The Death of Liability

Yale Law Journal

Volumn 106, Issue 1, 1996, Pages 1-92

  LoPucki, Lynn M ^a  

^a NONE

Author keywords

[No Author keywords available]

Indexed keywords

EID: 0002469635     PISSN: 00440094     EISSN: None     Source Type: Journal    
DOI: 10.2307/797267     Document Type: Article

References (485)

1. Within both spheres, social shaming is a significant element of the sanction. It is less so in the civil sphere, and, as will be discussed in this Article, is declining in respects important to the subject at hand. There is some crossover between the two spheres of the system. The criminal law imposes fines and enforces them only by proceeding against the defendant's property. See, e.g., Williams v. Illinois, 399 U.S. 235, 241-44 (1970) (holding that incarceration of indigent person beyond statutory limit because of failure to pay fine denies equal protection). The civil law relies on the threat of incarceration for contempt of court in some aspects of the collection process. See, e.g., CAL. CIV. PROC. CODE § 482.080 (West Supp. 1996) (providing for orders directing debtors to transfer property to levying officer and inclusion in such orders of notice that failure to comply may subject defendant to arrest and punishment for contempt of court).
2. The distinction I make here between liability and incarceration as law enforcement mechanisms closely parallels the distinction made by Guido Calabresi and Douglas Melamed between "liability rules" and "property rules." See Guido Calabresi & A. Douglas Melamed, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, 85 HARV. L. REV. 1089, 1092-93 (1972). Calabresi and Melamed refer to rules enforceable by criminal law or equitable remedy, ultimately backed by the threat of incarceration, as "property rules." Id. at 1126 ("In other words, we impose criminal sanctions as a means of deterring future attempts to convert property rules into liability rules."); see also Ian Ayres & Eric Talley, Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade, 104 YALE L.J. 1027, 1031 (1995); Louis Kaplow & Steven Shavell, Do Liability Rules Facilitate Bargaining? A Reply to Ayres and Talley, 105 YALE L.J. 221, 221-22 (1995) (describing "liability rule" as one under which "the injurer is free to harm the victim" and describing rule allowing victims injunctions as example of "property rule").
3. The distinction I make here between liability and incarceration as law enforcement mechanisms closely parallels the distinction made by Guido Calabresi and Douglas Melamed between "liability rules" and "property rules." See Guido Calabresi & A. Douglas Melamed, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, 85 HARV. L. REV. 1089, 1092-93 (1972). Calabresi and Melamed refer to rules enforceable by criminal law or equitable remedy, ultimately backed by the threat of incarceration, as "property rules." Id. at 1126 ("In other words, we impose criminal sanctions as a means of deterring future attempts to convert property rules into liability rules."); see also Ian Ayres & Eric Talley, Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade, 104 YALE L.J. 1027, 1031 (1995); Louis Kaplow & Steven Shavell, Do Liability Rules Facilitate Bargaining? A Reply to Ayres and Talley, 105 YALE L.J. 221, 221-22 (1995) (describing "liability rule" as one under which "the injurer is free to harm the victim" and describing rule allowing victims injunctions as example of "property rule").
4. The distinction I make here between liability and incarceration as law enforcement mechanisms closely parallels the distinction made by Guido Calabresi and Douglas Melamed between "liability rules" and "property rules." See Guido Calabresi & A. Douglas Melamed, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, 85 HARV. L. REV. 1089, 1092-93 (1972). Calabresi and Melamed refer to rules enforceable by criminal law or equitable remedy, ultimately backed by the threat of incarceration, as "property rules." Id. at 1126 ("In other words, we impose criminal sanctions as a means of deterring future attempts to convert property rules into liability rules."); see also Ian Ayres & Eric Talley, Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade, 104 YALE L.J. 1027, 1031 (1995); Louis Kaplow & Steven Shavell, Do Liability Rules Facilitate Bargaining? A Reply to Ayres and Talley, 105 YALE L.J. 221, 221-22 (1995) (describing "liability rule" as one under which "the injurer is free to harm the victim" and describing rule allowing victims injunctions as example of "property rule").
5. Most property rights are in fact enforced through liability; neither criminal incarceration nor equitable order is available to the plaintiff. The defendant who negligently destroys the plaintiff's property in an automobile accident or an industrial accident does not go to jail; the sole sanction is likely to be a judgment for money damages. When an invasion of property rights is deliberate, the system may sanction by criminal law or equitable order, but does not necessarily do so. The defendant who deliberately infringes a patent, holds over as a tenant, or refuses to surrender possession of collateral after default may eventually be ordered to cease violating the property rights of the plaintiff, but liability is likely to be the only sanction for violations committed prior to the order. See, e.g., Calabresi & Melamed, supra note 2, at 1093 (recognizing that property interest in one's house is protected by liability rules).
6. A debtor is judgment proof when the debtor has no wealth or holds its wealth in forms not subject to legal process for collection. That is, judgments against the debtor are uncollectible.
7. See PETER CANE, ATIYAH'S ACCIDENTS, COMPENSATION AND THE LAW 183-87 (1993) (discussing difficulty of collecting tort judgments from individual defendants); Jennifer H. Arlen & William J. Carney, Vicarious Liability for Fraud on Securities Markets: Theory and Evidence, 1992 U. ILL. L. REV. 691, 707 ("We expect that agents apprehended for fraud usually will be judgment proof, because the firm's value (and thus the agent's wealth and ability to satisfy the optimal damage award) declines dramatically when the fraud is revealed."); Thomas G. Bousquet, It's Time for Mandatory Malpractice Insurance, TEX. LAW., Dec. 6, 1993, at 17 (asserting that approximately 60% of attorneys in private practice in Texas have no professional liability insurance and that vast majority of those uninsured attorneys "either do not have the assets or the inclination (or both) to compensate clients whom they damage").
8. See PETER CANE, ATIYAH'S ACCIDENTS, COMPENSATION AND THE LAW 183-87 (1993) (discussing difficulty of collecting tort judgments from individual defendants); Jennifer H. Arlen & William J. Carney, Vicarious Liability for Fraud on Securities Markets: Theory and Evidence, 1992 U. ILL. L. REV. 691, 707 ("We expect that agents apprehended for fraud usually will be judgment proof, because the firm's value (and thus the agent's wealth and ability to satisfy the optimal damage award) declines dramatically when the fraud is revealed."); Thomas G. Bousquet, It's Time for Mandatory Malpractice Insurance, TEX. LAW., Dec. 6, 1993, at 17 (asserting that approximately 60% of attorneys in private practice in Texas have no professional liability insurance and that vast majority of those uninsured attorneys "either do not have the assets or the inclination (or both) to compensate clients whom they damage").
9. See PETER CANE, ATIYAH'S ACCIDENTS, COMPENSATION AND THE LAW 183-87 (1993) (discussing difficulty of collecting tort judgments from individual defendants); Jennifer H. Arlen & William J. Carney, Vicarious Liability for Fraud on Securities Markets: Theory and Evidence, 1992 U. ILL. L. REV. 691, 707 ("We expect that agents apprehended for fraud usually will be judgment proof, because the firm's value (and thus the agent's wealth and ability to satisfy the optimal damage award) declines dramatically when the fraud is revealed."); Thomas G. Bousquet, It's Time for Mandatory Malpractice Insurance, TEX. LAW., Dec. 6, 1993, at 17 (asserting that approximately 60% of attorneys in private practice in Texas have no professional liability insurance and that vast majority of those uninsured attorneys "either do not have the assets or the inclination (or both) to compensate clients whom they damage").
10. See, e.g., infra Subsection II.B.2.
11. See, e.g., Edward J. Kane, Interaction of Financial and Regulatory Innovation, 78 AM. ECON. REV. 328, 331 (1988) ("Advances in electronic and financial-contracting technology have played a major role . . . by creating unregulated or less-regulated 'loophole' substitutes for tightly regulated traditional products and ways of doing business,"); Joseph C. Shenker & Anthony J. Colletta, Asset Securitization: Evolution, Current Issues and New Frontiers, 69 TEX. L. REV. 1369, 1370-71 (1991) (listing new technology as one of several forces contributing to tremendous growth in asset securitization).
12. See, e.g., Edward J. Kane, Interaction of Financial and Regulatory Innovation, 78 AM. ECON. REV. 328, 331 (1988) ("Advances in electronic and financial-contracting technology have played a major role . . . by creating unregulated or less-regulated 'loophole' substitutes for tightly regulated traditional products and ways of doing business,"); Joseph C. Shenker & Anthony J. Colletta, Asset Securitization: Evolution, Current Issues and New Frontiers, 69 TEX. L. REV. 1369, 1370-71 (1991) (listing new technology as one of several forces contributing to tremendous growth in asset securitization).
13. For examples of the use of systems analysis in law, see LYNN M. LOPUCKI & ELIZABETH WARREN, SECURED CREDIT: A SYSTEMS APPROACH (1995); Todd R. Benson, Taking Security in China: Approaching U.S. Practices?, 21 YALE J. INT'L L. 183, 209-27 (1996); Lynn M. LoPucki, Why the Debtor's State of Incorporation Should Be the Proper Place for Article 9 Filing: A Systems Analysis, 79 MINN. L. REV. 577 (1995); Lynn M. LoPucki & George Triantis, A Systems Approach to Comparing U.S. and Canadian Reorganization of Financially Distressed Companies, 35 HARV. INT'L L.J. 267 (1994); Elizabeth Warren, Bankruptcy Policymaking in an Imperfect World, 92 MICH. L. REV. 336, 350-52 (1993).
14. For examples of the use of systems analysis in law, see LYNN M. LOPUCKI & ELIZABETH WARREN, SECURED CREDIT: A SYSTEMS APPROACH (1995); Todd R. Benson, Taking Security in China: Approaching U.S. Practices?, 21 YALE J. INT'L L. 183, 209-27 (1996); Lynn M. LoPucki, Why the Debtor's State of Incorporation Should Be the Proper Place for Article 9 Filing: A Systems Analysis, 79 MINN. L. REV. 577 (1995); Lynn M. LoPucki & George Triantis, A Systems Approach to Comparing U.S. and Canadian Reorganization of Financially Distressed Companies, 35 HARV. INT'L L.J. 267 (1994); Elizabeth Warren, Bankruptcy Policymaking in an Imperfect World, 92 MICH. L. REV. 336, 350-52 (1993).
15. For examples of the use of systems analysis in law, see LYNN M. LOPUCKI & ELIZABETH WARREN, SECURED CREDIT: A SYSTEMS APPROACH (1995); Todd R. Benson, Taking Security in China: Approaching U.S. Practices?, 21 YALE J. INT'L L. 183, 209-27 (1996); Lynn M. LoPucki, Why the Debtor's State of Incorporation Should Be the Proper Place for Article 9 Filing: A Systems Analysis, 79 MINN. L. REV. 577 (1995); Lynn M. LoPucki & George Triantis, A Systems Approach to Comparing U.S. and Canadian Reorganization of Financially Distressed Companies, 35 HARV. INT'L L.J. 267 (1994); Elizabeth Warren, Bankruptcy Policymaking in an Imperfect World, 92 MICH. L. REV. 336, 350-52 (1993).
16. For examples of the use of systems analysis in law, see LYNN M. LOPUCKI & ELIZABETH WARREN, SECURED CREDIT: A SYSTEMS APPROACH (1995); Todd R. Benson, Taking Security in China: Approaching U.S. Practices?, 21 YALE J. INT'L L. 183, 209-27 (1996); Lynn M. LoPucki, Why the Debtor's State of Incorporation Should Be the Proper Place for Article 9 Filing: A Systems Analysis, 79 MINN. L. REV. 577 (1995); Lynn M. LoPucki & George Triantis, A Systems Approach to Comparing U.S. and Canadian Reorganization of Financially Distressed Companies, 35 HARV. INT'L L.J. 267 (1994); Elizabeth Warren, Bankruptcy Policymaking in an Imperfect World, 92 MICH. L. REV. 336, 350-52 (1993).
17. For examples of the use of systems analysis in law, see LYNN M. LOPUCKI & ELIZABETH WARREN, SECURED CREDIT: A SYSTEMS APPROACH (1995); Todd R. Benson, Taking Security in China: Approaching U.S. Practices?, 21 YALE J. INT'L L. 183, 209-27 (1996); Lynn M. LoPucki, Why the Debtor's State of Incorporation Should Be the Proper Place for Article 9 Filing: A Systems Analysis, 79 MINN. L. REV. 577 (1995); Lynn M. LoPucki & George Triantis, A Systems Approach to Comparing U.S. and Canadian Reorganization of Financially Distressed Companies, 35 HARV. INT'L L.J. 267 (1994); Elizabeth Warren, Bankruptcy Policymaking in an Imperfect World, 92 MICH. L. REV. 336, 350-52 (1993).
18. A law-related system is a system in which law plays a role, usually along with social norms and physical subsystems such as police, courts, and jails. For a general discussion of the problem of identifying and isolating a "system" for study, see GERALD M. WEINBERG, AN INTRODUCTION TO GENERAL SYSTEMS THINKING 144-50 (1975).
19. For a discussion of the difficulties of inferring the goals of a system from observations of its operations, see id. at 87-122.
20. By contrast, law and economics attributes goals by postulating that all participants in an economic system are utility maximizers.
21. See LYNN M. LOPUCKI, STRATEGIES FOR CREDITORS IN BANKRUPTCY PROCEEDINGS (2d ed. 1991) [hereinafter LOPUCKI, STRATEGIES FOR CREDITORS] (identifying strategies used by or available to creditors before and during bankruptcy cases); Lynn M. LoPucki, Legal Culture, Legal Strategy, and the Law in Lawyers' Heads, 90 Nw. U. L. REV. 1498 (1996) [hereinafter LoPucki, The Law in Lawyers' Heads] (discussing legal strategy and strategic analysis as method for analysis of law-related systems); Mark J. Roe, Corporate Strategic Reaction to Mass Tort, 72 VA. L. REV. 1 (1986) (analyzing mass tort problem by examining strategies available to actors in system).
22. See LYNN M. LOPUCKI, STRATEGIES FOR CREDITORS IN BANKRUPTCY PROCEEDINGS (2d ed. 1991) [hereinafter LOPUCKI, STRATEGIES FOR CREDITORS] (identifying strategies used by or available to creditors before and during bankruptcy cases); Lynn M. LoPucki, Legal Culture, Legal Strategy, and the Law in Lawyers' Heads, 90 Nw. U. L. REV. 1498 (1996) [hereinafter LoPucki, The Law in Lawyers' Heads] (discussing legal strategy and strategic analysis as method for analysis of law-related systems); Mark J. Roe, Corporate Strategic Reaction to Mass Tort, 72 VA. L. REV. 1 (1986) (analyzing mass tort problem by examining strategies available to actors in system).
23. See LYNN M. LOPUCKI, STRATEGIES FOR CREDITORS IN BANKRUPTCY PROCEEDINGS (2d ed. 1991) [hereinafter LOPUCKI, STRATEGIES FOR CREDITORS] (identifying strategies used by or available to creditors before and during bankruptcy cases); Lynn M. LoPucki, Legal Culture, Legal Strategy, and the Law in Lawyers' Heads, 90 Nw. U. L. REV. 1498 (1996) [hereinafter LoPucki, The Law in Lawyers' Heads] (discussing legal strategy and strategic analysis as method for analysis of law-related systems); Mark J. Roe, Corporate Strategic Reaction to Mass Tort, 72 VA. L. REV. 1 (1986) (analyzing mass tort problem by examining strategies available to actors in system).
24. See LYNN M. LOPUCKI, STRATEGIES FOR CREDITORS IN BANKRUPTCY PROCEEDINGS (2d ed. 1991) [hereinafter LOPUCKI, STRATEGIES FOR CREDITORS] (identifying strategies used by or available to creditors before and during bankruptcy cases); Lynn M. LoPucki, Legal Culture, Legal Strategy, and the Law in Lawyers' Heads, 90 Nw. U. L. REV. 1498 (1996) [hereinafter LoPucki, The Law in Lawyers' Heads] (discussing legal strategy and strategic analysis as method for analysis of law-related systems); Mark J. Roe, Corporate Strategic Reaction to Mass Tort, 72 VA. L. REV. 1 (1986) (analyzing mass tort problem by examining strategies available to actors in system).
25. See LYNN M. LOPUCKI, STRATEGIES FOR CREDITORS IN BANKRUPTCY PROCEEDINGS (2d ed. 1991) [hereinafter LOPUCKI, STRATEGIES FOR CREDITORS] (identifying strategies used by or available to creditors before and during bankruptcy cases); Lynn M. LoPucki, Legal Culture, Legal Strategy, and the Law in Lawyers' Heads, 90 Nw. U. L. REV. 1498 (1996) [hereinafter LoPucki, The Law in Lawyers' Heads] (discussing legal strategy and strategic analysis as method for analysis of law-related systems); Mark J. Roe, Corporate Strategic Reaction to Mass Tort, 72 VA. L. REV. 1 (1986) (analyzing mass tort problem by examining strategies available to actors in system).
26. See LoPucki, The Law in Lawyers' Heads, supra note 12, at 1522-24 (discussing this terminology).
27. See Richard A. Posner, The Rights of Creditors of Affiliate Corporations, 43 U. CHI. L. REV. 499, 520 (1976) (proposing that every corporation engaged in dangerous activity should be required to post bond equal to highest reasonable estimate of its probable tort liability).
28. As it currently operates, this system can be deceptive. Contracting parties rely on their right to sue, only to learn that their debtor is judgment proof and others, who appeared to have taken the same risks, protected themselves in other ways. Once judgment proofing becomes the norm, the system likely will be less deceptive; contracting parties will know that they have no recourse except that provided in their contract.
29. See, e.g., Gary L. Blasi, What Lawyers Know: Lawyering Expertise, Cognitive Science, and the Functions of Theory, 45 J. LEGAL EDUC. 313, 384 (1995) ("The most fundamental 'superschemas' in the culture, by whatever name, are so pervasive and intrinsic to the conventions of thought that we are quite unaware of them. For this reason, the 'paradigms' in every field are generally described as they become history.").
30. Examples include the rule that shareholders are not liable for the debts of a corporation and the rule that one who does not have title to property cannot give title to it. The latter is usually referred to as the rule of nemo dat qui non habet. BLACK'S LAW DICTIONARY 1037 (6th ed. 1990) ("He who hath not cannot give.").
31. Examples of such deeply embedded principles include the principle that all property is owned by some person or entity and the principle that rights that are not property cannot be taken for debt, even though they might be valuable and transferable. Examples of such "nonproperty" include a celebrity's right to exploit his or her own image and various kinds of revocable government licenses. See LOPUCKI & WARREN, supra note 8, at 243-50.
32. See LoPucki, The Law in Lawyers' Heads, supra note 12.
33. See id. at 1533-41 (defining system-unintended strategy as strategy that designers of system do not intend to promote).
34. The law of some states does permit the court to order a debtor to surrender specific property and authorizes imprisonment of the debtor for contempt of court if the debtor does not comply. See infra note 165 and accompanying text. Unless specific property has been identified, the debtor might not have the present ability to comply and, therefore, use of the contempt power would be inappropriate. See infra note 166 and accompanying text.
35. The movement to eliminate imprisonment for debt had its roots in colonial times, and by the early 1900s, many states already had taken steps to eliminate "debtors' prisons." PETER J. COLEMAN, DEBTORS AND CREDITORS IN AMERICA 249-68 (1974). In some states, the abolition does not reach all types of debt for which one might be imprisoned. See, e.g., OR. CONST. art. I, § 19 ("There shall be no imprisonment for debt, except in case of fraud or absconding debtors."). Compare WIS. CONST. art. I, § 16 ("No person shall be imprisoned for debt arising out of or founded on a contract, express or implied."), with WIS. STAT. ANN. § 898.01-.31 (West 1983); id. § 898.01 (providing procedures for release of persons "confined in jail on an execution issued on a judgment recovered in an action founded on a tort"). Some jurisdictions provide for both the imprisonment of debtors and their subsequent release once the court is satisfied that they have surrendered their property. See, e.g., N.J. STAT. ANN. § 2A:20-1 (West Supp. 1995) ("Any person, in actual confinement for debt or damages in any jail of this state, who is willing to deliver up to his creditor or creditors all his estate, both real and personal, toward their payment, may bring an action, in a summary manner, for his discharge under this chapter, in the superior court."); Paul Marcotte, Debtor's Prison?: Court Jails N.J. Man Until He Discloses Assets, Posts Bond, A.B.A. J., Feb. 1990, at 28 (reporting refusal of bankruptcy judge to intervene to free debtor jailed by state court on "body execution").
36. The movement to eliminate imprisonment for debt had its roots in colonial times, and by the early 1900s, many states already had taken steps to eliminate "debtors' prisons." PETER J. COLEMAN, DEBTORS AND CREDITORS IN AMERICA 249-68 (1974). In some states, the abolition does not reach all types of debt for which one might be imprisoned. See, e.g., OR. CONST. art. I, § 19 ("There shall be no imprisonment for debt, except in case of fraud or absconding debtors."). Compare WIS. CONST. art. I, § 16 ("No person shall be imprisoned for debt arising out of or founded on a contract, express or implied."), with WIS. STAT. ANN. § 898.01-.31 (West 1983); id. § 898.01 (providing procedures for release of persons "confined in jail on an execution issued on a judgment recovered in an action founded on a tort"). Some jurisdictions provide for both the imprisonment of debtors and their subsequent release once the court is satisfied that they have surrendered their property. See, e.g., N.J. STAT. ANN. § 2A:20-1 (West Supp. 1995) ("Any person, in actual confinement for debt or damages in any jail of this state, who is willing to deliver up to his creditor or creditors all his estate, both real and personal, toward their payment, may bring an action, in a summary manner, for his discharge under this chapter, in the superior court."); Paul Marcotte, Debtor's Prison?: Court Jails N.J. Man Until He Discloses Assets, Posts Bond, A.B.A. J., Feb. 1990, at 28 (reporting refusal of bankruptcy judge to intervene to free debtor jailed by state court on "body execution").
37. The movement to eliminate imprisonment for debt had its roots in colonial times, and by the early 1900s, many states already had taken steps to eliminate "debtors' prisons." PETER J. COLEMAN, DEBTORS AND CREDITORS IN AMERICA 249-68 (1974). In some states, the abolition does not reach all types of debt for which one might be imprisoned. See, e.g., OR. CONST. art. I, § 19 ("There shall be no imprisonment for debt, except in case of fraud or absconding debtors."). Compare WIS. CONST. art. I, § 16 ("No person shall be imprisoned for debt arising out of or founded on a contract, express or implied."), with WIS. STAT. ANN. § 898.01-.31 (West 1983); id. § 898.01 (providing procedures for release of persons "confined in jail on an execution issued on a judgment recovered in an action founded on a tort"). Some jurisdictions provide for both the imprisonment of debtors and their subsequent release once the court is satisfied that they have surrendered their property. See, e.g., N.J. STAT. ANN. § 2A:20-1 (West Supp. 1995) ("Any person, in actual confinement for debt or damages in any jail of this state, who is willing to deliver up to his creditor or creditors all his estate, both real and personal, toward their payment, may bring an action, in a summary manner, for his discharge under this chapter, in the superior court."); Paul Marcotte, Debtor's Prison?: Court Jails N.J. Man Until He Discloses Assets, Posts Bond, A.B.A. J., Feb. 1990, at 28 (reporting refusal of bankruptcy judge to intervene to free debtor jailed by state court on "body execution").
38. The movement to eliminate imprisonment for debt had its roots in colonial times, and by the early 1900s, many states already had taken steps to eliminate "debtors' prisons." PETER J. COLEMAN, DEBTORS AND CREDITORS IN AMERICA 249-68 (1974). In some states, the abolition does not reach all types of debt for which one might be imprisoned. See, e.g., OR. CONST. art. I, § 19 ("There shall be no imprisonment for debt, except in case of fraud or absconding debtors."). Compare WIS. CONST. art. I, § 16 ("No person shall be imprisoned for debt arising out of or founded on a contract, express or implied."), with WIS. STAT. ANN. § 898.01-.31 (West 1983); id. § 898.01 (providing procedures for release of persons "confined in jail on an execution issued on a judgment recovered in an action founded on a tort"). Some jurisdictions provide for both the imprisonment of debtors and their subsequent release once the court is satisfied that they have surrendered their property. See, e.g., N.J. STAT. ANN. § 2A:20-1 (West Supp. 1995) ("Any person, in actual confinement for debt or damages in any jail of this state, who is willing to deliver up to his creditor or creditors all his estate, both real and personal, toward their payment, may bring an action, in a summary manner, for his discharge under this chapter, in the superior court."); Paul Marcotte, Debtor's Prison?: Court Jails N.J. Man Until He Discloses Assets, Posts Bond, A.B.A. J., Feb. 1990, at 28 (reporting refusal of bankruptcy judge to intervene to free debtor jailed by state court on "body execution").
39. Cf. ALEXANDER M. BICKEL & BENNO C. SCHMIDT, JR., THE OLIVER WENDELL HOLMES DEVISE HISTORY OF THE SUPREME COURT OF THE UNITED STATES 820-907 (1984) (discussing Supreme Court's development of rule prohibiting "peonage," or debt slavery).
40. "[P]rompted by a desire to protect a wife's property from her husband's creditors, as well as to give her legal autonomy," all common law property states enacted Married Women's Property Acts between 1839 and the end of the nineteenth century. JESSE DUKEMINIER & JAMES E. KRIER, PROPERTY 368 (3d ed. 1993).
41. The holder of a judgment may, however, enforce it against property formerly owned by the debtor that the debtor has fraudulently transferred to a third party. See UNIF. FRAUDULENT TRANSFER ACT § 7, 7A U.L.A. 660 (1984) (outlining creditors' remedies for fraudulently conveyed property).
42. To illustrate, assume that an unsecured creditor obtains a judgment against the debtor, obtains a writ of execution from the clerk of the court, and is about to levy. The debtor can defeat that levy by transferring his property to a competing creditor in satisfaction of the competing creditor's bona fide debt. The transfer is not fraudulent because the law deems it to be for "value." See UNIF. FRAUDULENT TRANFER ACT §§ 3(a), 4(a)(2), 5(a), 7A U.L.A. 650-57 (1984). If the transfer is as security, the secured creditor need only file a financing statement in the public records to perfect it before the levy occurs and the transfer will defeat the levy. See U.C.C. § 9-301(4) (1994). The progress an unsecured creditor makes through years of litigation can be defeated by acts that the debtor and favorite creditor can perform in a few minutes.
