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Rights of Secured Creditors in Chapter 11: New Paper

posted by Melissa Jacoby

ABITed Janger and I have posted a paper of interest to Credit Slips readers called Tracing Equity. We still have time to integrate feedback, so please download it and let us know what you think.

As the image accompanying this post suggests, the project was inspired in part by recommendations of the American Bankruptcy Institute's Chapter 11 Commission. Discussion of those proposals starts on page 51 of the PDF.

One of the main insights of Tracing Equity is that both Article 9 of the Uniform Commercial Code and the Bankruptcy Code distinguish between (1) lien-based priority over specific assets and their identifiable proceeds, and (2) unsecured claims against the residual value of the firm. By our reasoning, even attempts to obtain blanket security interests do not give secured lenders an entitlement to the going-concern and other bankruptcy-created value of a company in chapter 11. We explain why our read of the law is normatively preferable and, indeed, is baked into corporate and commercial law more generally--part of a large family of rules that guard against undercapitalization and judgment proofing.

Looking forward to your thoughts.




Read and very much enjoyed the paper! The descriptive part is well-taken, though only if one accepts an aggressive application of "equities of the case" in s. 552(b). I don't think your detractors (the blanket lien enthusiasts, whose argument you seem to be responding to) would embrace or encourage such a position on proceeds. And moving to the normative side, your thesis seems to be supported largely if not entirely by the operation of section 552(a) and (b) in cutting off what the blanket lien enthusiasts would regard as creditors' legitimate state law rights--certainly not normatively desirable from their perspective. I'm probably missing something, but your paper struck me as rejoining and reiterating a longstanding debate about the desirability of the Bankruptcy Courts intervening between secured creditors and their whole-kit-and-kaboodle rights under state law by, in part, imposing artificial values on assets (at varying points in time, by the way) rather than allowing "the market" to do so when the secured creditor(s) engaged its/their rights. I'm not sure the other side will feel at all moved by this paper's argument. Yes, we understand the Code does this, they'll say, we've been criticizing precisely these artificial effects of the automatic stay and the Chapter 11 plan process all along. What does this paper add to the debate other than a nice articulation of exactly what value (from operations, proceeds, and after-acquired collateral) is being expropriated from secured creditors for the benefit of out-of-the-money unsecured creditors et al.?

Thanks for reading and for the thoughts, Jason! It sounds like you and I agree on one thing: that single waterfall advocates will not change their minds based on this paper. Hoping the paper will be useful to a broader readership than that. As for the rest, including the state law baseline and characterizations of 552 interpretations, I respectfully disagree, for the reasons stated in the paper. But we'll try to make it clearer in the next revision.

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