine what Chapter 11 has become and assess whether that is what we want or need. If so, perhaps some amendments are needed to ensure that the benefits of the "new" chapter 11 are uniformly available nationwide to all creditors and debtors, rather than restricted to the accommodating jurisdictions.

[Michelle Harner]

Thank you so much for the comment, Prof. Kuney. I actually really like your reference to section 105 and the developments forged by courts under that provision in the context of assessing chapter 11's utility. From my perspective, the equitable nature of bankruptcy courts and their ability to fashion equitable remedies where necessary and appropriate often are essential to a successful corporate reorganization. Now that we have lived and worked with chapter 11 for over thirty years and observed how courts invoke their equitable powers, it may be time to evaluate what truly furthers the goals of chapter 11 and, as you suggest, formalize those processes into the Code. My only hesitation here is that some proponents might also then seek to restrict the equitable powers and discretion of the bankruptcy courts further, which I think would be a mistake. Thanks again, Michelle.