43. One ground for reversal might be that the transfer is avoidable in bankruptcy as a preference. But to avoid the transfer on that ground, the judgment creditor may face the formidable task of forcing the debtor into bankruptcy by the preference deadline, winning the preference litigation, and then collecting the resulting judgment of avoidance, which is itself an unsecured debt. See LOPUCKI, STRATEGIES FOR CREDITORS, supra note 12, at §§ 2.8-2.9. Strategies exist by which sophisticated debtors and their favorite creditors can insulate their transaction against later preference avoidance. See id. §§ 2.4.1, 2.16.3.
44. See 7 COLLIER ON BANKRUPTCY (Lawrence P. King ed., 15th ed. 1995) (setting forth text of exemption laws of all 50 states).
45. See FLA. CONST. art. X, § 4; TEX. PROP. CODE ANN. §§ 41.001-.002 (West Supp. 1995); see also Larry Rohter, Rich Debtors Finding Shelter Under a Populist Florida Law, N.Y. TIMES, July 25, 1993, § 1, at 1 (discussing purchase by debtors of multimillion dollar homes in Florida).
46. See FLA. CONST. art. X, § 4; TEX. PROP. CODE ANN. §§ 41.001-.002 (West Supp. 1995); see also Larry Rohter, Rich Debtors Finding Shelter Under a Populist Florida Law, N.Y. TIMES, July 25, 1993, § 1, at 1 (discussing purchase by debtors of multimillion dollar homes in Florida).
47. See FLA. CONST. art. X, § 4; TEX. PROP. CODE ANN. §§ 41.001-.002 (West Supp. 1995); see also Larry Rohter, Rich Debtors Finding Shelter Under a Populist Florida Law, N.Y. TIMES, July 25, 1993, § 1, at 1 (discussing purchase by debtors of multimillion dollar homes in Florida).
48. See infra notes 135-36 and accompanying text.
49. See, e.g., Homer Kripke, Law and Economics: Measuring the Economic Efficiency af Commerical Law in a Vacuum of Fact, 133 U. PA. L. REV. 929, 941-46 (1985) (claiming that lenders will not lend without security).
50. In this passage I have attempted to present the argument for the principle of subordination in its strongest terms. Elsewhere I have argued that involuntary creditors should have priority over secured creditors. See Lynn M. LoPucki, The Unsecured Creditor's Bargain, 80 VA. L. REV. 1887, 1908-16 (1994).
51. The typical statement of this principle restricts its benefit to "honest" debtors. The restriction is largely rhetorical. See LoPucki, The Law in Lawyers' Heads, supra note 12, at 1552 (explaining how bankruptcy procedures enable most dishonest debtors to qualify for discharge).
52. See 11 U.S.C. § 1141 (1994) (stating that confirmation of reorganization plan "discharges the debtor from any debt that arose before the date of such confirmation" and providing no exception for debts incurred through fraud or even criminal wrongdoing).
53. See id. §§ 541(a)(6), 552(b); see also ELIZABETH WARREN & JAY L. WESTBROOK, THE LAW OF DEBTORS AND CREDITORS 220, 246 (3d ed. 1996) (explaining operation of Bankruptcy Code).
54. See 11 U.S.C. § 523(a).
55. See id. § 1108 ("Unless the court, on request of a party in interest and after notice and a hearing, orders otherwise, the trustee may operate the debtor's business.").
56. See Warren, supra note 8, at 350-52 (describing policy behind productive use as preservation of value of business or assets).
57. See, e.g., FLA. STAT. ANN. §§ 76.04-.05 (West Supp. 1995) (stating grounds for attachment); TEX. CIV. PRAC. & REM. CODE ANN. § 61.001 (West 1986) (same).
58. See, e.g., FLA. STAT. ANN. §§ 76.04-.05 (West Supp. 1995) (stating grounds for attachment); TEX. CIV. PRAC. & REM. CODE ANN. § 61.001 (West 1986) (same).
59. See Connecticut v. Doehr, 501 U.S. 1, 16 (1991) ("Our cases have recognized [that a properly supported claim showing planned activities that would render the debtor judgment proof by the end of the pending litigation] would be an exigent circumstance permitting postponing any notice or hearing until after the attachment is effected."); Mitchell v. W.T. Grant Co., 416 U.S. 600 (1974) (upholding statute that provided for seizure of property without notice to owner debtor).
60. See Rhonda Wasserman, Equity Renewed: Preliminary Injunctions to Secure Potential Money Judgments, 67 WASH. L. REV. 257, 276 (1992) ("Many states authorize attachment only in certain kinds of cases - in contract actions, for example." (footnotes omitted)). But see ILL. COMP. STAT. ANN. 5/4-101 (West 1992) (providing for attachment in cases sounding in contract or tort).
61. See Rhonda Wasserman, Equity Renewed: Preliminary Injunctions to Secure Potential Money Judgments, 67 WASH. L. REV. 257, 276 (1992) ("Many states authorize attachment only in certain kinds of cases - in contract actions, for example." (footnotes omitted)). But see ILL. COMP. STAT. ANN. 5/4-101 (West 1992) (providing for attachment in cases sounding in contract or tort).
62. See Michael W. Gordon et al., Arbitration of Commercial Disputes in Mexico and the United States: A Panel Discussion, 2 U.S.-MEX. L.J. 111, 124 (1994) ("The United States is not party to . . . any . . . bilateral or multilateral treaty for the enforcement of foreign judgments.").
63. The possibility of change because they enable all debtors to defeat liability is explored in Part IV.
64. In the discussion that follows, the principles will be referred to by the headings under which each was presented in this Part.
65. In most kinds of businesses, "secured" loans in amounts that exceed the liquidation value of the collateral are not difficult to obtain. See WARREN & WESTBROOK, supra note 35, at 5 (citing Bank of America lending guide to effect that pledge of "all the assets in the business . . . generally is insufficient value to pay off the loan"). The lender understands that it will be partially unsecured in the event of liquidation, but bases the amount of the loan on the earning capacity of the business and charges a higher rate of interest to compensate for the additional risk. In some kinds of businesses - principally those in which the sole asset is real property - lenders typically seek to lend only the liquidation value of the collateral. If they lend precisely the liquidation value, that is sufficient substantially to judgment proof the debtor. If the debtor wants a loan in excess of the liquidation value, the debtor may be able to obtain it by providing the lender with personal guarantees, letters of credit, or other sufficient "credit enhancements."
66. See supra note 32 and accompanying text.
67. For simplicity, I have assumed that the holder of the first security interest exercises its rights to foreclose. If the holder of the first does not, the procedure is more complicated, but the result is the same. The value of the collateral is applied first to the most senior lien, then to subordinate liens in their order of priority until the value is exhausted or all liens have been paid. Only the balance is available to satisfy the new money judgment. See LOPUCKI & WARREN, supra note 8, at 527-31.
68. See Susan Block-Lieb, Why Creditors File So Few Involuntary Petitions and Why the Number Is Not Too Small, 57 BROOK. L. REV. 803, 844 (1991) ("General creditors need not, and often do not, seek the aid of the courts and their officers to coerce repayment of delinquent debts."). For an economic model that attempts to identify the circumstances in which tort claimants should drop their cases, see Kathryn E. Spier & Alan O. Sykes, Capital Structure, Priority Rules, and the Settlement of Civil Claims (Sept. 1995) (unpublished manuscript, on file with the Yale Law Journal).
69. See Susan Block-Lieb, Why Creditors File So Few Involuntary Petitions and Why the Number Is Not Too Small, 57 BROOK. L. REV. 803, 844 (1991) ("General creditors need not, and often do not, seek the aid of the courts and their officers to coerce repayment of delinquent debts."). For an economic model that attempts to identify the circumstances in which tort claimants should drop their cases, see Kathryn E. Spier & Alan O. Sykes, Capital Structure, Priority Rules, and the Settlement of Civil Claims (Sept. 1995) (unpublished manuscript, on file with the Yale Law Journal).
70. See, e.g., Security Pac. Bank v. Haines Terminal Highway Co., 869 P.2d 156, 158 (Alaska 1994) (stating in dicta that "the trial court properly held that [the judgment creditor] could not 'attach property that is subject to a security interest when that security interest is larger than any of the debtor's interests'" (citation omitted)); Grocers Supply Co. v. Intercity Inv. Properties, Inc., 795 S.W.2d 225, 227 (Tex. Civ. App. 1990, no writ) (holding judgment creditor who did not notify secured creditor before levying against collateral liable for secured creditor's damages in recovering property from judgment creditor). However, the judgment creditor may eventually be able to force the sale. See Frierson v. United Farm Agency, 868 F.2d 302, 305 (8th Cir. 1989) (holding that secured creditor can prevent execution only for purpose of enforcing its own interest, not to leave debtor in control).
71. This strategy dates at least from the equity receiverships of the late nineteenth century. See Theodore Eisenberg, Baseline Problems in Assessing Chapter 11, 43 U. TORONTO L.J. 633, 642 (1993) ("Indeed, the entire receivership procedure often was structured to assure that one and only one purchaser - the reorganization committee - could purchase the assets."). It continues in use today. See LOPUCKI, STRATEGIES FOR CREDITORS, supra note 12, at § 11.11.2 (describing use of strategy in cases under Chapter 11 of Bankruptcy Code).
72. This strategy dates at least from the equity receiverships of the late nineteenth century. See Theodore Eisenberg, Baseline Problems in Assessing Chapter 11, 43 U. TORONTO L.J. 633, 642 (1993) ("Indeed, the entire receivership procedure often was structured to assure that one and only one purchaser - the reorganization committee - could purchase the assets."). It continues in use today. See LOPUCKI, STRATEGIES FOR CREDITORS, supra note 12, at § 11.11.2 (describing use of strategy in cases under Chapter 11 of Bankruptcy Code).
73. To illustrate, a debtor with property worth $100 grants a security interest to secure a debt in the amount of $120. At any sale of this property, the secured creditor will be entitled either to have its lien survive the sale or to bid in at prices up to $120, without having to pay in additional capital. See LOPUCKI & WARREN, supra note 8, at 527-31. To acquire this property by bidding at a sale, a subsequent judgment creditor probably will have to pay $120, more than the property is worth.
74. See id. at 71-83.
75. See id. at 78-82.
76. See, e.g., In re T.F. Stone Co., 72 F.3d 466 (5th Cir. 1995) (declining to set aside tax sale of property for $325 even though property was soon resold for $39.500 because tax sale was for "reasonably equivalent value" within meaning of fraudulent transfer law). Until recently, bankruptcy courts attempted to maintain sale prices in these state courts by standing ready to set aside state court sales for less than 70% of market value in a bankruptcy case filed within one year. See, e.g., Durrett v. Washington Nat'l Ins. Co., 621 F.2d 201, 204 (5th Cir. 1980) (setting aside foreclosure sale). The Supreme Court recently barred the bankruptcy courts from setting aside regularly conducted, noncollusive state court foreclosure sales of real estate, regardless of the prices obtained. See BFP v. Resolution Trust Corp., 114 S. Ct. 1757, 1767 (1994).
77. One practitioner estimates that 80% of financial distress situations involving less than three million dollars in assets are resolved by this method, principally because the parties feel that the cost of Chapter 11 is unjustified. Telephone Interview with David Lander, Partner, Thompson & Mitchell, St. Louis, Missouri (June 13, 1996).
78. To illustrate, assume that property has a market value of $100, but would sell for $70 in a judicial sale. By granting a mortgage against the property in the amount of $75, the debtor creates a judgment-proof structure. That is, if judgments are later entered against the debtor, the alliance of debtor and secured creditor can control the property by purchasing it at sale for $75.
79. See 11 U.S.C. § 1108 (1994) (providing for continued operation of debtor's business in bankruptcy reorganization); id. § 1123 (providing that reorganization plan may provide for sale of "all or any part of the property of the estate").
80. See, e.g., In re Met-L-Wood Corp., 861 F.2d 1012, 1019 (7th Cir. 1988) (refusing to invalidate sale in which owner of debtor corporation purchased property through agent who did not disclose that owner was purchaser, because owner outbid at least one disinterested competitor).
81. See 11 U.S.C. § 1129(b) (mandating that court confirm plan of reorganization that respects rule of absolute priority among claims and interests). Provided that the debtor's assets are fully encumbered, that section mandates confirmation of a plan that provides no distribution to junior judgment lienors. See WARREN & WESTBROOK, supra note 35, at 713-14; see also LOPUCKI, STRATEGIES FOR CREDITORS, supra note 12, at § 11.11.2 (describing strategies by which debtor can strip liabilities through Chapter 11, without losing control of property).
82. See In re Landau Boat Co., 8 B.R. 436 (Bankr. W.D. Mo. 1981); In re Landau Boat Co., 13 B.R. 788 (Bankr. W.D. Mo. 1981) (confirming plan of reorganization that sold company to four members of board of directors); LOPUCKI, STRATEGIES FOR CREDITORS, supra note 12, at § 11.11.2 (describing commonly used methods for retaining ownership and control); Lynn M. LoPucki, The Debtor in Full Control - Systems Failure Under Chapter 11 of the Bankruptcy Code?, 57 AM. BANKR. L.J. 247, 264 (owner-managers retained control of 86% of businesses that closed during Chapter 11 and 75% of businesses that survived Chapter 11).
83. See In re Landau Boat Co., 8 B.R. 436 (Bankr. W.D. Mo. 1981); In re Landau Boat Co., 13 B.R. 788 (Bankr. W.D. Mo. 1981) (confirming plan of reorganization that sold company to four members of board of directors); LOPUCKI, STRATEGIES FOR CREDITORS, supra note 12, at § 11.11.2 (describing commonly used methods for retaining ownership and control); Lynn M. LoPucki, The Debtor in Full Control - Systems Failure Under Chapter 11 of the Bankruptcy Code?, 57 AM. BANKR. L.J. 247, 264 (owner-managers retained control of 86% of businesses that closed during Chapter 11 and 75% of businesses that survived Chapter 11).
84. A creditor secured under nonbankruptcy law has, in bankruptcy, a secured claim for the amount of the debt or the value of the collateral. See 11 U.S.C. § 506(a). Even in a cram down (in which a bankruptcy court imposes a reorganization plan on the parties), the holders of secured claims are entitled to "retain the liens securing such claims . . . to the extent of the allowed amount of such claims." Id. § 1129(b)(2)(A)(i)(I). The emerging debtor has, in essence, 100% secured financing. See In re E.I. Parks No. 1 Ltd. Partnership, 122 B.R. 549, 554 (Bankr. W.D. Ark. 1990) (noting that debtor is receiving what amounts to 100% financing).
85. A Chapter 11 followed shortly thereafter by another for the same debtor has become known in the bankruptcy community as a "Chapter 22." See, e.g., Oliver v. Kolody, 142 B.R. 486, 487 (Bankr. M.D. Fla. 1992) ("This is a Chapter 22 case . . . in that this is the second Chapter 11 case in which the Debtor seeks relief under Chapter 11 of the Bankruptcy Code.").
86. In a Chapter 11 case, unsecured creditors are entitled to the value of any unencumbered assets. See 11 U.S.C. §§ 1129(a)(7), (b)(2)(B).
87. See U.C.C. § 9-101 cmt. (1992).
88. See, e.g., Thomas C. Billig, What Price Bankruptcy: A Plea for "Friendly Adjustment", 14 CORNELL L.Q. 413, 436 (1929) (presenting data from liquidations in 1926 and 1927 showing unsecured creditors receiving 43% of dividends paid in bankruptcy cases and 73% of dividends paid in assignments for benefit of creditors).
89. U.C.C. § 9-101 cmt.
90. See, e.g., Vern Countryman, Code Security Interests in Bankruptcy, 75 COM. L.J. 269, 269 (1970) ("[M]any practitioners and bankruptcy referees tell me . . . more and more bankruptcy cases emerge with every scrap of the bankrupt's property covered by some sort of a Code security interest . . . That means, of course, that nothing will be distributed to any unsecured creditor, with or without priority.").
91. See ADMINISTRATIVE OFFICE OF THE U.S. COURTS, TABLES OF BANKRUPTCY STATISTICS 8-9 (1978) [hereinafter BANKRUPTCY STATISTICS].
92. See U.S. GEN. ACCT. OFFICE, CASE RECEIPTS PAID TO CREDITORS AND PROFESSIONALS 1 (July 1994); see also Michael J. Herbert & Domenic E. Pacitti, Down and Out in Richmond, Virginia: The Distribution of Assets in Chapter 7 Bankruptcy Proceedings Closed During 1984-87, 22 U. RICH. L. REV. 303, 316 (1988) (finding that 4.4% of Chapter 7 cases in study period resulted in distributions to unsecured creditors).
93. See U.S. GEN. ACCT. OFFICE, CASE RECEIPTS PAID TO CREDITORS AND PROFESSIONALS 1 (July 1994); see also Michael J. Herbert & Domenic E. Pacitti, Down and Out in Richmond, Virginia: The Distribution of Assets in Chapter 7 Bankruptcy Proceedings Closed During 1984-87, 22 U. RICH. L. REV. 303, 316 (1988) (finding that 4.4% of Chapter 7 cases in study period resulted in distributions to unsecured creditors).
94. See Billig, supra note 65, at 433. An "assignment liquidation," more commonly referred to today as an "assginment for the benefit of creditors," is a legal proceeding by which a debtor assigns all of its nonexempt assets to a trustee. The trustee liquidates the assets and distributes the proceeds to creditors in accord with their priorities. See WARREN & WESTBROOK, supra note 35, at 192-94.
95. See BANKRUPTCY STATISTICS, supra note 68, at A-16 (reporting data from which it can be calculated that only 19% of bankruptcy cases resulted in any distribution to general creditors and that, within that subset of cases, average dividend was 4.5 cents per dollar); Herbert & Pacitti, supra note 69, at 316 (finding average dividend to unsecured creditors in 4.4% of Chapter 7 cases that produced any dividend at all to be 3.2% of unsecured claims).
96. Steven L. Harris & Charles W. Mooney, Jr., A Property-Based Theory of Security Interests: Taking Debtors' Choices Seriously, 80 VA. L. REV. 2021, 2021 (1994) ("[W]e take as our 'first principle' that Uniform Commercial Code Article 9 should facilitate the creation of security interests. Stated otherwise, we think the transfer of an effective security interest ought to be as easy, inexpensive, and reliable as possible.").
97. See Report of the Article 9 Study Committee of the Permanent Editorial Board for the Uniform Commercial Code 43, 48, 50, 56, 60, 67, 68 (Dec. 1, 1992) (arguing for expansion of Article 9 scope in areas of general intangibles, credit card receivables, intellectual properly, insurance policies, tort claims, real estate, oil, gas and minerals-related collateral, and deposit accounts); U.C.C. §§ 9-102(a)(2)-(3), 9-104(7), (11), and Alternative B(12) & (13) (Apr. 16, 1996 Discussion Draft) (eliminating portions of exclusions for agricultural liens, payment intangibles, insurance policies, tort claims, and perhaps deposit accounts).
98. This development has prompted at least four proposals to modify the principle of subordination. See Lucian Ayre Bebchuk & Jesse M. Fried, The Uneasy Case for the Priority of Secured Claims in Bankruptcy, 105 YALE L.J. 857, 909 (1996) (proposing to limit secured status to fixed fraction of amount of secured debt, for example, 75%); LoPucki, supra note 32, at 1907-16 (proposing to give involuntary creditors priority over secured creditors); Ronald J. Mann, The First Shall Be Last: A Contextual Argument for Flipping Lien Priority, 75 TEX. L. REV. (forthcoming 1996) (proposing that mechanic's liens have priority over construction mortgages); Memorandum from Elizabeth Warren, Leo Gotlieb Professor of Law, Harvard University, to Council of the American Law Institute (Apr. 25, 1996) (proposing to limit secured status to 80% of collateral value).
99. This development has prompted at least four proposals to modify the principle of subordination. See Lucian Ayre Bebchuk & Jesse M. Fried, The Uneasy Case for the Priority of Secured Claims in Bankruptcy, 105 YALE L.J. 857, 909 (1996) (proposing to limit secured status to fixed fraction of amount of secured debt, for example, 75%); LoPucki, supra note 32, at 1907-16 (proposing to give involuntary creditors priority over secured creditors); Ronald J. Mann, The First Shall Be Last: A Contextual Argument for Flipping Lien Priority, 75 TEX. L. REV. (forthcoming 1996) (proposing that mechanic's liens have priority over construction mortgages); Memorandum from Elizabeth Warren, Leo Gotlieb Professor of Law, Harvard University, to Council of the American Law Institute (Apr. 25, 1996) (proposing to limit secured status to 80% of collateral value).
100. See LoPucki, supra note 32, at 1925-26 (discussing extent of unsecured lending); id. at 1930-31 (speculating that managers of largest companies protect themselves against ouster by causing their corporations to borrow unsecured, even though such borrowing is more expensive); Ronald J. Mann, Explaining the Pattern of Secured Credit from the Ground Up, 110 HARV. L. REV. (forthcoming 1997) (presenting evidence that creditworthiness, not size, is principal factor determining whether credit is secured or unsecured and arguing that highly creditworthy debtors are able to borrow unsecured because costs of securing debt exceed risk of loss from nonpayment); Robert E. Scott, A Relational Theory of Secured Financing, 86 COLUM. L. REV. 901, 941 (1986) (arguing that small firms cannot provide proof of capable management or solid base of existing assets, but can offer security).
101. See LoPucki, supra note 32, at 1925-26 (discussing extent of unsecured lending); id. at 1930-31 (speculating that managers of largest companies protect themselves against ouster by causing their corporations to borrow unsecured, even though such borrowing is more expensive); Ronald J. Mann, Explaining the Pattern of Secured Credit from the Ground Up, 110 HARV. L. REV. (forthcoming 1997) (presenting evidence that creditworthiness, not size, is principal factor determining whether credit is secured or unsecured and arguing that highly creditworthy debtors are able to borrow unsecured because costs of securing debt exceed risk of loss from nonpayment); Robert E. Scott, A Relational Theory of Secured Financing, 86 COLUM. L. REV. 901, 941 (1986) (arguing that small firms cannot provide proof of capable management or solid base of existing assets, but can offer security).
102. Scholars writing about this phenomenon from an economic perspective tend to focus on isolation of risk rather than on isolation of assets. See, e.g., Henry Hansmann & Reinier Kraakman, Toward Unlimited Shareholder Liability for Corporate Torts, 100 YALE L.J. 1879, 1920 (1991) ("[T]he subdivision [of a corporate group into constituent corporations] chosen for purposes of externalizing tort liability is likely to involve a larger number of subsidiaries and perhaps also a different partitioning of functions among them, as the firm tries to segregate its riskiest activities into separate corporations."); David W. Leebron, Limited Liability, Tort Victims, and Creditors, 91 COLUM. L. REV. 1565, 1613-14 (1991) ("A corporation can . . . limit its exposure to tort victims by segregating the business which causes injury into a separate corporate unit."). The difference may seem just a controversy over "half full" or "half empty," but the perspective adopted by these scholars appears to have prevented them from seeing the unrestrained potential of the parent-subsidiary strategy. Once one realizes that assets can be isolated, not just risks, the potential for judgment proofing becomes apparent.
103. Scholars writing about this phenomenon from an economic perspective tend to focus on isolation of risk rather than on isolation of assets. See, e.g., Henry Hansmann & Reinier Kraakman, Toward Unlimited Shareholder Liability for Corporate Torts, 100 YALE L.J. 1879, 1920 (1991) ("[T]he subdivision [of a corporate group into constituent corporations] chosen for purposes of externalizing tort liability is likely to involve a larger number of subsidiaries and perhaps also a different partitioning of functions among them, as the firm tries to segregate its riskiest activities into separate corporations."); David W. Leebron, Limited Liability, Tort Victims, and Creditors, 91 COLUM. L. REV. 1565, 1613-14 (1991) ("A corporation can . . . limit its exposure to tort victims by segregating the business which causes injury into a separate corporate unit."). The difference may seem just a controversy over "half full" or "half empty," but the perspective adopted by these scholars appears to have prevented them from seeing the unrestrained potential of the parent-subsidiary strategy. Once one realizes that assets can be isolated, not just risks, the potential for judgment proofing becomes apparent.
104. See, e.g., MICHAEL MORITZ & BARRETT SEAMAN, GOING FOR BROKE: LEE IACOCCA'S BATTLE TO SAVE CHRYSLER 65-68 (1984) (discussing Chrysler's financial, leasing, and realty subsidiaries, and similar subsidiaries of Ford and General Motors); Lynn M. LoPucki & William C. Whitford, Wickes Companies, Inc. 2 (Oct. 8, 1990) (memorandum, on file with author) (noting that early in Wickes reorganization effort, unsecured creditors of Wickes credit subsidiaries were successful in winning confirmation of plans of reorganization providing them with payment in full); Lynn M. LoPucki & William C. Whitford, White Motor Co. 4 (Mar. 17, 1989) (memorandum, on file with author) (noting early confirmation of similar plan for White Motors credit subsidiary).
105. For example, the Eighth Circuit has written: The doctrine of limited liability is intended precisely to protect a parent corporation whose subsidiary goes broke. That is the whole purpose of the doctrine, and those who have the right to decide such questions, that is, legislatures, believe that the doctrine, on the whole, is socially reasonable and useful. We think that the doctrine would largely be destroyed if a parent corporation could be held liable simply on the basis of errors in business judgment. Radaszewski v. Telecom Corp., 981 F.2d 305, 311 (8th Cir. 1992). See also In re Acushnet River, 675 F. Supp. 22, 34 (D. Mass. 1987) ("'[T]here is nothing fraudulent or against public policy in limiting one's liability by the appropriate use of corporate insulation.'") (quoting Miller v. Honda Motor Co., 779 F.2d 769, 773 (1st Cir. 1985)); Robert B. Thompson, Unpacking Limited Liability: Direct and Vicarious Liability of Corporate Participants for Torts of the Enterprise, 47 VAND. L. REV. 1, 6 (1994) ("The creation of a corporation . . . offers many advantages . . . but its most powerful effect is its insulation of participants from financial responsibility for debts of the enterprise."); Michael T.K. Horvath & Michael J. Woywode, Entrepreneurs and the Choice of Limited Liability (1996) (Working Paper No. 129, John M. Olin Program in Law and Economics, Stanford Law School) (unpublished manuscript, on file with the author) (purporting to prove, from data on German firms, that "riskier firms tend to organize as limited liability firms, controlling for firm size and entrepreneur characteristics"). Professor Robert Hamilton identifies isolation from the liabilities potentially generated by risky enterprises as the principal reason for maintaining the separate corporations in a corporate group. He also has identified the following as reasons for some separations: tradition; the desire for a separate board and officers; avoiding the jurisdiction of foreign courts; meeting minimum local ownership requirements in foreign countries; blocking the use of names and trademarks by others; and reducing the expenses of transferring the business of a subsidiary upon sale. Telephone Interview with Robert W. Hamilton, Minerva House Drysdale Regents Chair, University of Texas School of Law (July 6, 1995).
106. For example, the Eighth Circuit has written: The doctrine of limited liability is intended precisely to protect a parent corporation whose subsidiary goes broke. That is the whole purpose of the doctrine, and those who have the right to decide such questions, that is, legislatures, believe that the doctrine, on the whole, is socially reasonable and useful. We think that the doctrine would largely be destroyed if a parent corporation could be held liable simply on the basis of errors in business judgment. Radaszewski v. Telecom Corp., 981 F.2d 305, 311 (8th Cir. 1992). See also In re Acushnet River, 675 F. Supp. 22, 34 (D. Mass. 1987) ("'[T]here is nothing fraudulent or against public policy in limiting one's liability by the appropriate use of corporate insulation.'") (quoting Miller v. Honda Motor Co., 779 F.2d 769, 773 (1st Cir. 1985)); Robert B. Thompson, Unpacking Limited Liability: Direct and Vicarious Liability of Corporate Participants for Torts of the Enterprise, 47 VAND. L. REV. 1, 6 (1994) ("The creation of a corporation . . . offers many advantages . . . but its most powerful effect is its insulation of participants from financial responsibility for debts of the enterprise."); Michael T.K. Horvath & Michael J. Woywode, Entrepreneurs and the Choice of Limited Liability (1996) (Working Paper No. 129, John M. Olin Program in Law and Economics, Stanford Law School) (unpublished manuscript, on file with the author) (purporting to prove, from data on German firms, that "riskier firms tend to organize as limited liability firms, controlling for firm size and entrepreneur characteristics"). Professor Robert Hamilton identifies isolation from the liabilities potentially generated by risky enterprises as the principal reason for maintaining the separate corporations in a corporate group. He also has identified the following as reasons for some separations: tradition; the desire for a separate board and officers; avoiding the jurisdiction of foreign courts; meeting minimum local ownership requirements in foreign countries; blocking the use of names and trademarks by others; and reducing the expenses of transferring the business of a subsidiary upon sale. Telephone Interview with Robert W. Hamilton, Minerva House Drysdale Regents Chair, University of Texas School of Law (July 6, 1995).
107. In our study of the 43 largest bankruptcy reorganization cases of the 1980s, Professor Whitford and I found nine cases - Anglo Energy, Braniff Airlines, Charter Company, Combustion Equipment, Dreco Energy, Evans Products, FSC Corp., HRT, Manville Forest Products, Penn-Dixie, and Wickes Companies - in which the percentage recoveries of unsecured creditors varied substantially depending on which wholly owned member of the corporate group owed the debt. See Lynn M. LoPucki & William C. Whitford, Valuation Spreadsheets (various dates in 1988) (unpublished calculations, on file with author). These statistics may understate this strategy's importance because some members of corporate groups remained outside bankruptcy and paid their creditors 100 cents on the dollar while others paid less. See also In re Silicone Gel Breast Implants Prods. Liab. Litig., 837 F. Supp. 1128, 1138 (N.D. Ala. 1993) (refusing to disregard corporate entity of bankrupt Dow Corning to reach parent companies). But see In re Silicone Gel Breast Implants Prods. Liab. Litig., 887 F. Supp. 1455, 1460 (N.D. Ala. 1995) (vacating summary judgment in part to consider holding one parent company liable on "negligent undertaking" theory).
108. For a brief survey of such argument, see Stephen B. Presser, Thwarting the Killing of the Corporation: Limited Liability, Democracy, and Economics, 87 NW. U.L. REV. 148, 173 (1992). See also Thompson, supra note 78, at 35 ("Analyzing the parent-subsidiary cases under the economic factors discussed earlier . . . the case for limited liability, is, if anything, less persuasive.").
109. Note, Liability of a Corporation for Acts of a Subsidiary or Affiliate, 71 HARV. L. REV. 1122, 1131 (1958); see Phillip I. Blumberg, Limited Liability and Corporate Groups, 11 J. CORP. L. 573, 575-76 (1986) (arguing that limited liability within corporate groups is neither historically nor economically justified).
110. Note, Liability of a Corporation for Acts of a Subsidiary or Affiliate, 71 HARV. L. REV. 1122, 1131 (1958); see Phillip I. Blumberg, Limited Liability and Corporate Groups, 11 J. CORP. L. 573, 575-76 (1986) (arguing that limited liability within corporate groups is neither historically nor economically justified).
111. See Robert B. Thompson, Piercing the Corporate Veil: An Empirical Study, 76 CORNELL L. REV. 1036, 1055 (1991) (786 cases disregard to charge individual shareholders, 637 sought disregard to charge corporations).
112. Id. (showing peircing rate of 43% against individual shareholders and piercing rate 37% against corporate shareholders).
113. See Thompson, supra note 78, at 23 ("[T]he percentage of courts piercing the veil in tort cases within corporation groups (26.32%) is even less than in all tort cases (30.97%) or all cases involving corporate groups (37.31%)."). Professor Thompson concludes that "there remains a perplexing judicial reluctance to hold a corporate parent liable for the obligations of its subsidiaries when the parent possesses both the opportunity to control and the potential to share in residual earnings of a subsidiary." Id. at 5.
114. See, e.g., NLRB v. Fullerton Transfer & Storage Ltd., 910 F.2d 331, 336-39 (6th Cir. 1990) (upholding division of single business among three corporations - one to hire truck drivers, one to own trucks, and one to own real estate - and refusing to enforce NLRB back-pay order, obtained against corporation that hired drivers, against corporations that owned assets); PHILLIP I. BLUMBERG, THE LAW OF CORPORATE GROUPS: PROBLEMS IN THE BANKRUPTCY OR REORGANIZATION OF PARENT AND SUBSIDIARY CORPORATIONS, INCLUDING THE LAW OF CORPORATE GUARANTIES 7, 699-703 (1985) (arguing for use of "enterprise" concept but acknowledging that "entity" concept, which allows disregard only in "exceptional" cases, remains rule in cases involving principle of limited liability).
115. See, e.g., Alberto v. Diversified Group, Inc., 55 F.3d 201, 205 (5th Cir. 1995) (holding that no single factor can justify decision to disregard in Delaware); In re Vermont Toy Works, 82 B.R. 258, 307 (Bankr. D. Vt. 1987) ("'The conclusion to disregard the corporate entity may not, however, rest on a single factor, whether undercapitalization . . . or what-not . . . .'") (quoting DeWitt Truck Brokers v. W. Ray Flemming Fruit Co., 540 F.2d 681, 687 (4th Cir. 1976)); see also Presser, supra note 80, at 165-66 (arguing that undercapitalization alone is not regarded by courts as sufficient grounds for disregard of corporate entity).
116. ROBERT C. CLARK, CORPORATE LAW 74 (1986). It is also worth noting that the doctrine of undercapitalization refers only to the initial capitalization of the corporation. See Presser, supra note 80. at 165. Debtors employing the parent-subsidiary strategy may be able to avoid disregard by the simple strategy of initially providing a capitalization which later becomes inadequate by reason of business losses or a change in the nature of the business. Capital withdrawal that left an initially adequately capitalized corporation undercapitalized would arguably be a fraudulent transfer. See UNIF. FRAUDULENT TRANSFER ACT § 4(a), 7A U.L.A. 652 (1985). The judgment creditor's remedies for fraudulent transfer are considerably less effective than those available through disregard of the corporate entity. See infra notes 111-16 and accompanying text.
117. ROBERT C. CLARK, CORPORATE LAW 74 (1986). It is also worth noting that the doctrine of undercapitalization refers only to the initial capitalization of the corporation. See Presser, supra note 80. at 165. Debtors employing the parent-subsidiary strategy may be able to avoid disregard by the simple strategy of initially providing a capitalization which later becomes inadequate by reason of business losses or a change in the nature of the business. Capital withdrawal that left an initially adequately capitalized corporation undercapitalized would arguably be a fraudulent transfer. See UNIF. FRAUDULENT TRANSFER ACT § 4(a), 7A U.L.A. 652 (1985). The judgment creditor's remedies for fraudulent transfer are considerably less effective than those available through disregard of the corporate entity. See infra notes 111-16 and accompanying text.
118. One such factor would be the exercise of direct control over the operational decisions made by the subsidiary. See In re Silicone Gel Breast Implants Prods. Liab. Litig., 837 F. Supp. 1123 (N.D. Ala. 1993) (finding insufficient direct control to disregard corporate entity).
119. By this method, the strategist defeats only involuntary and unsophisticated creditors. Sophisticated lenders will require personal guarantees from the owners. See supra text accompanying note 15.
120. See, e.g., Steven L. Schwarcz, The Alchemy of Asset Securitization, 1 STAN. J.L. BUS. & FIN. 133, 133 n.1 (1994) (defining asset securitization as "a company's use of cash flows from its assets to raise funding"). Shenker & Colletta define asset securitization as: [t]he sale of equity or debt instruments, representing ownership interests in, or secured by, a segregated, income-producing asset or pool of assets, in a transaction structured to reduce or reallocate certain risks inherent in owning or lending against the underlying assets and to ensure that such interests are more readily marketable and, thus, more liquid than ownership interests in and loans against the underlying assets. Shenker & Colletta, supra note 7, at 1374-75.
121. Throughout this Section I refer to the originator of the asset-securitization transaction as the "debtor." The parties to an asset-securitization transaction would not use that term because they seek to create an owner-account servicer relationship rather than a debtor-creditor relationship. The difference between the two relationships is, however, minimal and does not, in my opinion, justify the confusion that would be created by referring to the user of secured credit as a borrower and the user of assets securitization as an "originator" or some such term.
122. These entities are sometimes referred to as "special purpose vehicles" or "SPVs." See Schwarcz, supra note 90, at 135-36 (describing use of "special purpose vehicles" in asset-securitization transactions).
123. See, e.g., Fred Vogelstein, Credit Cards Fuel Asset-Backed Issues, WALL ST. J., Oct. 30, 1995, at C1 (reporting that original issuance of asset-backed bonds grew at annual rate of 36% for previous two years).
124. See Shenker & Colletta, supra note 7, at 1380-81 & n.49.
125. See 80 FED. RESERVE BULL. A-40 tbl. 1.5 ll. 5, 12 (Feb. 1994).
126. Id. at tbl. 1.57 ll. 29, 52.
127. See Changes in Our Financial System: Globalization of Capital Markets and Securitization of Credit: Hearings Before the Senate Comm. on Banking, Housing, and Urban Affairs, 100th Cong. 137 (1987) (statement of Lowell L. Bryan) (explaining that such increases are made possible by benefits to players and sheer superiority of technology).
128. See Douglas G. Baird, Security Interests Reconsidered, 80 VA. L. REV. 2249, 2267-69 (1994) (recognizing that sales of accounts produce same problems as assignment of accounts as security and advocating public notice through filing for both); Mann, supra note 75, manuscript at 13 n.35 (reporting interviews in which debtors indicate that they regard borrowing and selling assets as functionally equivalent methods of financing); Paul M. Shupack, On Boundaries and Definitions: A Commentary on Dean Baird, 80 VA. L. REV. 2273, 2294-300 (1994) (criticizing Baird's filing proposals as unnecessary and impractical).
129. See Douglas G. Baird, Security Interests Reconsidered, 80 VA. L. REV. 2249, 2267-69 (1994) (recognizing that sales of accounts produce same problems as assignment of accounts as security and advocating public notice through filing for both); Mann, supra note 75, manuscript at 13 n.35 (reporting interviews in which debtors indicate that they regard borrowing and selling assets as functionally equivalent methods of financing); Paul M. Shupack, On Boundaries and Definitions: A Commentary on Dean Baird, 80 VA. L. REV. 2273, 2294-300 (1994) (criticizing Baird's filing proposals as unnecessary and impractical).
130. See Thompson, supra note 78, at 9, 29, 34, 40 (arguing that courts have been rightly reluctant to impose liability on passive shareholders, both in veil-piercing cases and failed leveraged buyouts, and concluding that "the insulation of limited liability should remain undisturbed for passive shareholders").
131. See, e.g., NLRB v. Fullerton Transfer & Storage Ltd., 910 F.2d 331, 333, 341-42 (6th Cir. 1990) (upholding division of single business among three corporations - one to hire truck drivers, one to own trucks, and one to own real estate - and refusing to enforce NLRB back-pay order, obtained against corporation that hired drivers, against corporations that owned assets).
132. If courts showed any inclination to hold bankruptcy-remote vehicles to the liability of their sellers, strategist-originators of future asset-securitization transactions could omit the bankruptcy-remote vehicles from the transactions. Public investors would then be direct owners of the securitized assets of large corporations. Courts should be no more willing to disregard such a transaction than they are to disregard the entity of a publicly held company - which they apparently have never done. See Presser, supra note 80, at 158 & n.36 (discussing literature and concluding that no court has pierced corporate veil of publicly held company).
133. Shenker & Colletta, supra note 7, at 1380.
134. J. Paul Forrester et al., Securitization of Project Finance Loans and Other Private Sector Infrastructure Loans, FINANCIER: ACMT, 1994, at 7-10.
135. See Schwarcz, supra note 90, at 152. Shenker and Colletta state that securitization of raw land that is not income producing also is "conceivable." Shenker & Colletta, supra note 7, at 1376 n.27; see also Vogelstein, supra note 93, at C18 (reporting deal in which cows are securitized and payments to investors "come from the sale of the fattened cattle for slaughter").
136. Cf. You Can Securitize Virtually Everything, BUS. WK., July 20, 1992, at 78 (discussing rapid growth of securitized finance and quoting Wall Street manager as saying "imagination is our only constraint - and time, because you can't chase every deal"); Charles Gasparino, Now They're Thinking of Investing in Deadbeat Dads, WALL ST. J., June 12, 1996, at C1 (reporting proposal from Morgan Stanley & Co. to New York City to securitize alimony and child support arrearages by issuing municipal bonds backed by security interest in arrearages).
137. Cf. You Can Securitize Virtually Everything, BUS. WK., July 20, 1992, at 78 (discussing rapid growth of securitized finance and quoting Wall Street manager as saying "imagination is our only constraint - and time, because you can't chase every deal"); Charles Gasparino, Now They're Thinking of Investing in Deadbeat Dads, WALL ST. J., June 12, 1996, at C1 (reporting proposal from Morgan Stanley & Co. to New York City to securitize alimony and child support arrearages by issuing municipal bonds backed by security interest in arrearages).
138. Bank accounts are subject to wide, rapid fluctuations in amount. But the debtor might be able to deal with the problem by guaranteeing the bankruptcy-remote entity a fixed balance and assuring its own performance by providing "credit enhancement facilities" such as bank letters of credit or surety bonds. See Schwarcz, supra note 90, at 139-40 (discussing credit enhancement facilities).
139. Companies rarely dispose of all assets that a judgment creditor might reach. Disposing of nearly all assets is almost as effective and is much easier. It follows that judgment proofing is not something that particular companies have or have not accomplished, but something that nearly all companies have accomplished to one degree or another. Later, I use the term "hard" judgment proofing to refer to situations where the judgment creditor can reach only nominal asset values and the term "soft" judgment proofing to refer to situations in which the judgment creditor can reach assets of substantial value, but insufficient value to satisfy the judgment. To hard judgment proof Exxon would appear to leave it without the cash necessary to conduct its business. But Zero-Asset Exxon could solve that problem by borrowing whatever cash it needed to operate and allowing the lender to retain a right of set-off or a security interest in its cash and deposit accounts. See U.C.C. §§ 9-304(1) 9-305 (1992) (providing for perfection of security interests in money and instruments); 11 U.S.C. § 506(a) (1994) (treating right of set-off as equivalent to security interest for purposes of determining secured claims in bankruptcy); In re Housecraft Indus., USA, 155 B.R. 79, 93 (Bankr. D. Vt. 1993) (illustrating perfection of security interest in deposit accounts by giving written notice to depositary banks).
140. To avoid taxation, the actual form of the distributions is likely to be more complex than cash dividends, but I assume cash dividends for simplicity of presentation. Few asset-securitization transactions today are followed by a distribution of the proceeds to shareholders. But see Holiday Corporation Announces Finalization of Recapitalization Financing, BUS. WIRE, Apr. 16, 1987 (describing transaction in which Holiday Corporation borrowed $1.225 billion and immediately distributed part of financing in $65-per-share dividend to shareholders). "Exxon" in this illustration distributes the proceeds to demonstrate the iudgment-proofing potential of asset securitization in its simplest, most direct form. The typical purpose of an asset-securitization transaction today is to remedy a working capital deficiency, to replace more expensive financing, or to acquire the working capital necessary for expansion of the company's operations. The proceeds either remain with the company or are used to retire other financing. Even so, the effect of these transactions is to reduce the ratio of available assets to potential liability, thereby "soft" judgment proofing the companies that engage in them. See supra note 107. These transactions soft judgment proof the company in a manner similar to secured lending but to a somewhat greater degree. Secured lenders usually require that the debtor retain equity in the asset that serves as collateral; that equity will be available to lower priority creditors. The point of asset securitization is that the debtor retains no significant equity. This makes asset securitization superior to secured lending to "hard" judgment proofing because it will defeat all or substantially all of the company's liabilities. Hard and soft judgment proofing are discussed further infra at text accompanying notes 203-04.
141. Its finances do not. From its revenues, Exxon would make periodic payments for the continued use of the assets it sold. A downturn in the business could throw Exxon into bankruptcy and its managers out into the job market. In modern finance theory, however, this is considered a positive feature of the financial structure rather than a problem with it. See infra notes 171-84 and accompanying text.
142. It is interesting to speculate on who would choose to own the shares in such a company. The share would be a high risk investment because the company would be bankruptcy prone, and, if bankruptcy results, the shares likely would be extinguished in return for only nominal compensation. See Lynn M. LoPucki & William C. Whitford, Bargaining Over Equity's Share in the Bankruptcy Reorganization of Large, Publicly Held Companies, 139 U. PA. L. REV. 125, 141-43 (1990) (showing mostly nominal recoveries for shareholders of insolvent companies in bankruptcy reorganization). The right to control Zero-Asset Exxon might be a substantial part of the value of the shares. If so, perhaps the type of firm that would place the highest value on the shares would be a management company that would attempt to keep Zero-Asset Exxon out of bankruptcy.
143. UNIF. FRAUDULENT TRANSFER ACT § 4(a)(1), 7A U.L.A. 652 (1985). An asset securitization, however, clearly would not be avoidable under § 4(a)(2). That section provides that: A transfer made . . . by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or after the transfer was made . . . , if the debtor made the transfer . . . without receiving a reasonably equivalent value in exchange for the transfer . . . , and the debtor: (i) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or (ii) intended to incur, or believed or reasonably should have believed that he [or she] would incur, debts beyond his [or her] ability to pay as they became due. Id. That the transaction is at arms length between the debtor and the public investors demonstrates that the debtor receives a reasonably equivalent value in an asset securitization.
144. See id. § 8(a) ("A transfer . . . is not voidable under Section 4(a)(1) against a person who took in good faith and for a reasonably equivalent value or against any subsequent transferee . . . .").
145. That liability for wrongful execution is the primary legal remedy available to defend a structure designed to defeat liability is ironic. If the attacker is judgment proof, the defender will have to be content with an injunction against future interferences with its property.
146. See UNIF. FRAUDULENT TRANSFER ACT § 4(a)(2)(i), 7A U.L.A. 653 (1985) (providing that transfer is fraudulent "if the debtor made the transfer . . . without receiving a reasonably equivalent value in exchange for the transfer . . . and the debtor . . . was engaged or was about to engage in a business . . . for which the remaining assets of the debtor were unreasonably small in relation to the business").
147. See infra notes 240-41 and accompanying text (discussing difficulty of enforcing liability against individual shareholders of publicly held company).
148. Even though Zero-Asset Exxon would remain solvent after the dividend, it could be argued that payment of the dividend was a fraudulent transfer under UNIF. FRAUDULENT TRANSFER ACT § 4(a)(2), 7A U.L.A. 653 (1985). But the statute of limitations would run on claims under that section four years after payment of the dividend. Id. § 9(b).
149. Grundfest hints at the development of such a division in response to shareholder unlimited liability, calling it a "clientele effect." See Joseph A. Grundfest, The Limited Future of Unlimited Liability: A Capital Markets Perspective, 102 YALE L.J. 387, 393 (1992) ("The result is a separating equilibrium in which no investor whose assets can be reached under a proportionate liability regime holds shares that could expose her to that risk.").
150. By "business securitization" I mean the sale of traditional interests in or claims against the business, such as stock or unsecured bonds. Asset securitization, by contrast, is a claim against the assets, not the business.
151. Schwarcz, supra note 90.
152. Id. at 148.
153. Id. at 151.
154. That is, absent the availability of asset securitization as a financing device, these types of companies would finance through unsecured debt. I do not mean to assert that the companies generally are using the proceeds of asset securitization to retire unsecured debt, though some probably are.
155. See, e.g., Committee on Bankr. & Corp. Reorg. of the Assoc. of the Bar of the City of N.Y., Structured Financing Techniques, 50 BUS. LAW. 527, 530-31 (1995) [hereinafter Structured Financing Techniques] ("Not only is the credit rating of the financing likely to be enhanced, but also the cost of the financing in the capital markets may be less than the cost of comparable financing in the bank or insurance company private market.").
156. See, e.g., Committee on Bankr. & Corp. Reorg. of the Assoc. of the Bar of the City of N.Y., Structured Financing Techniques, 50 BUS. LAW. 527, 530-31 (1995) [hereinafter Structured Financing Techniques] ("Not only is the credit rating of the financing likely to be enhanced, but also the cost of the financing in the capital markets may be less than the cost of comparable financing in the bank or insurance company private market.").
157. There could be other explanations. For example, bankruptcy reorganization may be an inefficient means for dealing with financial distress. See, e.g., Douglas G. Baird, The Uneasy Case for Corporate Reorganizations, 15 J. LEGAL STUD. 127 (1986) (asserting that bankruptcy liquidation may be more efficient than bankruptcy reorganization); Christopher W. Frost, Structured Finance and Corporate Risk Allocation 32 (May 23, 1996) (unpublished manuscript, on file with author) ("If the bankruptcy process is inefficient, structured finance may be a means by which all investors could make a binding promise to avoid the process (at least with respect to the securitized assets)."). But see Lynn M. LoPucki & William C. Whitford, Corporate Governance in the Bankruptcy Reorganization of Large, Publicly Held Companies, 141 U. PA. L. REV. 669, 753-67 (1993) (presenting data indicating that bankruptcy liquidation would be less efficient).
158. There could be other explanations. For example, bankruptcy reorganization may be an inefficient means for dealing with financial distress. See, e.g., Douglas G. Baird, The Uneasy Case for Corporate Reorganizations, 15 J. LEGAL STUD. 127 (1986) (asserting that bankruptcy liquidation may be more efficient than bankruptcy reorganization); Christopher W. Frost, Structured Finance and Corporate Risk Allocation 32 (May 23, 1996) (unpublished manuscript, on file with author) ("If the bankruptcy process is inefficient, structured finance may be a means by which all investors could make a binding promise to avoid the process (at least with respect to the securitized assets)."). But see Lynn M. LoPucki & William C. Whitford, Corporate Governance in the Bankruptcy Reorganization of Large, Publicly Held Companies, 141 U. PA. L. REV. 669, 753-67 (1993) (presenting data indicating that bankruptcy liquidation would be less efficient).
159. There could be other explanations. For example, bankruptcy reorganization may be an inefficient means for dealing with financial distress. See, e.g., Douglas G. Baird, The Uneasy Case for Corporate Reorganizations, 15 J. LEGAL STUD. 127 (1986) (asserting that bankruptcy liquidation may be more efficient than bankruptcy reorganization); Christopher W. Frost, Structured Finance and Corporate Risk Allocation 32 (May 23, 1996) (unpublished manuscript, on file with author) ("If the bankruptcy process is inefficient, structured finance may be a means by which all investors could make a binding promise to avoid the process (at least with respect to the securitized assets)."). But see Lynn M. LoPucki & William C. Whitford, Corporate Governance in the Bankruptcy Reorganization of Large, Publicly Held Companies, 141 U. PA. L. REV. 669, 753-67 (1993) (presenting data indicating that bankruptcy liquidation would be less efficient).
160. Even when the asset securitization replaces secured debt, the debtor obtains an advantage. Claims of ownership get full respect in bankruptcy, while the claims of secured creditors do not. See Bebchuk & Fried, supra note 74, at 871 (arguing that "certain features of Chapter 11 reorganizations tend either to waste value or to enrich junior claimants at the expense of secured creditors").
161. See Structured Financing Techniques, supra note 123, at 565-67.
162. On May 27, 1993, the Tenth Circuit Court of Appeals ruled that accounts sold to a third party prior to bankruptcy remained property of the debtor and were part of the bankruptcy estate. See Octagon Gas Sys., Inc. v. Rimmer, 995 F.2d 948 (10th Cir. 1993). As applied to asset securitizations involving accounts, the effect of Octagon Gas would have been to render the securitized accounts property of the bankruptcy estate. Asset securitization then would have failed in its essential purpose. In less than two weeks, the Permanent Editorial Board for the Uniform Commercial Code issued Commentary No. 14, U.C.C. § 9-102(1)(b), referring to the holding as "erroneously stated." Commentators have criticized the decision for its potential to interfere with asset securitization. See Baird, supra note 98, at 2267 n.42 (criticizing Octagon Gas for making sales of accounts more difficult). Since Octagon, the issue has not arisen in a reported case.
163. See, e.g., Schwarcz, supra note 90, at 151 (arguing, in essence, that securitization reduces net financing costs for debtor "[b]y eliminating the risk of bankruptcy to [the bankruptcy-remote entity's] investors"); see also Gregory R. Salath, Note, Reducing Health Care Costs Through Hospital Accounts Receivable Securitization, 80 VA. L. REV. 549, 559-60 (1994) ("The savings available through securitization depend on the insulation of the collateralized receivables from bankruptcy.").
164. See supra notes 28-30 and accompanying text.
165. See, e.g., In re Huth, 122 B.R. 724, 726 (Bankr. E.D. Mo. 1988) ("[A] creditor of only one of the debtors does not have a right to execute against property held as tenancy by the entireties.").
166. See, e.g., WARREN & WESTBROOK, supra note 35, at 132-33 ("Only when the value of the [collateral] exceeds the sum of the allowed secured claim and the debtor's exemption, would the [trustee in bankruptcy] be able to reach any value from the property.").
167. For a typical statute so providing, see WIS. STAT. ANN. § 815.18(h) (West 1994) ("'Exempt' means free from any lien obtained by judicial proceedings and is not liable to seizure or sale on execution or on any provisional or final process issued for any court, or any proceedings in aid of court process.").
168. See 11 U.S.C. § 522(b)-(c) (1994).
169. See In re Reed, 12 B.R. 41 (Bankr. N.D. Tex. 1981) (holding, based on comparison of language used by Texas legislature in personal property and homestead exemption statutes, that Texas legislature intended to permit debtors who acquire homesteads through fraud to retain them). But see In re Reed, 700 F.2d 986 (5th Cir. 1983) (denying Reed's discharge for fraud but still allowing him to retain fraudulently acquired homestead).
170. See 3 COMMISSION ON THE BANKR. LAWS OF THE U.S. REP. 55 (1973) ("[T]he panel is very strongly agreed as to the desirability of making exemption rules uniform throughout the nation . . . and of doing this by establishing a national exemption law . . . .").
171. See 11 U.S.C. § 522(d) (establishing "federal exemption" applicable in bankruptcy cases); id. § 522(b) (giving debtors right to choose between federal exemption and exemption available to them under state law).
172. S. REP. NO. 95-989, at 4 (1978).
173. See, e.g., COLEMAN, supra note 22, at 234-36 (explaining how Georgia attitudes that led to abolition of debtors' prisons also led to protection of homesteads beginning in 1845).
174. See LoPucki, The Law in Lawyers' Heads, supra note 12, at 1522-24.
175. To counter this strategy, the system provides for prejudgment attachment as an exception to the principle of enforcement only after judgment. The exception makes little practical difference, however, because its use is highly restricted, and creditors are seldom able to anticipate the debtor's removal strategy. See supra notes 39-41 and accompanying text.
176. See supra text accompanying note 42.
177. See, e.g., PETER SPERO, ASSET PROTECTION: LEGAL PLANNING AND STRATEGIES (1993); Savanna Mapelli, Judgment Proofing Your Wealthy Clients, N.J. L.J., Dec. 12, 1994, at 10, 32 ("The key is to choose a foreign jurisdiction that does not recognize U.S. judgments under the doctrine of comity."). The United States currently is not a party to any treaties for the enforcement of judgments. See supra note 42.
178. See, e.g., PETER SPERO, ASSET PROTECTION: LEGAL PLANNING AND STRATEGIES (1993); Savanna Mapelli, Judgment Proofing Your Wealthy Clients, N.J. L.J., Dec. 12, 1994, at 10, 32 ("The key is to choose a foreign jurisdiction that does not recognize U.S. judgments under the doctrine of comity."). The United States currently is not a party to any treaties for the enforcement of judgments. See supra note 42.
179. See Bureau of Nat'l Affairs, International Taxes, Treasury 'Scrambling' to Issue International Regulations, Official Says, DAILY REP. FOR EXECUTIVES, Jan. 17, 1992, at G-6 ("Asset-protection trusts in such jurisdictions as the Bahamas, Gibraltar, and the Cayman Islands are being marketed, often on a 'cookie cutter' basis . . . ."); Mapelli, supra note 142, at 32 (naming Bahamas, Belize, Bermuda, Cayman Islands, Cook Islands, Cyprus, Gibraltar, and Turks and Caicos Islands as countries where "legislators . . . have drafted special asset-protection trust legislation in order to attract the offshore trust business"); Gideon Rothschild, Asset Preservation: Legal and Ethical Strategies, N.Y. L.J., Mar. 11, 1994, at 1, 11 n.2 (naming same countries as "having statutes favorable to asset protection trusts," and naming British Virgin Islands, Isle of Man, Jersey, Liechtenstein, and Malta as "among the offshore financial centers . . . not usually considered as desirable for asset protection trusts").
180. See Bureau of Nat'l Affairs, International Taxes, Treasury 'Scrambling' to Issue International Regulations, Official Says, DAILY REP. FOR EXECUTIVES, Jan. 17, 1992, at G-6 ("Asset-protection trusts in such jurisdictions as the Bahamas, Gibraltar, and the Cayman Islands are being marketed, often on a 'cookie cutter' basis . . . ."); Mapelli, supra note 142, at 32 (naming Bahamas, Belize, Bermuda, Cayman Islands, Cook Islands, Cyprus, Gibraltar, and Turks and Caicos Islands as countries where "legislators . . . have drafted special asset-protection trust legislation in order to attract the offshore trust business"); Gideon Rothschild, Asset Preservation: Legal and Ethical Strategies, N.Y. L.J., Mar. 11, 1994, at 1, 11 n.2 (naming same countries as "having statutes favorable to asset protection trusts," and naming British Virgin Islands, Isle of Man, Jersey, Liechtenstein, and Malta as "among the offshore financial centers . . . not usually considered as desirable for asset protection trusts").
181. The Restatement reads: (1) Where a person creates for his own benefit a trust with a provision restraining the voluntary or involuntary transfer of his interest, his transferee or creditors can reach his interest. (2) Where a person creates for his own benefit a trust for support or a discretionary trust, his transferee or creditors can reach the maximum amount which the trustee under the terms of the trust could pay to him or apply for his benefit. RESTATEMENT (SECOND) OF TRUSTS § 156 (1957). For a more extensive discussion of U.S. policy against self-settled spendthrift trusts, see Elena Marly-Nelson, Offshore Asset Protection Trusts: Having Your Cake and Eating It Too, 47 RUTGERS L. REV. 11, 28-56 (1994).
182. The Restatement reads: (1) Where a person creates for his own benefit a trust with a provision restraining the voluntary or involuntary transfer of his interest, his transferee or creditors can reach his interest. (2) Where a person creates for his own benefit a trust for support or a discretionary trust, his transferee or creditors can reach the maximum amount which the trustee under the terms of the trust could pay to him or apply for his benefit. RESTATEMENT (SECOND) OF TRUSTS § 156 (1957). For a more extensive discussion of U.S. policy against self-settled spendthrift trusts, see Elena Marly-Nelson, Offshore Asset Protection Trusts: Having Your Cake and Eating It Too, 47 RUTGERS L. REV. 11, 28-56 (1994).
183. See William J. Zink, Assets of Foreign Grantor Trust Not Includible in Grantor's U.S. Gross Estate, TAX ADVISER, Feb. 1994, at 84.
184. Most lawyers who specialize in offshore asset-protection planning discourage planning designed to defeat present creditors. See, e.g., Mapelli, supra note 142, at 32 ("[A]n attorney should not assist a client in transferring assets to a foreign situs trust if the client already is a judgment debtor or if litigation is pending or a threat of suit has been made.").
185. See Thomas S. Carles, Asset Protection Trusts: Potent Claims Shields, N.J. L.J., Nov. 8, 1993, at 10 ("[T]he trustee usually is a recognized international banking institution."). To assure control over the trust, some lawyers recommend that the doctor name family members or associates as cotrustees; when "a threat of a claim appears on the horizon the foreign trustee has the power, pursuant to the trust agreement, to remove the domestic trustee(s) (to protect them from any potential court order).· Rothschild, supra note 143, at 4.
186. See Cook Islands International Trusts Act 1984 § 2 (as amended 1991), reprinted in LEWIS D. SOLOMON & LEWIS J. SARET, ASSET PROTECTION STRATEGIES 361 (1993) [hereinafter Cook Islands International Trusts Act] (defining "'protector' in relation to international trust [to mean] person who is the holder of power which when invoked is capable of directing trustee in matters relating to trust and in respect of which matters trustee has discretion and includes person who is holder of power of appointment or dismissal of trustees"); Rothschild, supra note 143, at 4 ("The Cook Islands, for example, has expanded the traditional scope of a protector's power by providing that the settlor may be a protector and may have certain powers over the trustees. These powers include the power to remove and replace trustees and veto investment and distribution decisions . . . ."). An example of a "typical trust protector veto power provision" appears in HOWARD D. ROSEN, ASSET PROTECTION PLANNING A-13-14 (1994).
187. See Cook Islands International Trusts Act 1984 § 2 (as amended 1991), reprinted in LEWIS D. SOLOMON & LEWIS J. SARET, ASSET PROTECTION STRATEGIES 361 (1993) [hereinafter Cook Islands International Trusts Act] (defining "'protector' in relation to international trust [to mean] person who is the holder of power which when invoked is capable of directing trustee in matters relating to trust and in respect of which matters trustee has discretion and includes person who is holder of power of appointment or dismissal of trustees"); Rothschild, supra note 143, at 4 ("The Cook Islands, for example, has expanded the traditional scope of a protector's power by providing that the settlor may be a protector and may have certain powers over the trustees. These powers include the power to remove and replace trustees and veto investment and distribution decisions . . . ."). An example of a "typical trust protector veto power provision" appears in HOWARD D. ROSEN, ASSET PROTECTION PLANNING A-13-14 (1994).
188. See Cook Islands International Trusts Act 1984 § 2 (as amended 1991), reprinted in LEWIS D. SOLOMON & LEWIS J. SARET, ASSET PROTECTION STRATEGIES 361 (1993) [hereinafter Cook Islands International Trusts Act] (defining "'protector' in relation to international trust [to mean] person who is the holder of power which when invoked is capable of directing trustee in matters relating to trust and in respect of which matters trustee has discretion and includes person who is holder of power of appointment or dismissal of trustees"); Rothschild, supra note 143, at 4 ("The Cook Islands, for example, has expanded the traditional scope of a protector's power by providing that the settlor may be a protector and may have certain powers over the trustees. These powers include the power to remove and replace trustees and veto investment and distribution decisions . . . ."). An example of a "typical trust protector veto power provision" appears in HOWARD D. ROSEN, ASSET PROTECTION PLANNING A-13-14 (1994).
189. See Cook Islands International Trusts Act 1984 § 2 (as amended 1991), reprinted in LEWIS D. SOLOMON & LEWIS J. SARET, ASSET PROTECTION STRATEGIES 361 (1993) [hereinafter Cook Islands International Trusts Act] (defining "'protector' in relation to international trust [to mean] person who is the holder of power which when invoked is capable of directing trustee in matters relating to trust and in respect of which matters trustee has discretion and includes person who is holder of power of appointment or dismissal of trustees"); Rothschild, supra note 143, at 4 ("The Cook Islands, for example, has expanded the traditional scope of a protector's power by providing that the settlor may be a protector and may have certain powers over the trustees. These powers include the power to remove and replace trustees and veto investment and distribution decisions . . . ."). An example of a "typical trust protector veto power provision" appears in HOWARD D. ROSEN, ASSET PROTECTION PLANNING A-13-14 (1994).
190. See ROSEN, supra note 148, at A-12 (providing example of duress provision); Mapelli, supra note 142, at 10 ("The trust documents also must mandate that the trustee ignore instructions made under duress so that if, for example, the U.S. settlor is court ordered to demand the return of assets protected by the trust, the trustee must ignore the settlor's directions.").
191. Planners generally recommend that real estate be deeded to the trust in order to avoid adverse tax consequences in the United States. See, e.g., Rothschild, supra note 143, at 4 (recommending conveyance of family residence or vacation home to trust to maintain mortgage interest deduction). Planners generally recommend that the doctor place the medical practice in a U.S. family limited partnership. As limited partner, the trust holds 99% ownership but has no control except the power to dissolve the partnership. As general partner, the doctor holds 1% ownership but has full control. When a claim threatens, the trust will dissolve the family limited partnership, so that the practice is owned directly by the trust. The family limited partnership is used because it maximizes the doctor's control over the assets and has valuable judgment-proofing characteristics that are beyond the scope of this Article. See ROSEN, supra note 148, at A-4-8 (discussing asset protection aspects of limited partnerships under Revised Uniform Limited Partnership Act of 1976); Barry S. Engel & Ronald L. Rudman, Family Limited Partnerships: New Meaning for "Limited", TR. & EST., July 1993, at 46, 47 (noting that creditor's charging order remedy against interests in limited partnership is much more limited than remedy creditor would have against property that was contributed, but arguing that recent court decisions have eroded protection); Rothschild, supra note 143, at 4.
192. Where the trustee fails to follow an instruction, the doctor could remove the trustee and substitute another. See supra note 148 and accompanying text (discussing powers of trust "protectors").
193. Investment in the United States might give a U.S. court the excuse it needs to apply U.S. law to void the spendthrift aspect of the trust. But the trust could remove the assets from the United States before the U.S. court could discover and attach them, rendering the court's ruling ineffective. See, e.g., Rothschild, supra note 143, at 4 ("Assets may be more at risk of becoming subject to a court's jurisdiction while physically in the U.S. even though they are owned by the trust. However, most individuals prefer not to transfer them offshore until it becomes necessary.").
194. See Priv. Ltr. Rul. 93-32-006 (Aug. 20, 1992); Zink, supra note 145, at 84 (summarizing ruling). But see Elena Marty-Nelson, Taxing Offshore Asset Protection Trusts: Icing on the Cake?, 15 VA. TAX REV. 399 (1996) (arguing existence of minor tax advantages to overseas asset-protection trusts).
195. See, e.g., Article 6 of the Hague Convention on the Law Applicable to Trusts and on Their Recognition ("A trust shall be governed by the law chosen by the settlor."), reprinted in ROSEN, supra note 148, at B-701; Cook Islands International Trusts Act, supra note 148, § 13G(3) ("A term of an international trust that the laws of the Cook Islands are to govern a particular aspect of the trust . . . is valid and effective accordingly.").
196. Oberst v. Oberst, 91 B.R. 97, 101 (Bankr. C.D. Cal. 1988). The full passage reads: While the Court finds it very difficult to locate the exact line between bankruptcy planning and hindering creditors, Congress has decided that the key is the intent of the debtor. If the debtor has a particular creditor or series of creditors in mind and is trying to remove his assets from their reach, this would be grounds to deny the discharge. If the debtor is merely looking to his future wellbeing, the discharge will be granted. This is an uncomfortable test and does not seem equitable, but it is the law. Id. See also Hurlbert v. Shakleton, 560 So. 2d 1276, 1278 (Fla. Dist. Ct. App. 1990) (remanding for finding of specific intent case of medical doctor who transferred his business to make it unreachable by his creditors because, as he explained, "'I wasn't able to get malpractice insurance, and I wanted to cover all the bases.'"). But see Mapelli, supra note 142, at 10 ("[A] foreign situs trust should be a planning tool for an individual fearing litigation but who is not currently involved in litigation as a defendant or even about to become a defendant.").
197. UNIF. FRAUDULENT TRANSFER ACT § 9, 7A U.L.A. 665 (1985) (fixing statute of limitations as four years from time transfer was made for most actions). If the plaintiff's action is based on actual intent to defraud, the plaintiff may bring it "within one year after the transfer . . . was or could reasonably have been discovered by the claimant." Id. An effective strategy for the doctor in this illustration would probably be to notify a malpractice plaintiff of his transfers at the time of the filing of the malpractice action, or even earlier. Plaintiff's counsel may not be aware that the statute of limitations will be running during the malpractice action. Astute plaintiffs counsel should then file the fraudulent transfer action along with the malpractice case, creating a complex litigation environment.
198. See supra note 42 and accompanying text (discussing principle of territoriality).
199. See supra notes 21-23 and accompanying text (discussing principle of enforcement only against property).
200. The U.S. court might, however, have the power to do so if the doctor were served in the main action before leaving the United States. The initial pleading in an action for money damages typically states only a cause of action for money damages. But where state statutes authorize enforcement of a judgment without additional service of process, the courts hold such enforcement constitutional. See Threlkeld v. Tucker, 496 F.2d 1101 (9th Cir. 1974) (permitting enforcement of California judgment against defendant who had consented to jurisdiction of California court, but removed himself from state prior to entry of judgment); Smith v. O'Byrne, 831 P.2d 709 (Or. App. 1992) (holding that Oregon court could conduct sale of intangible property of judgment debtor even though judgment debtor had removed himself from Oregon prior to entry of judgment and property was not located in Oregon).
201. See Cook Islands International Trusts Act, supra note 148, § 13D.
202. Id. § 5 (providing that trust "registered under this Act shall be a valid trust notwithstanding that it may be invalid according to the law of the settlor's domicile or residence or place of current incorporation").
203. See Mapelli, supra note 142, at 32 (suggesting necessity of relitigation of underlying claim). But see Rothschild, supra note 143, at 4 ("Even where a judgment is entered in a U.S. court, many trust-friendly jurisdictions do not honor U.S. judgments that are based on the application of laws contrary to their own substantive laws.").
204. See Mapelli, supra note 142, at 10; see also ROSEN, supra note 148, at A-12-13 (describing flight provisions and setting forth example).
205. See supra note 159.
206. See, e.g., CAL. CIV. PROC. CODE § 482.080 (West 1979 & Supp. 1996) (providing for entry of orders directing debtors to transfer property to levying officer and inclusion in such orders of notice that failure to comply may subject defendant to punishment for contempt of court).
207. See, e.g., United States v. Rylander, 460 U.S. 752, 757 (1983) ("In a civil contempt proceeding such as this, of course, a defendant may assert a present inability to comply with the order in question. . . . Where compliance is impossible, neither the moving party nor the court has any reason to proceed with the civil contempt action."); United States v. Bryan, 339 U.S. 323, 330-31 (1950) ("Ordinarily, one charged with contempt of court for failure to comply with a court order makes a complete defense by proving that he is unable to comply. A court will not imprison a witness for failure to produce documents which he does not have, unless he is responsible for their unavailability . . . ."); FTC v. Blaine, 308 F. Supp. 932, 933 (N.D. Ga. 1970) (stating with respect to documents respondent failed to produce: "However, the respondent can not be said to be 'responsible for their unavailability' if prior to the time he was served with a subpoena to produce the documents he had previously disposed of the same in good faith.").
208. While the settlor as protector has the authority to veto decisions of the trustee, he or she has no authority to take affirmative action. See Mapelli, supra note 142, at 10 ("[I]f, for example, the U.S. settlor is court ordered to demand the return of assets protected by the trust, the trustee must ignore the settlor's directions."); Rothschild, supra note 143, at 4 ("Since the protector's power is a negative power (as opposed to an affirmative power to initiate action) the protector cannot be compelled by a court to take action.").
209. To surrender assets in even a single case might damage the salability of Cook Islands trusts in the United States. Given the importance of the asset-protection trust industry to the Cook Islands, the Cook Islands financial institution that served as trustee would expect to be protected by the Cook Islands courts if it refused to surrender, and punished if it did not. In a contest of wills between a U.S. court determined to force the doctor to retrieve assets and a Cook Islands trustee determined to preserve its country's industry, the trustee clearly would win. The United States has a strong tradition against imprisonment for debt, even when the debtor behaved stupidly in getting into the situation that prevented payment.
210. This point is elaborated infra text accompanying notes 179-81.
211. In our study of the bankruptcy reorganizations of the 1980s, Whitford and I discovered the existence of a settlement norm requiring that everybody at the bargaining table get something, even those clearly lacking an entitlement in adjudication. See LoPucki & Whitford, supra note 110, at 158-60 (discussing norm).
212. For an explanation of how and why this occurs, see LoPucki, supra note 32, at 1903-06, 1931-36. The median firm in the American economy is surprisingly small. For example, the median firm proceeding under Chapter 11 of the Bankruptcy Code in the early 1980s had only about $250,000 in assets. See U.S. DEP'T OF JUSTICE, EXECUTIVE OFFICE FOR U.S. TRUSTEES, AN EVALUATION OF THE U.S. TRUSTEE PILOT PROGRAM FOR BANKRUPTCY ADMINISTRATION 47 (1983). This would suggest that, after adjustment for inflation, the corresponding figure today would be considerably less than $500,000. Even in the Central District of California, a district notorious for its large bankruptcy cases, approximately 45% of the cases fall in the under $1 million categories. See Lisa Hill Fenning & Craig A. Hart, Measuring Chapter II: The Real World of 500 Cases, 4 A.B.I. L. REV. 119, 137 (1996).
213. For an explanation of how and why this occurs, see LoPucki, supra note 32, at 1903-06, 1931-36. The median firm in the American economy is surprisingly small. For example, the median firm proceeding under Chapter 11 of the Bankruptcy Code in the early 1980s had only about $250,000 in assets. See U.S. DEP'T OF JUSTICE, EXECUTIVE OFFICE FOR U.S. TRUSTEES, AN EVALUATION OF THE U.S. TRUSTEE PILOT PROGRAM FOR BANKRUPTCY ADMINISTRATION 47 (1983). This would suggest that, after adjustment for inflation, the corresponding figure today would be considerably less than $500,000. Even in the Central District of California, a district notorious for its large bankruptcy cases, approximately 45% of the cases fall in the under $1 million categories. See Lisa Hill Fenning & Craig A. Hart, Measuring Chapter II: The Real World of 500 Cases, 4 A.B.I. L. REV. 119, 137 (1996).
214. Lack of adequate insurance at even the largest companies in America is commonplace. Manville, Texaco, A.H. Robbins, Union Carbide, Dow Chemical, Smith Manufacturing, and LTV were all in bankruptcy in part because they carried grossly inadequate liability insurance or because their carriers denied liability. See also Youell v. Exxon Corp., 74 F.3d 373 (1996) (describing litigation in which Exxon Corporation's liability insurers seek declaratory judgment that they are not liable for liability arising out of Exxon Valdez oil spill).
215. For example, Hansmann and Kraakman report, on the basis of an interview, that as of 1990: [O]f the roughly 350,000 insurance policies that Aetna writes for the "standard market" - which includes all business firms except the Fortune 500 - one-third have coverage limits of about $300,000 per accident, one-third have limits of about $500,000 per accident, and one-third have limits of about $1 million. In addition, 10% of all firms carry additional "umbrella" coverage. Of the latter firms, half carry $1 million in umbrella coverage per accident, one-quarter carry $2-3 million, and one-quarter - about 2.5% of all firms insured - carry $5 million or more. Hansmann & Kraakman, supra note 76, at 1889 n.25.
216. Small businesses tend to be owned by an individual or a family, and, as noted above, their assets are usually fully encumbered. There is little reason to expect that judgments in excess of policy limits are any more collectible from them than from automobile owners and drivers. One study indicated that only about 1% of automobile accident tort liability payments came from uninsured sources. See ALFRED F. CONARD ET AL., AUTOMOBILE ACCIDENT COSTS AND PAYMENTS 48 (1964). The figure is particularly striking when one considers that many drivers underinsure and an estimated 17.5% of drivers do not insure at all. See infra note 360.
217. See LoPucki & Whitford, supra note 110, at 142, 177 (showing substantial recoveries by unsecured creditors of insolvent companies).
218. See LoPucki, supra note 32, at 1924-25 (describing findings from empirical study of large companies in reorganization); Mann, supra note 75, at 60-61 (citing "the well known fact that the strongest companies use secured debt with relative infrequency").
219. Presser, supra note 80, at 159.
220. See LoPucki, supra note 32, at 1899 ("Security is an agreement between A and B that C take nothing.").
221. See Lynn M. LoPucki & William C. Whitford, Patterns in the Bankruptcy Reorganization of Large, Publicly Held Companies, 78 CORNELL L. REV. 597, 610-11, 618 (1993) (presenting data and concluding that "it was rare for existing shareholders to retain a majority of the reorganization shares").
222. See Stuart C. Gilson, Bankruptcy, Boards, Banks, and Blockholders, 27 J. FIN. ECON. 355, 356 (1990) (finding high CEO turnover during Chapter 11 reorganizations of large companies); LoPucki & Whitford, supra note 124, at 729 (stating that 95% of CEOs in office at time of business failure that led to bankruptcy had lost their positions by confirmation of plan).
223. Debt has been described as a means of controlling managers. See Oliver Hart & John Moore, Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management, 85 AM. ECON. REV. 567-68 (1995) (describing finance literature).
224. As Easterbrook and Fischel have suggested: Managers who have firm-specific investments of human capital cannot diversify the risk of business failure. . . . The purchase of insurance in amounts greater than the amount of the firm's capital is one method of reducing the amount that the firm must pay [managers for personal risk taking]. A firm with insurance against tort claims is less likely to become bankrupt, and thus less likely to impose costs on managers and other employees. Frank H. Easterbrook & Daniel R. Fischel, Limited Liability and the Corporation, 52 U. CHI. L. REV. 89, 107-08 (1985): see LoPucki, supra note 32, at 1930-31 ("By borrowing unsecured, the managers may be sacrificing the best interests of their companies to render their own positions less precarious.").
225. See Thompson, supra note 78, at 2 (1994) ("If the liability is
226. The assumption underlying this conclusion is that the gains from judgment proofing the company - an average of about five million dollars per year, see infra text accompanying note 190 - exceed the value to managers of avoiding Chapter 11 and the accompanying probability that they will lose their jobs. That is, the level of increased compensation the company would have to pay its top managers to accept the higher risk of bankruptcy and job loss that accompanies judgment proofing would be less than five million dollars per year.
227. See 1995 COST OF RISK SURVEY 1.
228. Total liability risk financing costs are the sum of liability insurance premiums and retained liability losses (uninsured losses). Id. at 21.
229. Id.
230. See infra note 225 and accompanying text.
231. See, e.g., John Brecher, A Proud Bird Loses Its Wings, NEWSWEEK, Oct. 3, 1983, at 71 (quoting airline analyst prediction that "[i]f Continental can operate in bankruptcy . . . a lot of airlines are going to go bankruptcy to alter their labor agreements") (alteration in original).
232. Fred Faust, Retailers Tighten Their Belts for a Lean '96, ST. LOUIS POST DISPATCH, Jan. 16, 1996, at 6C (quoting consultant on mergers, acquisitions, and restructurings).
233. See 1995 COST OF RISK SURVEY, supra note 188, at 46 (showing ratios of liability premiums to company revenues to be about eight times as high for $100 million companies (.75%) as for $5 billion companies (.096%)).
234. Id. at 49 (showing liability premiums as percent of revenue to be about 60 times as high for finance banks, savings & loans, and holding companies (.011%) as for real estate, and securities and commodities brokers (.656%)).
235. See Charles Robert Tremper, Compensation for Harm from Charitable Activity, 76 CORNELL L. REV. 401, 420 & n.97 (1991) (observing that during 1987-88 average insurance expenses of United Way agencies and other sources available for property and liability coverages (other than motor vehicle) reached between two and three percent of total operating expenses); Lee Berton, Ledgerdemain? Coopers & Lybrand Revised Notes of Audit a Year After the Fact, WALL ST. J., Nov. 2, 1995, at A1 ("Settlements of [malpractice] suits now devour an astonishing 12% of accounting and auditing revenue at the Big Six accounting firms."); Policing Cabs, SACRAMENTO BEE, Dec. 2, 1994, at B8 (noting that insurance for cab drivers can run as high as $9000 per year).
236. See Charles Robert Tremper, Compensation for Harm from Charitable Activity, 76 CORNELL L. REV. 401, 420 & n.97 (1991) (observing that during 1987-88 average insurance expenses of United Way agencies and other sources available for property and liability coverages (other than motor vehicle) reached between two and three percent of total operating expenses); Lee Berton, Ledgerdemain? Coopers & Lybrand Revised Notes of Audit a Year After the Fact, WALL ST. J., Nov. 2, 1995, at A1 ("Settlements of [malpractice] suits now devour an astonishing 12% of accounting and auditing revenue at the Big Six accounting firms."); Policing Cabs, SACRAMENTO BEE, Dec. 2, 1994, at B8 (noting that insurance for cab drivers can run as high as $9000 per year).
237. See Charles Robert Tremper, Compensation for Harm from Charitable Activity, 76 CORNELL L. REV. 401, 420 & n.97 (1991) (observing that during 1987-88 average insurance expenses of United Way agencies and other sources available for property and liability coverages (other than motor vehicle) reached between two and three percent of total operating expenses); Lee Berton, Ledgerdemain? Coopers & Lybrand Revised Notes of Audit a Year After the Fact, WALL ST. J., Nov. 2, 1995, at A1 ("Settlements of [malpractice] suits now devour an astonishing 12% of accounting and auditing revenue at the Big Six accounting firms."); Policing Cabs, SACRAMENTO BEE, Dec. 2, 1994, at B8 (noting that insurance for cab drivers can run as high as $9000 per year).
238. See, e.g., William J. Cook, An Easy Way out of this Mess, U.S. NEWS & WORLD REP., June 25, 1990, at 14 (reporting decision by Royal Dutch/Shell Oil Company to ship oil to United States on independent tankers "[r]ather than risk being stuck for [liabilities for cleaning up any possible spills]").
239. See infra note 298.
240. See LoPucki, supra note 32, at 1954-58.
241. See MARK R. GREENE ET AL., RISK AND INSURANCE 541, 543 (8th ed. 1992) (explaining that "[i]f each small group were . . . required to pay for its own losses, risk transfer would not be achieved," but also focusing on claims management as another key function of insurers).
242. See Robert J. Gilbert, Playing It Safe in Today's Real Estate Market with Environmental Insurance, MASS. LAW. WKLY., SUPP.: REAL EST., Dec. 5, 1994, at 1, 8 n.2 ("Many companies offer 'insurance' that essentially constitutes a surety bond; the insurer merely guarantees that the handler or transporter will be able to pay damages to third parties up to the amounts required in the financial responsibility law: the handler or transporter typically is obligated to repay the insurer for any amounts paid under the policy.").
243. Even large companies carry relatively low levels of insurance. See 1995 COST OF RISK SURVEY, supra note 188, at 69 (showing mode umbrella/excess liability limits carried by firms with revenues of $100 million to $500 million to be only $31 million to $50 million). In mass tort cases where the liability is in the hundreds of millions or billions of dollars, the insurers commonly deny coverage and litigate. See, e.g., Andrew Blum, Dow Corning Gets Some Cash, NAT'L L.J., Feb. 19, 1996, at A6 (describing litigation between Dow Corning and its insurers over insurers' attempt to void policies for Dow Corning's failure to disclose information about dangers of breast implants).
244. Even large companies carry relatively low levels of insurance. See 1995 COST OF RISK SURVEY, supra note 188, at 69 (showing mode umbrella/excess liability limits carried by firms with revenues of $100 million to $500 million to be only $31 million to $50 million). In mass tort cases where the liability is in the hundreds of millions or billions of dollars, the insurers commonly deny coverage and litigate. See, e.g., Andrew Blum, Dow Corning Gets Some Cash, NAT'L L.J., Feb. 19, 1996, at A6 (describing litigation between Dow Corning and its insurers over insurers' attempt to void policies for Dow Corning's failure to disclose information about dangers of breast implants).
245. "Soft" and "hard" judgment proofing are defined at supra note 107.
246. See, e.g., William A. Klein & Eric M. Zolt, Business Form, Limited Liability, and Tax Regimes: Lurching Toward a Coherent Outcome?, 66 COLO. L. REV. 1001, 1036 (1995) ("[I]t is clear that the rule of limited liability allows incorporated firms to shift to others some of the cost of their economic activity . . . .").
247. See supra note 196 (estimating costs of liability insurance).
248. See supra notes 182-85 and accompanying text (explaining conflict). Ultimately, managers may have no choice. The losses from failure to judgment proof a large debtor will fall on consensual unsecured creditors and shareholders. The impetus to judgment proof them can be expected to come from those groups. Unsecured lenders should demand security; the market for corporate equities should demand securities that evidence direct ownership of the corporation's assets as well as ownership of its operations.
249. See, e.g., Merton H. Miller, Financial Innovation: The Last Twenty Years and the Next, 21 J. FIN. & QUANTITATIVE ANALYSIS 459, 459 (1986) (arguing that "[t]he major impulses to successful financial innovations have come from regulations and taxes" and discussing numerous examples).
250. For discussions of the role of computer technology in recent financial innovation, see Tim S. Campbell, Innovations in Financial Intermediation, 32 BUS. HORIZONS 70, 70 (1989) ("Much of the actual work in financial services involves recording and communicating transactions. The cost of these services is largely a function of the level of computer and communications technology. With the increasing refinement of the microchip, more sophisticated systems for managing financial transactions have become practical."); John D. Finnerty, Financial Engineering in Corporate Finance: An Overview, 17 FIN. MGMT. 14, 29 (1988) ("The innovative financial processes [described in the article] reflect three basic causal factors: . . . (iii) the availability of relatively inexpensive computer technology to facilitate quicker financial transactions.").
251. For discussions of the role of computer technology in recent financial innovation, see Tim S. Campbell, Innovations in Financial Intermediation, 32 BUS. HORIZONS 70, 70 (1989) ("Much of the actual work in financial services involves recording and communicating transactions. The cost of these services is largely a function of the level of computer and communications technology. With the increasing refinement of the microchip, more sophisticated systems for managing financial transactions have become practical."); John D. Finnerty, Financial Engineering in Corporate Finance: An Overview, 17 FIN. MGMT. 14, 29 (1988) ("The innovative financial processes [described in the article] reflect three basic causal factors: . . . (iii) the availability of relatively inexpensive computer technology to facilitate quicker financial transactions.").
252. For example, a debtor and creditor can agree that the loan be repayable "on demand." Until a demand is made, the loan is not overdue. Such a loan can remain outstanding for years. See U.C.C. § 1-208 cmt. (referring to "demand instruments . . . whose very nature permits call at any time with or without reason").
253. See In re Hillsborough Holdings Corp., 166 B.R. 461, 465-66 (Bankr. M.D. Fla. 1994) (describing complex cash management system in which each corporate subsidiary had its own checking account and had discretion to pay its own expenses, but checking accounts balances were maintained at zero by transferring group funds into accounts on daily basis).
254. See, e.g., Southmark Corp. v. Grosz (In re Southmark), 49 F.3d 1111, 1114 (5th Gr. 1995) ("Although each company's receipts and disbursements are commingled in the [cash management system] for cash management purposes, they are segregated for record keeping purposes and can be readily identified."); In re Cardinal Indus. Inc., 116 B.R. 964, 967 (Bankr. S.D. Ohio 1990) ("Funds from different segments of the organization were routinely used to support other operations of the organization. On occasion, funds from cash-rich partnerships were used to support underperforming or immature properties of other partnerships. These intercompany transfers were reflected in the cash management system as advances and reimbursements.").
255. See Schwarcz, supra note 90, at 141-42 ("To achieve a true sale, an originator must limit, if not forego, its right to the residual value of the receivables sold to the SPV. . . . Because the amount of receivables sold may turn out to be greater than what was needed to pay the SPVs securities, the overpayment represents an indirect, but real, cost to the originator."); Steven L. Schwarcz, The Parts Are Greater than the Whole: How Securitization of Divisible Interests Can Revolutionize Structured Finance and Open the Capital Markets to Middle-Market Companies, 1993 COLUM. BUS. L. REV. 139, 153-54 (referring to equity as "over-collateralization" and "cumbersome and expensive solution").
256. See, e.g., Asset Protection Planning: Expert Outlines Advantages of Offshore Trusts to Preserve Assets, 6 INSIGHTS & STRATEGIES, July 23, 1993, at 1, 2 (quoting Ronald L. Rudman that "[w]ith advanced telecommunications and international banking facilities, it is just as easy to hold accounts and assets overseas as it is in another U.S. city").
257. See Peter A. Alces & Robert M. Lloyd, Report of the Uniform Commercial Code Article 9 Filing System Task Force to the Permanent Editorial Board's Article 9 Study Committee 19-25 (1991) (discussing lag in implementation of new technologies in statewide Article 9 filing systems).
258. See id. at 20-21 (noting technological superiority of British Columbia filing system).
259. See Peter A. Alces, Abolish the Article 9 Filing System, 79 MINN. L. REV. 679, 689-93 (1995) (presenting empirical evidence of high cost of filing and searching). But see Mann, supra note 75, at 45-49 (discussing information costs of secured lending); id. at 51-53 (expressing doubt that filing fees alone could be sufficient to alter decision to lend secured or unsecured).
260. See Edward I. Altman, A Further Empirical Investigation of the Bankruptcy Cost Question, 39 J. FIN. 1067, 1076-78 (1984) (finding direct costs of large reorganization cases to average 6.0% of total assets); Daryl M. Guffey & William T. Moore, Direct Bankruptcy Costs: Evidence from the Trucking Industry, 26 FIN. REV. 223, 231 (1991) (finding direct costs of trucking industry reorganizations to average 9.12% of total assets); Robert M. Lawless et al., A Glimpse at Professional Fees and Other Direct Costs in Small Firm Bankruptcies, 1994 U. ILL. L. REV. 847, 868 (finding in study of Chapter 11 cases in Memphis, Tennessee division of bankruptcy court that direct costs of bankruptcy averaged 21.55% of debtors' total assets as reported in petition); Jerold B. Warner, Bankruptcy Costs: Some Evidence, 32 J. FIN. 337, 343 (1977) (finding direct costs of large reorganization cases to average 4.0% of market value of assets); Lawrence A. Weiss, Bankruptcy Resolution: Direct Costs and Violation of Priority Claims, 27 J. FIN. ECON. 285, 290 (1990) (finding direct costs in large reorganizations to average 3.1% of total assets); Michelle J. White, Bankruptcy Costs and the New Bankruptcy Code, 38 J. FIN. 477, 484 (1983) (finding direct costs of large reorganization cases to average 6.0% of disbursements to all creditors).
261. See Edward I. Altman, A Further Empirical Investigation of the Bankruptcy Cost Question, 39 J. FIN. 1067, 1076-78 (1984) (finding direct costs of large reorganization cases to average 6.0% of total assets); Daryl M. Guffey & William T. Moore, Direct Bankruptcy Costs: Evidence from the Trucking Industry, 26 FIN. REV. 223, 231 (1991) (finding direct costs of trucking industry reorganizations to average 9.12% of total assets); Robert M. Lawless et al., A Glimpse at Professional Fees and Other Direct Costs in Small Firm Bankruptcies, 1994 U. ILL. L. REV. 847, 868 (finding in study of Chapter 11 cases in Memphis, Tennessee division of bankruptcy court that direct costs of bankruptcy averaged 21.55% of debtors' total assets as reported in petition); Jerold B. Warner, Bankruptcy Costs: Some Evidence, 32 J. FIN. 337, 343 (1977) (finding direct costs of large reorganization cases to average 4.0% of market value of assets); Lawrence A. Weiss, Bankruptcy Resolution: Direct Costs and Violation of Priority Claims, 27 J. FIN. ECON. 285, 290 (1990) (finding direct costs in large reorganizations to average 3.1% of total assets); Michelle J. White, Bankruptcy Costs and the New Bankruptcy Code, 38 J. FIN. 477, 484 (1983) (finding direct costs of large reorganization cases to average 6.0% of disbursements to all creditors).
262. See Edward I. Altman, A Further Empirical Investigation of the Bankruptcy Cost Question, 39 J. FIN. 1067, 1076-78 (1984) (finding direct costs of large reorganization cases to average 6.0% of total assets); Daryl M. Guffey & William T. Moore, Direct Bankruptcy Costs: Evidence from the Trucking Industry, 26 FIN. REV. 223, 231 (1991) (finding direct costs of trucking industry reorganizations to average 9.12% of total assets); Robert M. Lawless et al., A Glimpse at Professional Fees and Other Direct Costs in Small Firm Bankruptcies, 1994 U. ILL. L. REV. 847, 868 (finding in study of Chapter 11 cases in Memphis, Tennessee division of bankruptcy court that direct costs of bankruptcy averaged 21.55% of debtors' total assets as reported in petition); Jerold B. Warner, Bankruptcy Costs: Some Evidence, 32 J. FIN. 337, 343 (1977) (finding direct costs of large reorganization cases to average 4.0% of market value of assets); Lawrence A. Weiss, Bankruptcy Resolution: Direct Costs and Violation of Priority Claims, 27 J. FIN. ECON. 285, 290 (1990) (finding direct costs in large reorganizations to average 3.1% of total assets); Michelle J. White, Bankruptcy Costs and the New Bankruptcy Code, 38 J. FIN. 477, 484 (1983) (finding direct costs of large reorganization cases to average 6.0% of disbursements to all creditors).
263. See Edward I. Altman, A Further Empirical Investigation of the Bankruptcy Cost Question, 39 J. FIN. 1067, 1076-78 (1984) (finding direct costs of large reorganization cases to average 6.0% of total assets); Daryl M. Guffey & William T. Moore, Direct Bankruptcy Costs: Evidence from the Trucking Industry, 26 FIN. REV. 223, 231 (1991) (finding direct costs of trucking industry reorganizations to average 9.12% of total assets); Robert M. Lawless et al., A Glimpse at Professional Fees and Other Direct Costs in Small Firm Bankruptcies, 1994 U. ILL. L. REV. 847, 868 (finding in study of Chapter 11 cases in Memphis, Tennessee division of bankruptcy court that direct costs of bankruptcy averaged 21.55% of debtors' total assets as reported in petition); Jerold B. Warner, Bankruptcy Costs: Some Evidence, 32 J. FIN. 337, 343 (1977) (finding direct costs of large reorganization cases to average 4.0% of market value of assets); Lawrence A. Weiss, Bankruptcy Resolution: Direct Costs and Violation of Priority Claims, 27 J. FIN. ECON. 285, 290 (1990) (finding direct costs in large reorganizations to average 3.1% of total assets); Michelle J. White, Bankruptcy Costs and the New Bankruptcy Code, 38 J. FIN. 477, 484 (1983) (finding direct costs of large reorganization cases to average 6.0% of disbursements to all creditors).
264. See Edward I. Altman, A Further Empirical Investigation of the Bankruptcy Cost Question, 39 J. FIN. 1067, 1076-78 (1984) (finding direct costs of large reorganization cases to average 6.0% of total assets); Daryl M. Guffey & William T. Moore, Direct Bankruptcy Costs: Evidence from the Trucking Industry, 26 FIN. REV. 223, 231 (1991) (finding direct costs of trucking industry reorganizations to average 9.12% of total assets); Robert M. Lawless et al., A Glimpse at Professional Fees and Other Direct Costs in Small Firm Bankruptcies, 1994 U. ILL. L. REV. 847, 868 (finding in study of Chapter 11 cases in Memphis, Tennessee division of bankruptcy court that direct costs of bankruptcy averaged 21.55% of debtors' total assets as reported in petition); Jerold B. Warner, Bankruptcy Costs: Some Evidence, 32 J. FIN. 337, 343 (1977) (finding direct costs of large reorganization cases to average 4.0% of market value of assets); Lawrence A. Weiss, Bankruptcy Resolution: Direct Costs and Violation of Priority Claims, 27 J. FIN. ECON. 285, 290 (1990) (finding direct costs in large reorganizations to average 3.1% of total assets); Michelle J. White, Bankruptcy Costs and the New Bankruptcy Code, 38 J. FIN. 477, 484 (1983) (finding direct costs of large reorganization cases to average 6.0% of disbursements to all creditors).
265. See Edward I. Altman, A Further Empirical Investigation of the Bankruptcy Cost Question, 39 J. FIN. 1067, 1076-78 (1984) (finding direct costs of large reorganization cases to average 6.0% of total assets); Daryl M. Guffey & William T. Moore, Direct Bankruptcy Costs: Evidence from the Trucking Industry, 26 FIN. REV. 223, 231 (1991) (finding direct costs of trucking industry reorganizations to average 9.12% of total assets); Robert M. Lawless et al., A Glimpse at Professional Fees and Other Direct Costs in Small Firm Bankruptcies, 1994 U. ILL. L. REV. 847, 868 (finding in study of Chapter 11 cases in Memphis, Tennessee division of bankruptcy court that direct costs of bankruptcy averaged 21.55% of debtors' total assets as reported in petition); Jerold B. Warner, Bankruptcy Costs: Some Evidence, 32 J. FIN. 337, 343 (1977) (finding direct costs of large reorganization cases to average 4.0% of market value of assets); Lawrence A. Weiss, Bankruptcy Resolution: Direct Costs and Violation of Priority Claims, 27 J. FIN. ECON. 285, 290 (1990) (finding direct costs in large reorganizations to average 3.1% of total assets); Michelle J. White, Bankruptcy Costs and the New Bankruptcy Code, 38 J. FIN. 477, 484 (1983) (finding direct costs of large reorganization cases to average 6.0% of disbursements to all creditors).
266. See Michael Bradley & Michael Rosenzweig, The Untenable Case for Chapter 11, 101 YALE L.J. 1043, 1068 (1992) (attributing putative $14 billion loss in stockholder wealth in listed firms to change in bankruptcy law); Robert H. Mnookin & Robert B. Wilson, Rational Bargaining and Market Efficiency: Understanding Pennzoil v. Texaco, 75 VA. L. REV. 295, 297 (1989) (attributing $3.4 billion decline in combined trading values of Texaco and Pennzoil stock to threat of bankruptcy by Texaco and resulting costs).
267. See Michael Bradley & Michael Rosenzweig, The Untenable Case for Chapter 11, 101 YALE L.J. 1043, 1068 (1992) (attributing putative $14 billion loss in stockholder wealth in listed firms to change in bankruptcy law); Robert H. Mnookin & Robert B. Wilson, Rational Bargaining and Market Efficiency: Understanding Pennzoil v. Texaco, 75 VA. L. REV. 295, 297 (1989) (attributing $3.4 billion decline in combined trading values of Texaco and Pennzoil stock to threat of bankruptcy by Texaco and resulting costs).
268. See supra note 73 and accompanying text; Harris & Mooney, supra note 72, at 2021 ("[W]e think the transfer of an effective security interest ought to be as easy, inexpensive, and reliable as possible.").
269. Recent events involving Marriott Corporation illustrate the depth and sensitivity of contemporary cultural and political attitudes toward judgment proofing. See Pauline Yoshihashi, For Bill Marriott Jr., The Hospitality Trade Turns Inhospitable, WALL ST. J., Dec. 18, 1992, at Al. In October of 1992, Marriott announced a plan to split the $8.3 billion dollar company in two. One of the emerging companies would own the most promising assets, and the other would take "virtually all of Marriott's debt" and "scads of unsold land and hotels." Id. Even though this soft judgment proofing was directed at consensual bond investors rather than involuntary creditors and presumably did not violate their legal rights, in reporting on it the Wall Street Journal used the words "sleaze" and "sleazy" and spoke of "angry" institutional investors, the company "get[ting] a lot of heat," and "sully[ing] their reputation." Id.
270. See, e.g., Scott Kerin, Alaska Sport Fishing Association v. Exxon Corporation Highlights the Need to Take a Hard Look at the Doctrine of Parens Patriae When Applied in Natural Resource Damage Litigation, 25 ENVTL. L. 897, 902 n.30 (1995) (listing payments made by, and liability assessed against, Exxon).
271. See Exxon Oil Spill: Hearing Before the Senate Comm. on Commerce, Science, and Transp., 101st Cong. 47, 52-53, 56-61 (1989) (statement of L.G. Rawl, Chairman of Board and Chief Executive Officer, Exxon Corp.),
272. See Exxon "Strictly Liable", NAT'L L.J., Oct. 8, 1990, at 6 (reporting that, in In re Exxon Valdez Oil Spill Litigation, Alaska Superior Court Judge Brian Shortell ruled that Exxon Corporation and Exxon Shipping were strictly liable for all damages proximately caused by Exxon Valdez oil spill); Roverto Iraola, Criminal Liability of a Parent Company for the Conduct of Its Subsidiary: The Spillover of the Exxon Valdez, 31 CRIM. L. BULL. 3, 7-9 (1995) (describing basis for U.S. district court ruling that Exxon Corporation was criminally liable for conduct of its subsidiary. Exxon Shipping, which operated Exxon Valdez).
273. See Exxon "Strictly Liable", NAT'L L.J., Oct. 8, 1990, at 6 (reporting that, in In re Exxon Valdez Oil Spill Litigation, Alaska Superior Court Judge Brian Shortell ruled that Exxon Corporation and Exxon Shipping were strictly liable for all damages proximately caused by Exxon Valdez oil spill); Roverto Iraola, Criminal Liability of a Parent Company for the Conduct of Its Subsidiary: The Spillover of the Exxon Valdez, 31 CRIM. L. BULL. 3, 7-9 (1995) (describing basis for U.S. district court ruling that Exxon Corporation was criminally liable for conduct of its subsidiary. Exxon Shipping, which operated Exxon Valdez).
274. See, e.g., MICHAEL MORITZ & BARRETT SEAMAN, GOING FOR BROKE 316-17 (1981) (describing incident in which debtor Chrysler Corporation managed to cast small Rockford, Illinois bank as villain for refusing to sign workout agreement that unilaterally reduced amount Chrysler owed bank).
275. Of the 40 largest bankruptcy reorganizations, 38 occurred after 1979. See BANKRUPTCY YEARBOOK & ALMANAC 63 (Christopher M. McHugh ed., 3d ed. 1993).
276. The numbers of corporations in groups ranged from 2 to 352; most groups had between 3 and 26. See Lynn M. LoPucki & William C. Whitford, Venue Choice and Forum Shopping in the Bankruptcy Reorganization of Large, Publicly Held Companies, 1991 WIS. L. REV. 11, 21 (reporting data and noting that in some cases, all entities were components of single enterprise). Blumberg reports that the 1000 largest companies in the United States have an average of approximately 48 subsidiaries. See PHILLIP I. BLUMBERG, THE LAW OF CORPORATE GROUPS: PROCEDURAL PROBLEMS IN THE LAW OF PARENT AND SUBSIDIARY CORPORATIONS 465-68 (1983) (tbl.).
277. The numbers of corporations in groups ranged from 2 to 352; most groups had between 3 and 26. See Lynn M. LoPucki & William C. Whitford, Venue Choice and Forum Shopping in the Bankruptcy Reorganization of Large, Publicly Held Companies, 1991 WIS. L. REV. 11, 21 (reporting data and noting that in some cases, all entities were components of single enterprise). Blumberg reports that the 1000 largest companies in the United States have an average of approximately 48 subsidiaries. See PHILLIP I. BLUMBERG, THE LAW OF CORPORATE GROUPS: PROCEDURAL PROBLEMS IN THE LAW OF PARENT AND SUBSIDIARY CORPORATIONS 465-68 (1983) (tbl.).
278. The five are Seatrain Lines, MGF, Towner Petroleum, Air Florida, and Braniff Airlines. This statistic is calculated from previously published data. See LoPucki & Whitford, supra note 110, at 142 (providing data on distributions to unsecured creditors); LoPucki & Whitford, supra note 182, at 614 (providing appendix listing value of assets of companies studied).
279. Sales and leasebacks were. The bankrupt airlines in our study were lessees of most of the fleets, so that the aircraft were not part of the bankruptcy estate. The effect of such a transaction is functionally similar to asset securitization.
280. See Schwarcz, supra note 90, at 139 ("[P]ublic securitization is rarely cost effective for transactions of less than $50 million and is more common for transactions in the $100 million or higher range.").
281. A judgment-proof company has lower costs than a vulnerable company in three respects. First, financing is available to the judgment-proof company at lower rates because the financiers are insulated from liability. Second, the judgment-proof company need not purchase liability insurance. Third, the judgment-proof company can settle litigation against it more cheaply because judgments obtained will be uncollectible.
282. This is essentially the formulation successfully employed by many of the same companies during the 1980s when they were criticized for actions that reduced their labor costs.
283. See, e.g., Hansmann & Kraakman, supra note 76, at 1920 ("[L]imited liability in tort permits the firm's owners to determine unilaterally how much of their property will be exposed to potential tort claims, thereby inviting opportunism and inefficiency.").
284. See supra text accompanying note 3.
285. The contracts contemplated will place the liability on the lowest cost avoider, who will have the incentive to take all cost-effective safety and compliance measures. See Susan Block-Lieb, The Unsecured Creditor's Bargain: A Reply, 80 VA. L. REV. 1989, 1997-2000 (1994) (explaining means by which "second-best actors" return liability to lowest cost avoider). Professor Reinier Kraakman has described this system strategy as "third-party enforcement." See Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. ECON. & ORG. 53, 53 (1986) (describing "gatekeeping liability" as liability imposed on private persons such as accountants and lawyers "to prevent misconduct by withholding support").
286. The contracts contemplated will place the liability on the lowest cost avoider, who will have the incentive to take all cost-effective safety and compliance measures. See Susan Block-Lieb, The Unsecured Creditor's Bargain: A Reply, 80 VA. L. REV. 1989, 1997-2000 (1994) (explaining means by which "second-best actors" return liability to lowest cost avoider). Professor Reinier Kraakman has described this system strategy as "third-party enforcement." See Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. ECON. & ORG. 53, 53 (1986) (describing "gatekeeping liability" as liability imposed on private persons such as accountants and lawyers "to prevent misconduct by withholding support").
287. See, e.g., Janet C. Alexander, Unlimited Shareholder Liability Through a Procedural Lens, 106 HARV. L. REV. 387 (1992); Grundfest, supra note 117; Henry Hansmann & Reinier Kraakman, Do the Capital Markets Compel Limited Liability? A Response to Professor Grundfest, 102 YALE L.J. 427 (1992) [hereinafter Hansmann & Kraakman, A Response to Professor Grundfest]; Henry Hansmann & Reinier Kraakman, A Procedural Focus on Unlimited Shareholder Liability, 106 HARV. L. REV. 446 (1992); Hansmann & Kraakman, supra note 76, at 1880 (arguing weakness of existing justifications for shareholder limited liability and asserting that burden is now on proponents of limited liability to provide persuasive exposition); Leebron, supra note 76, at 1650 ("With [certain] exceptions, limited liability of shareholders seems on balance to be justified."); Thompson, supra note 78.
288. See, e.g., Janet C. Alexander, Unlimited Shareholder Liability Through a Procedural Lens, 106 HARV. L. REV. 387 (1992); Grundfest, supra note 117; Henry Hansmann & Reinier Kraakman, Do the Capital Markets Compel Limited Liability? A Response to Professor Grundfest, 102 YALE L.J. 427 (1992) [hereinafter Hansmann & Kraakman, A Response to Professor Grundfest]; Henry Hansmann & Reinier Kraakman, A Procedural Focus on Unlimited Shareholder Liability, 106 HARV. L. REV. 446 (1992); Hansmann & Kraakman, supra note 76, at 1880 (arguing weakness of existing justifications for shareholder limited liability and asserting that burden is now on proponents of limited liability to provide persuasive exposition); Leebron, supra note 76, at 1650 ("With [certain] exceptions, limited liability of shareholders seems on balance to be justified."); Thompson, supra note 78.
289. See, e.g., Janet C. Alexander, Unlimited Shareholder Liability Through a Procedural Lens, 106 HARV. L. REV. 387 (1992); Grundfest, supra note 117; Henry Hansmann & Reinier Kraakman, Do the Capital Markets Compel Limited Liability? A Response to Professor Grundfest, 102 YALE L.J. 427 (1992) [hereinafter Hansmann & Kraakman, A Response to Professor Grundfest]; Henry Hansmann & Reinier Kraakman, A Procedural Focus on Unlimited Shareholder Liability, 106 HARV. L. REV. 446 (1992); Hansmann & Kraakman, supra note 76, at 1880 (arguing weakness of existing justifications for shareholder limited liability and asserting that burden is now on proponents of limited liability to provide persuasive exposition); Leebron, supra note 76, at 1650 ("With [certain] exceptions, limited liability of shareholders seems on balance to be justified."); Thompson, supra note 78.
290. See, e.g., Janet C. Alexander, Unlimited Shareholder Liability Through a Procedural Lens, 106 HARV. L. REV. 387 (1992); Grundfest, supra note 117; Henry Hansmann & Reinier Kraakman, Do the Capital Markets Compel Limited Liability? A Response to Professor Grundfest, 102 YALE L.J. 427 (1992) [hereinafter Hansmann & Kraakman, A Response to Professor Grundfest]; Henry Hansmann & Reinier Kraakman, A Procedural Focus on Unlimited Shareholder Liability, 106 HARV. L. REV. 446 (1992); Hansmann & Kraakman, supra note 76, at 1880 (arguing weakness of existing justifications for shareholder limited liability and asserting that burden is now on proponents of limited liability to provide persuasive exposition); Leebron, supra note 76, at 1650 ("With [certain] exceptions, limited liability of shareholders seems on balance to be justified."); Thompson, supra note 78.
291. See, e.g., Hansmann & Kraakman, supra note 76, at 1890 ("Thus we have good reason to believe that a shift to unlimited liability would be less likely to greatly increase risk-bearing by shareholders of small corporations than to induce those shareholders to purchase adequate insurance.").
292. One indicator of the proponents' expectations is their unanimous preference for pro rata liability rather than joint and several liability among shareholders. One who expected all liability to be paid would prefer a system based on joint and several liability among shareholders. If the system designer were confident that the loss could be transferred to any equity holders, it is a short, easy step to transfer it to the appropriate equity holders. None of the commentators advocate joint and several liability, suggesting that they doubt that deep pocket shareholders would be able to obtain contributions from other shareholders. See, e.g., Grundfest, supra note 117, at 388 ("[A] search for alternative liability regimes . . . seems to have settled on proportionate liability as the most plausible substitute for the traditional limited liability rule."); Hansmann & Kraakman, supra note 76, at 1894 ("[T]he pro rata rule is clearly the superior alternative for publicly-held corporations. The advantage of promulgating a single rule for all corporations makes the case for the pro rata rule compelling for closely-held firms as well."); Leeborn, supra note 76, at 1649.
293. See Hansmann & Kraakamn, supra note 76, at 1901 (arguing that "the collecting effort would not need to reach every shareholder to serve its purpose. So long as it could succeed against most shareholders, including the largest shareholders, it would force public corporations to bear the bulk of their expected liability costs.").
294. As Leebron has suggested: The costs of locating, suing, and enforcing what will probably be small judgment against a large number of shareholders would be large compared to the amount of such judgments. The amount collected, unless unlimited liability were extended to the costs of collection, would be substantially diminished. This would be another reason to expect shareholders and financial creditors to contract around such unlimited liability. Leebron, supra note 76, at 1611.
295. In addressing this problem, Hansmann and Kraakman make the simplifying assumption that all shareholder liability accrues to the owners of stock on a single "liability date" for "a particular action or pattern of conduct [that] was expected to give rise to tort claims that might exceed the net value of the firm." Hansmann & Kraakamn, supra note 76, at 1898. This unrealistic assumption is the basis for further assumptions that it will be easy to identify the liable shareholders and determine the amounts of their liabilities, that only a single action will be necessary against each shareholder, and that the action will therefore be analogous to the action bya bankruptcy trustee to collect "accounts receivable from hundreds or thousands of debtors." Id. at 1900. The assumption is unrealistic because much mass tort and environmental liability accrues over long periods of time as a result of numerous, successive acts. Setting a liability date before the course of conduct is complete makes shareholders liable for management decisions that have not yet taken place. For example, by setting liability dates today, the tobacco industry could place liability on today's shareholders for a pattern of action that is not yet complete, and, at the same time, exempt future shareholders from liability for that pattern of action. Yet if Hansmann and Kraakman modify their proposal to permit successive actions against shareholders as a liability situation deteriorated, or to permit manegement to wait to sue until the "pattern of conduct" was complete, solvent shareholders would have time to dump their shares before liability attached to them. Hansmann and Kraakman would use management's announcement that "a particular action or pattern of conduct was expected to give rise to tort claims that might exceed the net value of the firm" as the trigger for shareholder liability. Id. at 1898. But in an insolvent company, every tortious act gives rise to liability expected to exceed the value of the company. Management would have to make another annoucement every time a company truck hit a pedestrian, imposing a new flood of liability in petty amounts on shareholders who might number in the tens of thousands.
296. See id. at 1901 ("[T]he collection effort would not need to reach every shareholder to serve its purpose. So long as it could succeed against most shareholders, including the largest shareholders, it would force public corporations to bear the bulk of their expected liability costs."). But see LOPUCKI & WARREN, supra note 8, at 5-20 (describing difficulty of collecting small unsecured debts through judicial process).
297. See Hansmann & Kraakman, supra note 76, at 1900 ("Moreover, even small shareholders might be induced to cooperate simply by adding collection costs to the assessment bill of shareholders who unsuccessfully sought to contest their assessments.").
298. See Leebron, supra note 76, at 1612 ("[T]he transaction costs of collecting from small shareholders would significantly blunt its effect."); Thompson, supra note 78, at 20 ("Yet as Leebron recognizes, the costs would consume the benefit of collecting from many small shareholdings so that enforcement is likely only to be feasible for entities such as parent-subsidiary groups.").
299. See Hansmann & Kraakman, supra note 76, at 1900 n.57; see also Carolyn Kay Brancato, The Pivotal Role of Institutional Investors in Capital Markets 19-20 (1990) (Columbia Law School mimeo) (paper presented at the Salomon Brothers Center's and Rutgers Center's Conference on the Fiduciary Responsibilities of Institutional Investors) (estimating that "institutional investors now hold 45% of total U.S. equities and 48.1% of the equity in the 1,000 largest U.S. corporations").
300. See Hansmann & Kraakman, supra note 76, at 1899-901; Thompson, supra note 78, at 31 ("[P]ro rata liability of shareholders for torts of their corporations . . . would discourage mutual funds from holding large blocks of stock since a large, well-financed shareholder would be a much more attractive defendant than would many dispersed shareholders.").
301. In dealing with pass-through strategies, the system will be hampered by its focus on ownership. "Ownership" is merely a form. Strategists can avoid it by using other forms that accomplish their purposes equally well.
302. See 29 U.S.C. § 1056(d)(1) (1994) (providing that "[e]ach pension plan shall provide that benefits provided under the plan may not be assigned or alienated"); Patterson v. Shumate, 112 S. Ct. 2242 (1992) (holding that debtors' interests in ERISA pension plans are excluded from debtors' bankruptcy estates).
303. Grundfest describes a strategy for replicating equity returns while avoiding a proposed proportionate liability by placing the equity in trust and having the trust issue debt securities. See Grundfest, supra note 117, at 409. His strategy seems to be in no way dependent on use of a trust as its vehicle and in no way related to the strategies presented in this subsection.
304. See Cook v. Holland, 575 S.W.2d 468, 475 (Ky. Ct. App. 1978) ("[Sections 7-306 and 3-808 of the Uniform Probate Code] were designed to make the trust estate a 'quasi-corporation' for the purposes of tort liability. The . . . trustee is treated as though he were an agent for a corporation."); RESTATEMENT (SECOND) OF TRUSTS § 265 (1959) ("Where a liability to third persons is imposed upon a person, not as a result of a contract made by him . . . but because he is the holder of the title to property, a trustee as holder of the title to the trust property is subject to personal liability, but only to the extent to which the trust estate is sufficient to indemnify him."); UNIF. PROBATE CODE § 7-306(b), 8 U.L.A. 560 (1983) ("A trustee is personally liable for obligations arising from ownership or control of property of the trust estate or for torts committed in the course of administration of the trust estate only if he is personally at fault.").
305. See Just Pants v. Bank of Ravenswood, 483 N.E.2d 331, 335 (Ill. App. Ct. 1985) ("Where the trustee is given full control in the management of the business of the trust, the beneficiaries have no personal liability."); Cook, 575 S.W.2d at 476 ("The beneficiaries have no personal liability for [the trust employee's] negligence."); RESTATEMENT (SECOND) OF TRUSTS § 276 (1959) ("The beneficiary as such is not personally liable to third persons for torts committed by the trustee in the course of the administration of the trust.").
306. See, e.g., Inside Scoop, Inc. v. Curry, 755 F. Supp. 426, 430 (D.D.C. 1989) (discussing use of Massachusetts Business Trusts and noting that they have limited liability); Robert M. Lloyd, Article 9 and Real Estate Law: Practical Solutions for Some Bothersome Problems, 29 IDAHO L. REV. 583, 623-26 (1993) (discussing use of Illinois Land Trusts).
307. See Grundfest, supra note 117, at 395-99.
308. See Alexander, supra note 235, at 394-404.
309. See Grundfest, supra note 117, at 399 (noting that existence of attachment-proof foreign investors means that introduction of proportionate liability may not change equity prices at all).
310. See id. at 390 ("The stock price effect of a proportionate liability rule can therefore never be greater than the transaction cost of the cheapest arbitrage that avoids liability generated by the rule."); id. at 399 ("Simply put, the presence of these [remote] investors means that the introduction of proportionate liability may not change equity prices at all.").
311. The funds invested by German corporations probably would be American. That is, Americans would buy stock in German limited liability corporations which would then invest the funds in American unlimited liability corporations. The United States could not prevent such investment because: (1) it would be incapable of tracing the funds through Germany; and (2) prevention probably would close the investment door to American funds without ending the German domination - the money would come from elsewhere.
312. See Grundfest, supra note 117, at 399 ("Foreign capital would be able to enter U.S. markets quickly and easily to take advantage of any opportunities created by the adoption of proportionate liability, and domestic capital would be invested in foreign vehicles that purchase domestic U.S. securities or are otherwise immune to proportionate liability judgments . . . .").
313. See Hansmann & Kraakman, A Response to Professor Grundfest, supra note 235, at 433. Hansmann and Kraakman wisely refrain from proposing either minimum capital requirements for investors or minimum capital requirements for businesses. The former probably would substantially reduce the amounts of capital available for investment in U.S. corporations and also would close the U.S. markets to ordinary Americans. The latter would reduce business opportunities for the least-advantaged Americans. See infra Section IV.G.
314. See Grundfest, supra note 117, at 424 n.149.
315. See Hansmann & Kraakman, A Response To Professor Grundfest, supra note 235, at 433 n.18.
316. Id.
317. See LoPucki, supra note 32, at 1907-16.
318. For an analysis of the problem in the language of economics, see Bebchuk & Fried, supra note 74, at 895-903 (demonstrating that full priority for secured creditors is "inefficient").
319. See supra Section II.A.
320. Fittingly, the solution was first proposed by students. See Christopher M.E. Painter, Note, Tort Creditor Priority in the Secured Credit System: Asbestos Times, the Worst of Times, 36 STAN. L. REV. 1045, 1080-83 (1984) ("Tort-claim superiority over secured creditors is, therefore, the most efficient and equitable solution."); Note, Developments in the Law: Toxic Waste Litigation, 99 HARV. L. REV. 1458, 1594-1601 (1986) (advocating exemption of government regulation of toxic wastes from automatic stay and advocating priority for tort claims by victims of hazardous wastes); see also Kathryn R. Heidt, Cleaning Up Your Act: Efficiency Considerations in the Battle for the Debtor's Assets in Toxic Waste Bankruptcies, 40 RUTGERS L. REV. 819, 849 (1988) (advocating priority for costs of toxic waste cleanup); Daniel Keating, Pension Insurance, Bankruptcy and Moral Hazard, 1991 WIS. L. REV. 65, 100-01 (advocating priority for claims of Pension Benefit Guaranty Corporation over secured creditors). In a variant of this solution, Bebchuk and Fried have recently proposed limiting the priority given to secured creditors to 75% of their secured claims. See Bebchuk & Fried, supra note 74, at 909-11. Elizabeth Warren has proposed an amendment to U.C.C. § 9-301 to "carve out" 20% of secured creditors' collateral for unsecured creditors. See Letter from Elizabeth Warren, Leo Gotlieb Professor of Law, Harvard University, to Geoffrey Hazard, Trustee Professor of Law, University of Pennsylvania (Apr. 25, 1996) (on file with author).
321. Fittingly, the solution was first proposed by students. See Christopher M.E. Painter, Note, Tort Creditor Priority in the Secured Credit System: Asbestos Times, the Worst of Times, 36 STAN. L. REV. 1045, 1080-83 (1984) ("Tort-claim superiority over secured creditors is, therefore, the most efficient and equitable solution."); Note, Developments in the Law: Toxic Waste Litigation, 99 HARV. L. REV. 1458, 1594-1601 (1986) (advocating exemption of government regulation of toxic wastes from automatic stay and advocating priority for tort claims by victims of hazardous wastes); see also Kathryn R. Heidt, Cleaning Up Your Act: Efficiency Considerations in the Battle for the Debtor's Assets in Toxic Waste Bankruptcies, 40 RUTGERS L. REV. 819, 849 (1988) (advocating priority for costs of toxic waste cleanup); Daniel Keating, Pension Insurance, Bankruptcy and Moral Hazard, 1991 WIS. L. REV. 65, 100-01 (advocating priority for claims of Pension Benefit Guaranty Corporation over secured creditors). In a variant of this solution, Bebchuk and Fried have recently proposed limiting the priority given to secured creditors to 75% of their secured claims. See Bebchuk & Fried, supra note 74, at 909-11. Elizabeth Warren has proposed an amendment to U.C.C. § 9-301 to "carve out" 20% of secured creditors' collateral for unsecured creditors. See Letter from Elizabeth Warren, Leo Gotlieb Professor of Law, Harvard University, to Geoffrey Hazard, Trustee Professor of Law, University of Pennsylvania (Apr. 25, 1996) (on file with author).
322. Fittingly, the solution was first proposed by students. See Christopher M.E. Painter, Note, Tort Creditor Priority in the Secured Credit System: Asbestos Times, the Worst of Times, 36 STAN. L. REV. 1045, 1080-83 (1984) ("Tort-claim superiority over secured creditors is, therefore, the most efficient and equitable solution."); Note, Developments in the Law: Toxic Waste Litigation, 99 HARV. L. REV. 1458, 1594-1601 (1986) (advocating exemption of government regulation of toxic wastes from automatic stay and advocating priority for tort claims by victims of hazardous wastes); see also Kathryn R. Heidt, Cleaning Up Your Act: Efficiency Considerations in the Battle for the Debtor's Assets in Toxic Waste Bankruptcies, 40 RUTGERS L. REV. 819, 849 (1988) (advocating priority for costs of toxic waste cleanup); Daniel Keating, Pension Insurance, Bankruptcy and Moral Hazard, 1991 WIS. L. REV. 65, 100-01 (advocating priority for claims of Pension Benefit Guaranty Corporation over secured creditors). In a variant of this solution, Bebchuk and Fried have recently proposed limiting the priority given to secured creditors to 75% of their secured claims. See Bebchuk & Fried, supra note 74, at 909-11. Elizabeth Warren has proposed an amendment to U.C.C. § 9-301 to "carve out" 20% of secured creditors' collateral for unsecured creditors. See Letter from Elizabeth Warren, Leo Gotlieb Professor of Law, Harvard University, to Geoffrey Hazard, Trustee Professor of Law, University of Pennsylvania (Apr. 25, 1996) (on file with author).
323. Fittingly, the solution was first proposed by students. See Christopher M.E. Painter, Note, Tort Creditor Priority in the Secured Credit System: Asbestos Times, the Worst of Times, 36 STAN. L. REV. 1045, 1080-83 (1984) ("Tort-claim superiority over secured creditors is, therefore, the most efficient and equitable solution."); Note, Developments in the Law: Toxic Waste Litigation, 99 HARV. L. REV. 1458, 1594-1601 (1986) (advocating exemption of government regulation of toxic wastes from automatic stay and advocating priority for tort claims by victims of hazardous wastes); see also Kathryn R. Heidt, Cleaning Up Your Act: Efficiency Considerations in the Battle for the Debtor's Assets in Toxic Waste Bankruptcies, 40 RUTGERS L. REV. 819, 849 (1988) (advocating priority for costs of toxic waste cleanup); Daniel Keating, Pension Insurance, Bankruptcy and Moral Hazard, 1991 WIS. L. REV. 65, 100-01 (advocating priority for claims of Pension Benefit Guaranty Corporation over secured creditors). In a variant of this solution, Bebchuk and Fried have recently proposed limiting the priority given to secured creditors to 75% of their secured claims. See Bebchuk & Fried, supra note 74, at 909-11. Elizabeth Warren has proposed an amendment to U.C.C. § 9-301 to "carve out" 20% of secured creditors' collateral for unsecured creditors. See Letter from Elizabeth Warren, Leo Gotlieb Professor of Law, Harvard University, to Geoffrey Hazard, Trustee Professor of Law, University of Pennsylvania (Apr. 25, 1996) (on file with author).
324. Arguably, the system has already adopted this strategy with regard to secured creditors that have the capability to influence their debtors' decisions regarding hazardous waste. See United States v. Fleet Factors Corp., 901 F.2d 1550 (11th Cir. 1990) (holding that secured creditor participating in management of facility containing hazardous waste could be liable under 42 U.S.C. § 9607(a)(2) (1993), even though secured creditor's involvement was insufficient to render it "operator" of facility).
325. See Note, Investor Liability: Financial Innovations in the Regulatory State and the Coming Revolution in Corporate Law, 107 HARV. L. REV. 1941 (1994) (advocating parallel treatment of debt and equity investments in order to avoid arbitrage potential described by Grundfest); cf. Hansmann & Kraakman, supra note 76, at 1919-20 (arguing against unlimited liability for contract creditors).
326. See Grundfest, supra note 117. Based largely on putative strategies that would convert liability-encumbered equity into liability-free debt, see id. at 408-10, Professor Grundfest concludes that shareholder unlimited liability of the kind currently under consideration "is not a practical alternative to limited liability - at least for corporations with liquid, actively traded equity." Id. at 420.
327. Commentators have falsely assumed that all investments in a business are in the form of debt or equity. See, e.g., Note, supra note 267, at 1956 (making assumption that parallel treatment of debt and equity was parallel treatment of "all forms of investment"). Ownership of the assets used in a business constitutes a third form.
328. Professor Ayer has argued persuasively that there is no real distinction between the lender who finances the debtor's purchase of an asset and the owner who leases the assets, but merely a continuum of possible transactions. See John D. Ayer, On the Vacuity of the Sale/Lease Distinction, 68 IOWA L. REV. 667 (1983); John D. Ayer, An Unrepentant View of the Sale-Lease Distinction, 4 J. BANKR. L. & PRAC. 291 (1995).
329. Professor Ayer has argued persuasively that there is no real distinction between the lender who finances the debtor's purchase of an asset and the owner who leases the assets, but merely a continuum of possible transactions. See John D. Ayer, On the Vacuity of the Sale/Lease Distinction, 68 IOWA L. REV. 667 (1983); John D. Ayer, An Unrepentant View of the Sale-Lease Distinction, 4 J. BANKR. L. & PRAC. 291 (1995).
330. Hansmann & Kraakman, supra note 76, at 1913-14. Disaggregation did not distress Hansmann and Kraakman because their focus was on economic efficiency rather than the future of liability. They saw disaggregation as a possible offset to excessive incentives for aggregation. To the extent they were concerned with liability, they saw the solution to disaggregation as lying in the more extreme measures discussed in the next two sections. See infra Sections IV.D-E.
331. See Stephen M. Bainbridge, The Politics of Corporate Governance, 18 HARV. J.L. & PUB. POL'Y 671, 681-82 (1995) (describing "a nexus or web of explicit and implicit contracts" theory as "prevailing theory of the firm"); Ronald H. Coase, The Nature of the Firm, 4 ECONOMICA 386 (1937) (characterizing bounds of firm as that range of exchanges over which market system was suppressed and resource allocation was accomplished instead by authority and direction); Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. FIN. ECON. 305, 311 (1976) ("The private corporation or firm is simply one form of legal fiction which serves as a nexus for contracting relationships . . . . [I]t makes little or no sense to try to distinguish those things which are 'inside' the firm (or any other organization) from those things that are 'outside' of it.").
332. See Stephen M. Bainbridge, The Politics of Corporate Governance, 18 HARV. J.L. & PUB. POL'Y 671, 681-82 (1995) (describing "a nexus or web of explicit and implicit contracts" theory as "prevailing theory of the firm"); Ronald H. Coase, The Nature of the Firm, 4 ECONOMICA 386 (1937) (characterizing bounds of firm as that range of exchanges over which market system was suppressed and resource allocation was accomplished instead by authority and direction); Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. FIN. ECON. 305, 311 (1976) ("The private corporation or firm is simply one form of legal fiction which serves as a nexus for contracting relationships . . . . [I]t makes little or no sense to try to distinguish those things which are 'inside' the firm (or any other organization) from those things that are 'outside' of it.").
333. See Stephen M. Bainbridge, The Politics of Corporate Governance, 18 HARV. J.L. & PUB. POL'Y 671, 681-82 (1995) (describing "a nexus or web of explicit and implicit contracts" theory as "prevailing theory of the firm"); Ronald H. Coase, The Nature of the Firm, 4 ECONOMICA 386 (1937) (characterizing bounds of firm as that range of exchanges over which market system was suppressed and resource allocation was accomplished instead by authority and direction); Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. FIN. ECON. 305, 311 (1976) ("The private corporation or firm is simply one form of legal fiction which serves as a nexus for contracting relationships . . . . [I]t makes little or no sense to try to distinguish those things which are 'inside' the firm (or any other organization) from those things that are
334. Franchising is another example of disaggregated enterprise. Franchisors seek to profit from huge, far-flung operations while isolating themselves from the liability generated by those operations. The system has responded predictably, seeking to impose vicarious liability on franchisors in some situations. It is a half-hearted response, however, usually limited to those situations where the franchisor controls the liability-generating conduct. See, e.g., David A. Beyer, Franchise Vicarious Liability in Florida, 69 FLA. BAR J. 62, 65 (1995) (comparing grounds for holding franchisors liable).
335. See Goldberg v. Lee Express Cab Corp., 634 N.Y.S.2d 337, 338 n.1 (Sup. Ct. 1995) (noting that "'what appears to be a rather common practice in the taxicab industry of vesting the ownership of a taxi fleet in many corporations, each owning only one or two cabs' . . . remains a common practice in the taxicab industry to this day." (quoting Walkovszky v. Carlton, 223 N.E.2d 6, 7 (N.Y. 1966))); Walkovszky v. Carlton, 223 N.E.2d 6, 7 (N.Y. 1966) (describing group of corporations engaged in taxicab business in New York City, each with minimal assets); Bill Gifford, Zoned Out, WASH. POST, Nov. 6, 1994, (Magazine), at W10 (describing largest Washington D.C. taxicab business, which tour coowners have divided into eleven taxicab operating companies along with other supporting corporations).
336. See, e.g., Glenn Collins, Hungry Shareholders vs. Wary Managers, N.Y. TIMES, Nov. 4, 1995, § 1, at 37 (describing shareholders' efforts to force RJR Nabisco to spin off tobacco operations and noting that another tobacco company, Liggett Group, Inc., had already completed spinoffs); Glenn Collins, New Pressures on Philip Morris, N.Y. TIMES, Sept. 21, 1994, at D1 (describing pressures on Philip Morris to spin off tobacco operations "to wall off the tobacco business from Philip Morris's food and beer business . . . as investors see the troublesome potential for legal liability and higher taxes on cigarettes"); Glenn Collins, Paper Maker to Spin off Tobacco Units, N.Y. TIMES, May 10, 1995, at D1 (describing announcement by Kimberly-Clark Corporation that its tobacco operations would produce $100 million in cash in coming months, and that Kimberly-Clark would use cash to purchase its own shares, that Kimberly-Clark would then spin off its tobacco operations as separate corporation, and noting that "analysts said [the spin off] had been prompted by shareholders' concern over the legal liabilities of cigarettes"); Eben Shapiro, Philip Morris May Be Vulnerable over Tobacco Even if Firm Splits, WALL ST. J., May 25, 1994, at B3 (speculating about possible spin off to separate company's food and tobacco operations and noting they already are separately incorporated).
337. See, e.g., Glenn Collins, Hungry Shareholders vs. Wary Managers, N.Y. TIMES, Nov. 4, 1995, § 1, at 37 (describing shareholders' efforts to force RJR Nabisco to spin off tobacco operations and noting that another tobacco company, Liggett Group, Inc., had already completed spinoffs); Glenn Collins, New Pressures on Philip Morris, N.Y. TIMES, Sept. 21, 1994, at D1 (describing pressures on Philip Morris to spin off tobacco operations "to wall off the tobacco business from Philip Morris's food and beer business . . . as investors see the troublesome potential for legal liability and higher taxes on cigarettes"); Glenn Collins, Paper Maker to Spin off Tobacco Units, N.Y. TIMES, May 10, 1995, at D1 (describing announcement by Kimberly-Clark Corporation that its tobacco operations would produce $100 million in cash in coming months, and that Kimberly-Clark would use cash to purchase its own shares, that Kimberly-Clark would then spin off its tobacco operations as separate corporation, and noting that "analysts said [the spin off] had been prompted by shareholders' concern over the legal liabilities of cigarettes"); Eben Shapiro, Philip Morris May Be Vulnerable over Tobacco Even if Firm Splits, WALL ST. J., May 25, 1994, at B3 (speculating about possible spin off to separate company's food and tobacco operations and noting they already are separately incorporated).
338. See, e.g., Glenn Collins, Hungry Shareholders vs. Wary Managers, N.Y. TIMES, Nov. 4, 1995, § 1, at 37 (describing shareholders' efforts to force RJR Nabisco to spin off tobacco operations and noting that another tobacco company, Liggett Group, Inc., had already completed spinoffs); Glenn Collins, New Pressures on Philip Morris, N.Y. TIMES, Sept. 21, 1994, at D1 (describing pressures on Philip Morris to spin off tobacco operations "to wall off the tobacco business from Philip Morris's food and beer business . . . as investors see the troublesome potential for legal liability and higher taxes on cigarettes"); Glenn Collins, Paper Maker to Spin off Tobacco Units, N.Y. TIMES, May 10, 1995, at D1 (describing announcement by Kimberly-Clark Corporation that its tobacco operations would produce $100 million in cash in coming months, and that Kimberly-Clark would use cash to purchase its own shares, that Kimberly-Clark would then spin off its tobacco operations as separate corporation, and noting that "analysts said [the spin off] had been prompted by shareholders' concern over the legal liabilities of cigarettes"); Eben Shapiro, Philip Morris May Be Vulnerable over Tobacco Even if Firm Splits, WALL ST. J., May 25, 1994, at B3 (speculating about possible spin off to separate company's food and tobacco operations and noting they already are separately incorporated).
339. See, e.g., Glenn Collins, Hungry Shareholders vs. Wary Managers, N.Y. TIMES, Nov. 4, 1995, § 1, at 37 (describing shareholders' efforts to force RJR Nabisco to spin off tobacco operations and noting that another tobacco company, Liggett Group, Inc., had already completed spinoffs); Glenn Collins, New Pressures on Philip Morris, N.Y. TIMES, Sept. 21, 1994, at D1 (describing pressures on Philip Morris to spin off tobacco operations "to wall off the tobacco business from Philip Morris's food and beer business . . . as investors see the troublesome potential for legal liability and higher taxes on cigarettes"); Glenn Collins, Paper Maker to Spin off Tobacco Units, N.Y. TIMES, May 10, 1995, at D1 (describing announcement by Kimberly-Clark Corporation that its tobacco operations would produce $100 million in cash in coming months, and that Kimberly-Clark would use cash to purchase its own shares, that Kimberly-Clark would then spin off its tobacco operations as separate corporation, and noting that "analysts said [the spin off] had been prompted by shareholders' concern over the legal liabilities of cigarettes"); Eben Shapiro, Philip Morris May Be Vulnerable over Tobacco Even if Firm Splits, WALL ST. J., May 25, 1994, at B3 (speculating about possible spin off to separate company's food and tobacco operations and noting they already are separately incorporated).
340. See, e.g., U.S. SMALL BUS. ADMIN., ANNUAL REPORT ON SMALL BUSINESS AND COMPETITION 36 (1995) (reporting that number of businesses with employees "has grown at a rate just under 2 percent a year, about equal to the rate of growth of the general population and of the work force" while rate of growth in number of business filing tax returns has grown at compound rate of 3.9% per year over most recent 12-year span). That the number of businesses filing tax returns has grown so much faster than the number of businesses with employees suggests that persons formerly "employees" have instead become "independent contractors." The change may have the effect of insulating the employers from liability for their acts. The SBA also reports a growth in small business's share of total employment, but (for reasons not stated in the report) attributes the increase "more to the growth of industries in which small businesses have been leaders than to any current economic advantage of small operations." Id. at 43.
341. See Alan Murray, Mom, Apple Pie and Small Business, WALL ST. J., Aug. 15, 1994, at A1 (speculating that low wage businesses will disaggregate to take advantage of 25-worker exemption from Democratic health care proposal).
342. The traditional conceptualization holds that the forms in which business is conducted - department store, mall, or food court - are the products of efficiencies of scale inherent in the nature of the tasks being performed. Because the nature of the task cannot change, the traditional conceptualization is static; changes in economies of scale are described as changes in task and each new task comes as a surprise. The conceptualization I advocate is one in which computerization has freed the form of organization from the task. Any task can be accomplished through any organization. The costs of all sizes of organization are potentially the same because the computer can translate one size of organization to another at a cost that can be negligible. The concept of economy of scale should be recognized as unrelated to firm size.
343. See, e.g., Robinson v. Jiffy Executive Limousine Co., 4 F.3d 237, 241 (3d Cir. 1993) (concluding that under New Jersey law, persons hiring financially irresponsible independent contractors are not liable for torts those contractors commit).
344. They may continue to exist for tax or other purposes.
345. Klein and Zolt's proposal that every sole proprietor and partner enjoy limited liability without having to endure the formalities of incorporation may prove to have been the first shot in the battle for deentification. See Klein & Zolt, supra note 204, at 1037 (referring to their new default provision regarding limited liability as "opt out" rather than "opt in" provision); Larry E. Ribstein, Limited Liability and Theories of the Corporation, 50 MD. L. REV. 80, 129 (1991) ("[L]imited tort liability should be available without formal incorporation.").
346. See supra Subsection II.B.1.
347. See PHILLIP I. BLUMBERG, THE LAW OF CORPORATE GROUPS: BANKRUPTCY LAW § 18.02, at 699-704 (1985) (advocating expansion of enterprise liability in place of entity liability).
348. To my knowledge, no one has seriously proposed this radical form of enterprise liability.
349. PHILLIP I. BLUMBERG, THE LAW OF CORPORATE GROUPS: PROCEDURAL PROBLEMS IN THE LAW OF PARENT AND SUBSIDIARY CORPORATIONS § 22.03.2, at 431 (1983).
350. See, e.g., id. at 435 ("In the strongly integrated group, the parent and subsidiaries comprise a single business enterprise . . .").
351. See BLUMBERG, supra note 283, § 10.10.1, at 417-18 (discussing substantive consolidation of corporate groups in bankruptcy).
352. Financial statements would be of little use because they pertain only to the entity structure the debtor sought to create; no one would have the incentives or the ability to prepare meaningful financial statements for the "enterprise" that would later be declared by the court.
353. Current law can be read to respond to situations such as this with the doctrine of nondelegable duty: One who employs an independent contractor to do work which the employer should recognize as likely to create during its progress a peculiar risk of harm to others unless special precautions are taken, is subject to liability for physical harm caused to them by the failure of the contractor to exercise reasonable care to take such precautions . . . . RESTATEMENT (SECOND) OF TORTS § 416 (1965): see Dickerson, Inc. v. United States, 875 F.2d 1577, 1583 (11th Cir. 1989) ("Under Florida law, if the work contracted for is an inherently dangerous activity, the employer has a nondelegable duty of reasonable care to take precautions ensuring that the independent contractor carries out the task in a non-negligent manner."). But this doctrine presupposes a delegator who is not judgment proof. The strategist can frustrate the doctrine by identifying the entity the court will regard as delegator and rendering that entity judgment proof. The doctrine is ineffective against the strategist because the doctrine is rooted in entity rather than enterprise theory. Any attempt to shift it to enterprise theory encounters the problem discussed here: inability to define the enterprise.
354. Hansmann & Kraakman, supra note 76, at 1915.
355. As an embellishment on their proposal, Hansmann and Kraakman propose the imposition of mandatory insurance on those engaged in high risk industries. They acknowledge that mandatory insurance will not itself work to assure payment of liabilities. But they theorize that the cost of the insurance may be sufficient to offset the incentives toward disaggregation. See id. at 1915 n.96 ("That is, one would not rely on the insurance requirement to solve the externality problem itself, but only to discourage inefficient disaggregation."). Their embellishment is difficult to evaluate because they do not indicate which fragments of a disaggregated firm would be required to carry the insurance.
356. See Status of States, 81 A.B.A. J., Aug. 1995, at 59 (asserting that 41 states have modified or abolished joint and several liability since 1986); e.g., 1995 N.J. Sess. Law Serv. 141 (West) (relieving sellers of defective products of strict liability claims except where manufacturer "has no known agents, facility, or other presence within the United States" or "has no attachable assets or has been adjudicated bankrupt and a judgment is not otherwise recoverable from the assets of the bankruptcy estate"). While this wording theoretically leaves open the possibility of suing the seller after pursuing to judgment the action against the manufacturer, the practical effect will be to deprive the plaintiff of any remedy at all in cases where the manufacturer is in business at the time the plaintiff commences the action, but not at the time the plaintiff seeks to collect the judgment.
357. The underlying premise is that parties should not be liable for what they cannot control. Trading partner liability almost inevitably violates this premise.
358. See Arlen & Carney, supra note 5 (proposing to hold liable particular agents who commit fraud on securities markets and to excuse their employers from vicarious liability unless employer is in bad faith).
359. See Kenneth S. Abraham & Paul C. Weiler, Enterprise Medical Liability and the Evolution of the American Health Care System, 108 HARV. L. REV. 381 (1994) (proposing to excuse doctors from liability for medical malpractice and instead hold enterprises with which they are associated vicariously liable). The Abraham-Weiler proposal is not entirely a reduction in liability; it provides for some expansion of liability to enterprises that would not have liability under current law.
360. Klein & Zolt, supra note 204, at 1040. But see Reinier H. Kraakman, Corporate Liability Strategies and the Costs of Legal Controls, 93 YALE L.J. 857, 868-76 (1984) (advocating manager and director liability for tons of corporations as means of protecting against "asset insufficiency").
361. The Third Circuit has wrestled with this issue of definition. In Becker v. Interstate Properties, 569 F.2d 1203 (3d Cir. 1977), the court held an employer liable for the tort of its independent contractor because the independent contractor was only minimally insured and not otherwise financially responsible. Sixteen years later, in Robinson v. Jiffy Executive Limousine Co., 4 F.3d 237 (3d Cir. 1993), the court retreated from Becker, noting that the New Jersey Courts had, in the interim, declined to follow it. Quoting the dissent in Becker, the Robinson court opined that holding employers liable for the torts of their financially irresponsible independent contractors would "cause uncertainty and doubt for every financial strata and every court, as well as hinder the employment opportunities of an independent contractor trying to enter the market place but lacking much in the way of start-up capital." Id. at 242. The court also asserted that the rule would "impose prohibitive obligations [of investigation] on employers of independent contractors." Id. at 242-43. In reversing its position, the Third Circuit retreated to the basic system principle of collection only from the property of the debtor.
362. The difficulty of defining boundaries is evident with regard to liability for the treatment, storage, and disposal of hazardous waste (TSD). See Michael Lange, Corporate Strategies for Evading Environmental and Tort Liability (Mar. 8, 1991) (unpublished manuscript, on file with author). The TSD industry arguably came into existence as a disaggregation response to the imposition of liability for the handling of toxic wastes. That is, the generators of waste, many of whom were large, solvent companies, responded to the imposition of liability by contracting the work out to small TSD companies that could externalize the risk of liability. See William Goldfarb, Kepone: A Case Study, 8 ENVTL. L. 645, 658-60 (1977); Debra K. Rubin, Cleanup Firms Cover Their Assets, ENGINEERING NEWS-RECORD, Mar. 6, 1986, at 50 (describing strategic formation by engineering firms of "independent" entities to do hazardous waste consulting). The system responded by imposing liability on the generator of toxic waste for acts committed by others in the treatment, storage, or disposal of the generator's waste. See 42 U.S.C.A. § 9607(a)(3) (West 1995). The gambit was a success in that it elicited the desired response from the industry. TSD companies increased their capital. See Lange, supra, at 54. It is, however, no coincidence that the system's success has come in a field that has generated tremendous controversy over the imposition of liability on innocent parties who have no means of avoiding it. See, e.g., Michael I. Greenberg & David M. Shaw, To Lend or Not to Lend - That Should Not Be the Question: The Uncertainties of Lender Liability Under CERCLA, 41 DUKE L.J. 1211, 1211 (1992) ("Uncertainty and confusion pervade environmental liability standards . . . ."). The system successfully expanded liability but is now locked in controversy over what is necessarily an arbitrary boundary.
363. The difficulty of defining boundaries is evident with regard to liability for the treatment, storage, and disposal of hazardous waste (TSD). See Michael Lange, Corporate Strategies for Evading Environmental and Tort Liability (Mar. 8, 1991) (unpublished manuscript, on file with author). The TSD industry arguably came into existence as a disaggregation response to the imposition of liability for the handling of toxic wastes. That is, the generators of waste, many of whom were large, solvent companies, responded to the imposition of liability by contracting the work out to small TSD companies that could externalize the risk of liability. See William Goldfarb, Kepone: A Case Study, 8 ENVTL. L. 645, 658-60 (1977); Debra K. Rubin, Cleanup Firms Cover Their Assets, ENGINEERING NEWS-RECORD, Mar. 6, 1986, at 50 (describing strategic formation by engineering firms of "independent" entities to do hazardous waste consulting). The system responded by imposing liability on the generator of toxic waste for acts committed by others in the treatment, storage, or disposal of the generator's waste. See 42 U.S.C.A. § 9607(a)(3) (West 1995). The gambit was a success in that it elicited the desired response from the industry. TSD companies increased their capital. See Lange, supra, at 54. It is, however, no coincidence that the system's success has come in a field that has generated tremendous controversy over the imposition of liability on innocent parties who have no means of avoiding it. See, e.g., Michael I. Greenberg & David M. Shaw, To Lend or Not to Lend - That Should Not Be the Question: The Uncertainties of Lender Liability Under CERCLA, 41 DUKE L.J. 1211, 1211 (1992) ("Uncertainty and confusion pervade environmental liability standards . . . ."). The system successfully expanded liability but is now locked in controversy over what is necessarily an arbitrary boundary.
364. The difficulty of defining boundaries is evident with regard to liability for the treatment, storage, and disposal of hazardous waste (TSD). See Michael Lange, Corporate Strategies for Evading Environmental and Tort Liability (Mar. 8, 1991) (unpublished manuscript, on file with author). The TSD industry arguably came into existence as a disaggregation response to the imposition of liability for the handling of toxic wastes. That is, the generators of waste, many of whom were large, solvent companies, responded to the imposition of liability by contracting the work out to small TSD companies that could externalize the risk of liability. See William Goldfarb, Kepone: A Case Study, 8 ENVTL. L. 645, 658-60 (1977); Debra K. Rubin, Cleanup Firms Cover Their Assets, ENGINEERING NEWS-RECORD, Mar. 6, 1986, at 50 (describing strategic formation by engineering firms of "independent" entities to do hazardous waste consulting). The system responded by imposing liability on the generator of toxic waste for acts committed by others in the treatment, storage, or disposal of the generator's waste. See 42 U.S.C.A. § 9607(a)(3) (West 1995). The gambit was a success in that it elicited the desired response from the industry. TSD companies increased their capital. See Lange, supra, at 54. It is, however, no coincidence that the system's success has come in a field that has generated tremendous controversy over the imposition of liability on innocent parties who have no means of avoiding it. See, e.g., Michael I. Greenberg & David M. Shaw, To Lend or Not to Lend - That Should Not Be the Question: The Uncertainties of Lender Liability Under CERCLA, 41 DUKE L.J. 1211, 1211 (1992) ("Uncertainty and confusion pervade environmental liability standards . . . ."). The system successfully expanded liability but is now locked in controversy over what is necessarily an arbitrary boundary.
365. The difficulty of defining boundaries is evident with regard to liability for the treatment, storage, and disposal of hazardous waste (TSD). See Michael Lange, Corporate Strategies for Evading Environmental and Tort Liability (Mar. 8, 1991) (unpublished manuscript, on file with author). The TSD industry arguably came into existence as a disaggregation response to the imposition of liability for the handling of toxic wastes. That is, the generators of waste, many of whom were large, solvent companies, responded to the imposition of liability by contracting the work out to small TSD companies that could externalize the risk of liability. See William Goldfarb, Kepone: A Case Study, 8 ENVTL. L. 645, 658-60 (1977); Debra K. Rubin, Cleanup Firms Cover Their Assets, ENGINEERING NEWS-RECORD, Mar. 6, 1986, at 50 (describing strategic formation by engineering firms of "independent" entities to do hazardous waste consulting). The system responded by imposing liability on the generator of toxic waste for acts committed by others in the treatment, storage, or disposal of the generator's waste. See 42 U.S.C.A. § 9607(a)(3) (West 1995). The gambit was a success in that it elicited the desired response from the industry. TSD companies increased their capital. See Lange, supra, at 54. It is, however, no coincidence that the system's success has come in a field that has generated tremendous controversy over the imposition of liability on innocent parties who have no means of avoiding it. See, e.g., Michael I. Greenberg & David M. Shaw, To Lend or Not to Lend - That Should Not Be the Question: The Uncertainties of Lender Liability Under CERCLA, 41 DUKE L.J. 1211, 1211 (1992) ("Uncertainty and confusion pervade environmental liability standards . . . ."). The system successfully expanded liability but is now locked in controversy over what is necessarily an arbitrary boundary.
366. Hansmann & Kraakman, supra note 76, at 1915.
367. When faced with this problem in an analogous context, Hansmann and Kraakman chose to make the stopping point the first "well-capitalized" institution. See Hansmann & Kraakman, A Response to Professor Grundfest, supra note 235, at 433 (fixing stopping point by inquiring into whether investor in shares is liability-evading foreigner). While that method of fixing a stopping point might at first seem principled, it ultimately proves tautological. The problem they were addressing was to determine the value that should be available to involuntary creditors. Yet to define "well-capitalized" requires the same determination. In attempting to answer the second question, Hansmann and Kraakman will have to define "well-capitalized," and, perhaps more problematically, they will have to provide some means for system participants, such as the customer who pulls up to the Exxon pump, to know the capitalization of those through whom they are receiving the product.
368. The argument presented here is an elaboration of an argument I have made elsewhere. See LoPucki, supra note 32, at 1906-07.
369. For an elaboration of the idea presented here, see Gary T. Schwartz, The Ethics and the Economics of Tort Liability Insurance, 75 CORNELL L. REV. 313, 347 (1990) (arguing that "there is a range of inadvertent negligent conduct that is imperfectly controllable").
370. See, e.g., Schwartz, supra note 302, at 313 (noting that "many scholars share in the view that tort law's deterrence objective is 'severely, perhaps fatally undermined' by the prevalence of insurance" (citations omitted)).
371. See, e.g., Jon D. Hanson & Kyle D. Logue, The First-Party Insurance Externality: An Economic Justification for Enterprise Liability, 76 CORNELL L. REV. 129, 131 (1990) ("That insurance can blunt the deterrence effects of a liability rule is uncontroversial." (footnotes omitted)). The problem is sometimes discussed as one of "moral hazard." That is, the insurance creates a moral hazard because once the premium for the year is fixed, the insured may be able to profit by increasing the risk to others, with no additional cost to the insured. The problem is considered "moral" because the insured can take advantage at the cost of others.
372. See, e.g., Sean W. Gallagher, Note, The Public Policy Exclusion anil Insurance for Intentional Employment Discrimination, 92 MICH. L. REV. 1256, 1322 (1994) (arguing that "the primary reason that courts impose a public policy exclusion to void coverage for intentional employment discrimination is to maintain the deterrent effect of discrimination liability").
373. The same concept is sometimes captured in the phrase "elasticity of risk" or in the economist's term, "moral hazard." See KENNETH S. ABRAHAM, DISTRIBUTING RISK: INSURANCE, LEGAL THEORY, AND PUBLIC POLICY 15 (1986) (discussing insurers' controls over moral hazard); GREENE ET AL., supra note 200, at 11 (explaining moral hazard); Schwartz, supra note 302, at 343 ("The unavailability of insurance . . . may verify that [the system] . . . is targeting for liability precisely those forms of conduct that are so readily controllable by defendants as to render unacceptable to insurers the moral-hazard prospect of insurance policies.").
374. The same concept is sometimes captured in the phrase "elasticity of risk" or in the economist's term, "moral hazard." See KENNETH S. ABRAHAM, DISTRIBUTING RISK: INSURANCE, LEGAL THEORY, AND PUBLIC POLICY 15 (1986) (discussing insurers' controls over moral hazard); GREENE ET AL., supra note 200, at 11 (explaining moral hazard); Schwartz, supra note 302, at 343 ("The unavailability of insurance . . . may verify that [the system] . . . is targeting for liability precisely those forms of conduct that are so readily controllable by defendants as to render unacceptable to insurers the moral-hazard prospect of insurance policies.").
375. See ABRAHAM, supra note 306, at 71-74 (discussing feature rating and experience rating).
376. See STEVEN SHAVELL, ECONOMIC ANALYSIS OF ACCIDENT LAW 210-11 (1987) (assuming "insurers can determine injurers' levels of care, their liability insurance policies will supply them with full coverage and will have provisions inducing them to take optimal care"); Logue, supra note 186, at 1375-76 (arguing that liability insurance can ameliorate judgment-proof problem through feature and experience rating and by making insurance proceeds available along with debtor's own assets). But see Steven A. Kunzman, The Insurer as Surrogate Regulator of the Hazardous Waste Industry: Solution or Perversion?, 20 FORUM 469, 481-88 (1985) (challenging assertion that insurance premiums can force firms to internalize costs).
377. See STEVEN SHAVELL, ECONOMIC ANALYSIS OF ACCIDENT LAW 210-11 (1987) (assuming "insurers can determine injurers' levels of care, their liability insurance policies will supply them with full coverage and will have provisions inducing them to take optimal care"); Logue, supra note 186, at 1375-76 (arguing that liability insurance can ameliorate judgment-proof problem through feature and experience rating and by making insurance proceeds available along with debtor's own assets). But see Steven A. Kunzman, The Insurer as Surrogate Regulator of the Hazardous Waste Industry: Solution or Perversion?, 20 FORUM 469, 481-88 (1985) (challenging assertion that insurance premiums can force firms to internalize costs).
378. See STEVEN SHAVELL, ECONOMIC ANALYSIS OF ACCIDENT LAW 210-11 (1987) (assuming "insurers can determine injurers' levels of care, their liability insurance policies will supply them with full coverage and will have provisions inducing them to take optimal care"); Logue, supra note 186, at 1375-76 (arguing that liability insurance can ameliorate judgment-proof problem through feature and experience rating and by making insurance proceeds available along with debtor's own assets). But see Steven A. Kunzman, The Insurer as Surrogate Regulator of the Hazardous Waste Industry: Solution or Perversion?, 20 FORUM 469, 481-88 (1985) (challenging assertion that insurance premiums can force firms to internalize costs).
379. See ABRAHAM, supra note 306, at 77 ("Because the members of each [risk] class are charged in accord with [the insurers'] expected costs, total premiums are designed to cover the aggregate losses of the class. No subsidies run from one risk class to another. The only subsidy under this ideal flows from the lucky to the unlucky.").
380. The primary incentive not to drive carelessly may be to avoid injury to one's self in an accident, not to avoid liability to another. Conduct that results in civil liability may also result in criminal liability or action against the wrongdoer.
381. Insureds might purchase such a policy to gain the insurer's expertise in claims administration, see supra note 200, or as a means of complying with financial responsibility laws, see supra note 201. See also Kenneth S. Abraham, Environmental Liability and the Limits of Insurance, 88 COLUM. L. REV. 942, 980-85 (1988) (arguing that retroactive indexing of premiums might ease environmental liability crisis but noting that bankruptcy of insured would thwart technique).
382. See ABRAHAM, supra note 306, at 18 ("The law governing the devices that are used in combination with differential pricing to mitigate moral hazard in insurance - exceptions to coverage, coinsurance, and application screening, among others - should take the function of these devices into account if the effects of civil liability and insurance law are to work in tandem and not at cross purposes.").
383. Compulsory liability insurance, by contrast, is for the benefit of the injured third party. With respect to compulsory liability insurance, it makes no sense to permit insurers to deny coverage for fraud in the insurance application. Current law reflects this distinction. See, e.g., Pekin Ins. Co. v. Super, 912 F. Supp. 409, 413 (S.D. Ind. 1995) (holding that "when a third party is injured by an insured who gained their [sic] policy by fraud, an insurer may assert the common law defense of material misrepresentation so as to avoid coverage in excess of the levels required by Indiana's Financial Responsibility Law, but that an insurer may not avoid coverage up to that amount in any circumstance"); Omaha Property & Casualty Co. v. Crosby, 756 F. Supp. 1380, 1384 (D. Mont. 1990) ("When a state compulsory insurance statute exists, courts have 'universally held or recognized that an insurer cannot, on the ground of fraud or misrepresentations relating to the inception of the policy, retrospectively avoid coverage . . . so as to escape liability to a third party.'" (citations omitted)).
384. See, e.g., GREENE ET AL., supra note 200, at 45 ("From the standpoint of the insurer, there are several requisites of insurable risks that must be met . . . The loss, should it occur, must be accidental and unintentional in nature from the viewpoint of the insured."); INSURANCE SERV. ORG., Commercial General Liability Coverage Form (CG 00 01 11 88), reprinted in KENNETH S. ABRAHAM, INSURANCE LAW AND REGULATION: CASES AND MATERIALS 442, para. 2.a (2d ed. 1995) ("This insurance does not apply to '[b]odily injury' or 'property damage' expected or intended from the standpoint of the insured."); Abraham, supra note 311, at 952 ("[T]here is no coverage against liability for harm that is caused intentionally or nearly intentionally."); James L. Rigelhaupt, Jr., Annotation, Construction and Application of Provision of Liability Insurance Policy Expressly Excluding Injuries Intended or Expected by Insured, 31 A.L.R. 4TH 957 (1984). Even though no exclusion of punitive damages appears in the commercial general liability policy, a substantial minority of courts refuse to permit coverage on public policy grounds. See Gary S. Franklin, Comment, Punitive Damages Insurance: Why Some Courts Take the Smart Out of "Smart Money", 40 U. MIAMI L. REV. 979, 1000-01 n.84 (1986) (citing cases permitting and denying coverage on public policy grounds).
385. See, e.g., GREENE ET AL., supra note 200, at 45 ("From the standpoint of the insurer, there are several requisites of insurable risks that must be met . . . The loss, should it occur, must be accidental and unintentional in nature from the viewpoint of the insured."); INSURANCE SERV. ORG., Commercial General Liability Coverage Form (CG 00 01 11 88), reprinted in KENNETH S. ABRAHAM, INSURANCE LAW AND REGULATION: CASES AND MATERIALS 442, para. 2.a (2d ed. 1995) ("This insurance does not apply to '[b]odily injury' or 'property damage' expected or intended from the standpoint of the insured."); Abraham, supra note 311, at 952 ("[T]here is no coverage against liability for harm that is caused intentionally or nearly intentionally."); James L. Rigelhaupt, Jr., Annotation, Construction and Application of Provision of Liability Insurance Policy Expressly Excluding Injuries Intended or Expected by Insured, 31 A.L.R. 4TH 957 (1984). Even though no exclusion of punitive damages appears in the commercial general liability policy, a substantial minority of courts refuse to permit coverage on public policy grounds. See Gary S. Franklin, Comment, Punitive Damages Insurance: Why Some Courts Take the Smart Out of "Smart Money", 40 U. MIAMI L. REV. 979, 1000-01 n.84 (1986) (citing cases permitting and denying coverage on public policy grounds).
386. See, e.g., GREENE ET AL., supra note 200, at 45 ("From the standpoint of the insurer, there are several requisites of insurable risks that must be met . . . The loss, should it occur, must be accidental and unintentional in nature from the viewpoint of the insured."); INSURANCE SERV. ORG., Commercial General Liability Coverage Form (CG 00 01 11 88), reprinted in KENNETH S. ABRAHAM, INSURANCE LAW AND REGULATION: CASES AND MATERIALS 442, para. 2.a (2d ed. 1995) ("This insurance does not apply to '[b]odily injury' or 'property damage' expected or intended from the standpoint of the insured."); Abraham, supra note 311, at 952 ("[T]here is no coverage against liability for harm that is caused intentionally or nearly intentionally."); James L. Rigelhaupt, Jr., Annotation, Construction and Application of Provision of Liability Insurance Policy Expressly Excluding Injuries Intended or Expected by Insured, 31 A.L.R. 4TH 957 (1984). Even though no exclusion of punitive damages appears in the commercial general liability policy, a substantial minority of courts refuse to permit coverage on public policy grounds. See Gary S. Franklin, Comment, Punitive Damages Insurance: Why Some Courts Take the Smart Out of "Smart Money", 40 U. MIAMI L. REV. 979, 1000-01 n.84 (1986) (citing cases permitting and denying coverage on public policy grounds).
387. See, e.g., GREENE ET AL., supra note 200, at 45 ("From the standpoint of the insurer, there are several requisites of insurable risks that must be met . . . The loss, should it occur, must be accidental and unintentional in nature from the viewpoint of the insured."); INSURANCE SERV. ORG., Commercial General Liability Coverage Form (CG 00 01 11 88), reprinted in KENNETH S. ABRAHAM, INSURANCE LAW AND REGULATION: CASES AND MATERIALS 442, para. 2.a (2d ed. 1995) ("This insurance does not apply to '[b]odily injury' or 'property damage' expected or intended from the standpoint of the insured."); Abraham, supra note 311, at 952 ("[T]here is no coverage against liability for harm that is caused intentionally or nearly intentionally."); James L. Rigelhaupt, Jr., Annotation, Construction and Application of Provision of Liability Insurance Policy Expressly Excluding Injuries Intended or Expected by Insured, 31 A.L.R. 4TH 957 (1984). Even though no exclusion of punitive damages appears in the commercial general liability policy, a substantial minority of courts refuse to permit coverage on public policy grounds. See Gary S. Franklin, Comment, Punitive Damages Insurance: Why Some Courts Take the Smart Out of "Smart Money", 40 U. MIAMI L. REV. 979, 1000-01 n.84 (1986) (citing cases permitting and denying coverage on public policy grounds).
388. See, e.g., GREENE ET AL., supra note 200, at 45 ("From the standpoint of the insurer, there are several requisites of insurable risks that must be met . . . The loss, should it occur, must be accidental and unintentional in nature from the viewpoint of the insured."); INSURANCE SERV. ORG., Commercial General Liability Coverage Form (CG 00 01 11 88), reprinted in KENNETH S. ABRAHAM, INSURANCE LAW AND REGULATION: CASES AND MATERIALS 442, para. 2.a (2d ed. 1995) ("This insurance does not apply to '[b]odily injury' or 'property damage' expected or intended from the standpoint of the insured."); Abraham, supra note 311, at 952 ("[T]here is no coverage against liability for harm that is caused intentionally or nearly intentionally."); James L. Rigelhaupt, Jr., Annotation, Construction and Application of Provision of Liability Insurance Policy Expressly Excluding Injuries Intended or Expected by Insured, 31 A.L.R. 4TH 957 (1984). Even though no exclusion of punitive damages appears in the commercial general liability policy, a substantial minority of courts refuse to permit coverage on public policy grounds. See Gary S. Franklin, Comment, Punitive Damages Insurance: Why Some Courts Take the Smart Out of "Smart Money", 40 U. MIAMI L. REV. 979, 1000-01 n.84 (1986) (citing cases permitting and denying coverage on public policy grounds).
389. See Gary Marchant, Modified Rules for Modified Bugs: Balancing Safety and Efficiency in the Regulation of Deliberate Release of Genetically Engineered Microorganisms, 1 HARV. J.L. & TECH. 163, 192 (1988) ("Many biotechnology companies are new, and relatively small, and may not have sufficient assets to withstand a large damage claim. The problem of judgment-proof firms is exacerbated by the unavailability of liability insurance for companies undertaking releases of genetically engineered microorganisms into the environment."). But see Product & Professional Liability Insurance for Biotechnology Products Now Available, 6 BIOTECH L. REP. 404 (1987) ("The Association of Biotechnology Companies has announced that it has secured, after lengthy negotiations, product and professional liability insurance for biotechnology products, including those released into the environment.").
390. See Gary Marchant, Modified Rules for Modified Bugs: Balancing Safety and Efficiency in the Regulation of Deliberate Release of Genetically Engineered Microorganisms, 1 HARV. J.L. & TECH. 163, 192 (1988) ("Many biotechnology companies are new, and relatively small, and may not have sufficient assets to withstand a large damage claim. The problem of judgment-proof firms is exacerbated by the unavailability of liability insurance for companies undertaking releases of genetically engineered microorganisms into the environment."). But see Product & Professional Liability Insurance for Biotechnology Products Now Available, 6 BIOTECH L. REP. 404 (1987) ("The Association of Biotechnology Companies has announced that it has secured, after lengthy negotiations, product and professional liability insurance for biotechnology products, including those released into the environment.").
391. See, e.g., Easterbrook & Fischel, supra note 185, at 107 ("[I]nvestors should not be willing to pay insurers to reduce risk. Why buy something you already have for free?"); Alan O. Sykes, Judicial Limitations on the Discretion of Liability Insurers to Settle or Litigate: An Economic Critique, 72 TEX. L. REV. 1345, 1361 (1994) ("Individuals who are entirely judgment proof, for example, have no reason to purchase insurance at all - it is irrational to insure against loss if you have nothing to lose.").
392. See, e.g., Easterbrook & Fischel, supra note 185, at 107 ("[I]nvestors should not be willing to pay insurers to reduce risk. Why buy something you already have for free?"); Alan O. Sykes, Judicial Limitations on the Discretion of Liability Insurers to Settle or Litigate: An Economic Critique, 72 TEX. L. REV. 1345, 1361 (1994) ("Individuals who are entirely judgment proof, for example, have no reason to purchase insurance at all - it is irrational to insure against loss if you have nothing to lose.").
393. It is not entirely clear that liability insurance will help. On the one hand, a policy of liability insurance may pay an obligation that otherwise would push the debtor into bankruptcy. On the other, the existence of the policy may attract litigation that otherwise would not be filed; the resulting judgments may exceed the policy limit, pushing the debtor into bankruptcy. Which tendency would predominate probably is a question that can be answered only empirically, if at all.
394. See, e.g., Gilbert, supra note 201, at 1 ("[W]ith 'lender liability' under the Comprehensive Environmental Response and Compensation Liability Act (CERCLA) still a source of potential exposure, lenders may require borrowers to obtain [environmental impairment] insurance . . . ." (footnote omitted)).
395. See, e.g., Stephen Keating, Taxis Still on the Road Strapped Yellow Cab Pays Liability Insurance, DENVER POST, May 11, 1994, at C1 (describing incident in which Colorado Department of Revenue attempted to shut down self-insured Yellow Cab Company for inability 10 pay tort claims and Yellow Cab executive responded by displaying check that would pay for insurance and asserting that "[e]veryone that travels in a Yellow Cab is protected").
396. For example, building contractors sometimes require that subcontractors working on the job carry liability insurance and hospitals sometimes require that affiliated doctors carry medical malpractice insurance.
397. During Chapter 11 bankruptcy, the debtor can choose which of its contracts it wishes to perform. See 11 U.S.C. § 365(a) (1994). It can affirm those contracts and reject the rest, converting the latter to liability for breach which will, in all likelihood, be dischargeable. See id. §§ 365(g), 502(i). The drafting problem is merely to make sure that the debtor has sufficient incentives to choose to perform the construction contract.
398. Illustrating this cultural preference, Professor James J. White wrote in response to an earlier draft of this Article that "no one will do surgery with your physician who has taken all his assets offshore and who has 'gone naked.' In fact, a surgeon without insurance will probably not be allowed to operate." Letter from James J. White, Robert A. Sullivan Professor of Law, University of Michigan Law School, to Lynn M. LoPucki 3 (Nov. 10, 1995) (on file with author).
399. See Eugene R. Anderson et al., Liability Insurance: A Primer for Corporate Counsel, 49 BUS. LAW. 259, 265 (1993) (describing how old "occurrence" policy was effectively withdrawn from U.S. market and replaced with new policy offered in two mutually "exclusive forms" - "occurrence" and "claims-made").
400. See Alan Corp. v. International Surplus Lines Ins., 22 F.3d 339 (1st Cir. 1994) (upholding insurer's denial of coverage under "claims-made" pollution liability policy because government did not initiate environmental enforcement action during policy period even though insured notified insurer of environmental damage during policy period). See generally In re Insurance Antitrust Litig., 938 F.2d 919, 923 (9th Cir. 1991) (holding primary insurers and reinsurers may have violated antitrust laws in pressuring Insurance Service Office to eliminate accidental pollution coverage from its market dominant Commercial General Liability Insurance form and to issue second, "claims-made," form), aff'd in part, rev'd in part on other grounds and remanded sub nom. Hartford Fire Ins. Co. v. California, 509 U.S. 764 (1993).
401. See Abraham, supra note 311, at 980 (noting that, with reference to claims-made coverage, "only liabilities developing during the first few years after the policy is sold need to be predicted"); Andrew Reidy & Robert Carter, Insurance Helps Breathe Life into Tobacco Litigation, CONN. L. TRIB., Apr. 17, 1995, at 24 (reporting that tobacco industry insurers are expected to raise "trigger of coverage" issue created by issuance of claims-made policies with respect to cigarette litigation).
402. See Abraham, supra note 311, at 980 (noting that, with reference to claims-made coverage, "only liabilities developing during the first few years after the policy is sold need to be predicted"); Andrew Reidy & Robert Carter, Insurance Helps Breathe Life into Tobacco Litigation, CONN. L. TRIB., Apr. 17, 1995, at 24 (reporting that tobacco industry insurers are expected to raise "trigger of coverage" issue created by issuance of claims-made policies with respect to cigarette litigation).
403. See, e.g., DONALD S. MALECKI & ARTHUR L. FLITNER, COMMERCIAL GENERAL LIABILITY 3 (1994) ("Contrary to expectations, the claims-made form has seen only limited use since its introduction, due perhaps to the 'soft market' conditions that set in during the late-1980s."); Abraham, supra note 311, at 965 n.73 ("The effort to introduce a claims-made [commercial general liability], however, has not met with success. Some state regulators have been reluctant to approve the new policy for general use, and the consuming public has not reacted favorably to its introduction.").
404. See, e.g., DONALD S. MALECKI & ARTHUR L. FLITNER, COMMERCIAL GENERAL LIABILITY 3 (1994) ("Contrary to expectations, the claims-made form has seen only limited use since its introduction, due perhaps to the 'soft market' conditions that set in during the late-1980s."); Abraham, supra note 311, at 965 n.73 ("The effort to introduce a claims-made [commercial general liability], however, has not met with success. Some state regulators have been reluctant to approve the new policy for general use, and the consuming public has not reacted favorably to its introduction.").
405. See, e.g., Leslie Cheek III, Risk-Spreaders or Risk Eliminators? An Insurer's Perspective on the Liability and Financial Responsibility Provisions of RCRA and CERCLA, 2 VA. J. NAT'L RES. L. 149, 159 (1982) (quoting "basic principle developed by the American Insurance Association that '[c]laims-made insurance policies should be acceptable alternatives to the standard occurrence-based contracts'" (citation omitted)); Gilbert, supra note 201, at 6 ("Regardless of the specific coverage provided, today's [environmental impairment] insurance nearly always is written on a 'claims-made' or 'discovery' basis . . . . [I]t is nearly impossible to find [environmental impairment] coverage on an 'occurrence' basis."); John Sherlock, Legal Malpractice Insurance Competitive: A Guide to Choosing a Carrier in a Crowded Marketplace, LEGAL INTELLIGENCER, June 2, 1995, at 3 ("All lawyers' professional liability policies are written on 'claims-made' policy forms. This means coverage under the policy does not trigger until the claim is made.").
406. See, e.g., Leslie Cheek III, Risk-Spreaders or Risk Eliminators? An Insurer's Perspective on the Liability and Financial Responsibility Provisions of RCRA and CERCLA, 2 VA. J. NAT'L RES. L. 149, 159 (1982) (quoting "basic principle developed by the American Insurance Association that '[c]laims-made insurance policies should be acceptable alternatives to the standard occurrence-based contracts'" (citation omitted)); Gilbert, supra note 201, at 6 ("Regardless of the specific coverage provided, today's [environmental impairment] insurance nearly always is written on a 'claims-made' or 'discovery' basis . . . . [I]t is nearly impossible to find [environmental impairment] coverage on an 'occurrence' basis."); John Sherlock, Legal Malpractice Insurance Competitive: A Guide to Choosing a Carrier in a Crowded Marketplace, LEGAL INTELLIGENCER, June 2, 1995, at 3 ("All lawyers' professional liability policies are written on 'claims-made' policy forms. This means coverage under the policy does not trigger until the claim is made.").
407. See, e.g., Leslie Cheek III, Risk-Spreaders or Risk Eliminators? An Insurer's Perspective on the Liability and Financial Responsibility Provisions of RCRA and CERCLA, 2 VA. J. NAT'L RES. L. 149, 159 (1982) (quoting "basic principle developed by the American Insurance Association that '[c]laims-made insurance policies should be acceptable alternatives to the standard occurrence-based contracts'" (citation omitted)); Gilbert, supra note 201, at 6 ("Regardless of the specific coverage provided, today's [environmental impairment] insurance nearly always is written on a 'claims-made' or 'discovery' basis . . . . [I]t is nearly impossible to find [environmental impairment] coverage on an 'occurrence' basis."); John Sherlock, Legal Malpractice Insurance Competitive: A Guide to Choosing a Carrier in a Crowded Marketplace, LEGAL INTELLIGENCER, June 2, 1995, at 3 ("All lawyers' professional liability policies are written on 'claims-made' policy forms. This means coverage under the policy does not trigger until the claim is made.").
408. See, e.g., Steven Shavell, The Judgment Proof Problem, 6 INT'L REV. L. & ECON. 45, 54 (1986) (suggesting compulsory insurance as possible response to problem of judgment-proof tortfeasors); Note, Designer Genes that Don't Fit: A Tort Regime for Commercial Releases of Genetic Engineering Products, 100 HARV. L. REV. 1086, 1099-100 (1987) (advocating financial responsibility requirements such as mandatory insurance to deal with problem of judgment-proof firms).
409. See, e.g., Steven Shavell, The Judgment Proof Problem, 6 INT'L REV. L. & ECON. 45, 54 (1986) (suggesting compulsory insurance as possible response to problem of judgment-proof tortfeasors); Note, Designer Genes that Don't Fit: A Tort Regime for Commercial Releases of Genetic Engineering Products, 100 HARV. L. REV. 1086, 1099-100 (1987) (advocating financial responsibility requirements such as mandatory insurance to deal with problem of judgment-proof firms).
410. Liability insurance is compulsory in about 40 American jurisdictions. See 1992 SUMMARY OF SELECTED STATE LAWS AND REGULATIONS RELATING TO AUTOMOBILE INSURANCE 18-27 (1992) (showing that 39 states have "compulsory liability insurance"); ROBERT H. JOOST, AUTOMOBILE INSURANCE AND NO-FAULT LAW 2D § 1:8 (Supp. 1995) ("In 1995, 40 American jurisdictions required all motorists to maintain BI liability insurance or its equivalent."). According to Joost, 11 other American jurisdictions have "financial responsibility" laws that give drivers the option of buying insurance or otherwise providing for their own financial responsibility. See id. But the limits of insurance or financial responsibility are modest. Only three states require insurance in an amount greater than $25,000 for one victim, and only three require insurance in an amount greater than $50,000 for all victims in a single accident. See id. at §§ 4:34, 5:18 & 6:31 (1992) (containing tables from which this conclusion can be derived). In states where liability insurance is compulsory, a substantial portion of all drivers do not carry insurance. See infra note 360.
411. Liability insurance is compulsory in about 40 American jurisdictions. See 1992 SUMMARY OF SELECTED STATE LAWS AND REGULATIONS RELATING TO AUTOMOBILE INSURANCE 18-27 (1992) (showing that 39 states have "compulsory liability insurance"); ROBERT H. JOOST, AUTOMOBILE INSURANCE AND NO-FAULT LAW 2D § 1:8 (Supp. 1995) ("In 1995, 40 American jurisdictions required all motorists to maintain BI liability insurance or its equivalent."). According to Joost, 11 other American jurisdictions have "financial responsibility" laws that give drivers the option of buying insurance or otherwise providing for their own financial responsibility. See id. But the limits of insurance or financial responsibility are modest. Only three states require insurance in an amount greater than $25,000 for one victim, and only three require insurance in an amount greater than $50,000 for all victims in a single accident. See id. at §§ 4:34, 5:18 & 6:31 (1992) (containing tables from which this conclusion can be derived). In states where liability insurance is compulsory, a substantial portion of all drivers do not carry insurance. See infra note 360.
412. See U.S. CHAMBER OF COMMERCE, 1995 ANALYSIS OF WORKERS' COMPENSATION LAWS 1, 3-5 (1995) (showing workers' compensation statutes of all 50 states as "compulsory" with insurance "required"); Worker's Comp. L. Rep. (CCH) 5011-14 (1993) (showing state-by-state requirements for workers' compensation insurance).
413. See U.S. CHAMBER OF COMMERCE, 1995 ANALYSIS OF WORKERS' COMPENSATION LAWS 1, 3-5 (1995) (showing workers' compensation statutes of all 50 states as "compulsory" with insurance "required"); Worker's Comp. L. Rep. (CCH) 5011-14 (1993) (showing state-by-state requirements for workers' compensation insurance).
414. See 42 U.S.C. § 2210(b) (1988 & Supp. V 1993) (requiring, as condition of licensing nuclear power plant, that operator prove financial responsibility in amount set by Nuclear Regulatory Commission). As of 1989, the Commission had set the amount at approximately seven billion dollars. See John F. McNett, Nuclear Indemnity for Government Contractors Under the Price-Anderson Amendments, 19 PUB. CONT. L.J. 1 (1989).
415. See 42 U.S.C. § 2210(b) (1988 & Supp. V 1993) (requiring, as condition of licensing nuclear power plant, that operator prove financial responsibility in amount set by Nuclear Regulatory Commission). As of 1989, the Commission had set the amount at approximately seven billion dollars. See John F. McNett, Nuclear Indemnity for Government Contractors Under the Price-Anderson Amendments, 19 PUB. CONT. L.J. 1 (1989).
416. See Federal Aviation Act, 49 U.S.C. §§ 1301-1542, revised, codified and reenacted without substantive change at 49 U.S.C.A. § 40101-41741 (West Supp. 1995). Section 41112 specifically addresses financial responsibility requirements, and regulations have been promulgated pursuant thereto. See 14 C.F.R. § 205.5(b) (1995) (requiring that commercial airlines maintain liability insurance totaling $20 million plus $300,000 times 75% of number of passenger seats installed in aircraft).
417. See Resources Conservation and Recovery Act of 1976 § 3004, 42 U.S.C. § 6924(a) (1988) (mandating promulgation of regulations for financial responsibility requirements for operators of facilities for treatment, storage, and disposal of hazardous waste); Hazardous and Solid Waste Amendments of 1984 § 205, 42 U.S.C. § 6924(t) (listing insurance coverage as one means of satisfying financial responsibility requirements).
418. E.g., 49 U.S.C.A. § 31138 (1994), amended by ICC Termination Act of 1995, Pub. L. No. 104-88, § 104(d), 109 Stat. 803, 919 (1995) (commercial transportation of passengers by motor vehicle); 49 U.S.C.A. § 31139, amended by ICC Termination Act of 1995, Pub. L. No. 104-88,8 104(e), 109 Stat. 803, 919 (1995) (same); 49 U.S.C.A. § 70112 (commercial space launch activities).
419. See, e.g., DEL. CODE ANN. tit. 6, § 1546 (1993) (requiring $1,000,000 in liability insurance or reserves for limited liability partnership).
420. I assume that insurance commissioners will continue to require that insurance companies demonstrate their solvency in order to continue to be licensed to write policies. But see Gilbert, supra note 201, at 7 (referring to existence in private insurance market of "'cut through' endorsements, which require an insurer's parent company to guarantee the coverage in the event of the insurer's insolvency"). The existence of these endorsements suggests that: (1) insurance companies are compartmentalizing their operations in separate corporations to limit their liability (that is, soft-judgment proofing); and (2) the impact is great enough that sophisticated persons who deal with insurers insist on nullifying the strategy by requiring that the parent company guarantee payment.
421. See supra notes 331-34 and accompanying text.
422. The ability to assure a third party of the payment of a debt is itself a valuable asset. The debtor would not want to own sufficient assets for its own assurance to be adequate; that would expose the assets to the liability system. Instead, the debtor would itself remain judgment proof, but purchase a third-party guarantee of obligations for which it chose to assure payment. The technique is no different than that employed by many, if not most, owners of small businesses today. They incorporate their business so that they will not be personally liable for tort claims, and they induce banks to lend to their corporations by personally guaranteeing corporate repayment of the loans. See RONALD J. MANN, PAYMENT AND CREDIT SYSTEMS Assignment 24 (1996).
423. See Cheek, supra note 327, at 175 ("Just as an automobile owner can rind a mechanic willing to dismantle the vehicle's air pollution control equipment, so a hazardous waste facility operator would be able to find an insurer willing to waive enforcement of expensive loss prevention rules for a minor increase in the premium.").
424. See, e.g., P.R. Newswire Ass'n, Inc., Uninsured Taxicabs May Put Public At Risk; 'Play It Straight,' Long Warns Insurance Agents, Dec. 16, 1993 (reporting possibly widespread practice of selling taxicab drivers inexpensive personal automobile policies rather than much more expensive commercial coverage required by law).
425. The market in which the commercial liability insurance forms are generated is not entirely free. See Hartford Fire Ins. Co. v. California, 509 U.S. 764 (1993) (holding that primary insurers and reinsurers may have violated antitrust laws in compelling Insurance Service Office to eliminate accidental pollution coverage from its market dominant Commercial General Liability Insurance form and to compel issuance of second, "claims-made" form); see also In re Insurance Antitrust Litig., 938 F2d 919, 923 (9th Cir. 1991 ), aff'd in part, rev'd in part on other grounds and remanded sub nom. Hartford Fire Ins. v. California, 509 U.S. 764 (1993). Nevertheless, there is a market process at work that produces an evolution in policy provisions.
426. See, e.g., Anderson et al., supra note 323, at 280 ("In addition to the 'expected or intended' exclusion, Coverage A [of the commercial general liability policy] contains twelve other exclusions."); Gilbert, supra note 201, at 6 (describing numerous exclusions contained in environmental impairment insurance policies); Kirk A. Pasich, The Breadth of Insurance Coverage for Environmental Claims, 52 OHIO ST. L.J. 1131, 1131-32 (1991) ("Most insurance carriers . . . deny that they have any duty to pay the costs of cleaning up the environment or to pay damage claims against their insureds. Thus, insureds and insurance carriers are now litigating over myriad issues with respect to insurance carriers' obligations to defend and indemnify their insureds against claims relating to environmental contamination."); Reidy & Carter, supra note 325, at 24 (suggesting that "[t]he main defense the insurance industry is likely to litigate is whether the tobacco-related suits constitute an 'accident' or 'occurrence' so as to be covered under liability insurance" and that other likely issues include trigger date for coverage and pollution exclusion).
427. See, e.g., Anderson et al., supra note 323, at 280 ("In addition to the 'expected or intended' exclusion, Coverage A [of the commercial general liability policy] contains twelve other exclusions."); Gilbert, supra note 201, at 6 (describing numerous exclusions contained in environmental impairment insurance policies); Kirk A. Pasich, The Breadth of Insurance Coverage for Environmental Claims, 52 OHIO ST. L.J. 1131, 1131-32 (1991) ("Most insurance carriers . . . deny that they have any duty to pay the costs of cleaning up the environment or to pay damage claims against their insureds. Thus, insureds and insurance carriers are now litigating over myriad issues with respect to insurance carriers' obligations to defend and indemnify their insureds against claims relating to environmental contamination."); Reidy & Carter, supra note 325, at 24 (suggesting that "[t]he main defense the insurance industry is likely to litigate is whether the tobacco-related suits constitute an 'accident' or 'occurrence' so as to be covered under liability insurance" and that other likely issues include trigger date for coverage and pollution exclusion).
428. See, e.g., Anderson et al., supra note 323, at 280 ("In addition to the 'expected or intended' exclusion, Coverage A [of the commercial general liability policy] contains twelve other exclusions."); Gilbert, supra note 201, at 6 (describing numerous exclusions contained in environmental impairment insurance policies); Kirk A. Pasich, The Breadth of Insurance Coverage for Environmental Claims, 52 OHIO ST. L.J. 1131, 1131-32 (1991) ("Most insurance carriers . . . deny that they have any duty to pay the costs of cleaning up the environment or to pay damage claims against their insureds. Thus, insureds and insurance carriers are now litigating over myriad issues with respect to insurance carriers' obligations to defend and indemnify their insureds against claims relating to environmental contamination."); Reidy & Carter, supra note 325, at 24 (suggesting that "[t]he main defense the insurance industry is likely to litigate is whether the tobacco-related suits constitute an 'accident' or 'occurrence' so as to be covered under liability insurance" and that other likely issues include trigger date for coverage and pollution exclusion).
429. See, e.g., Anderson et al., supra note 323, at 280 ("In addition to the 'expected or intended' exclusion, Coverage A [of the commercial general liability policy] contains twelve other exclusions."); Gilbert, supra note 201, at 6 (describing numerous exclusions contained in environmental impairment insurance policies); Kirk A. Pasich, The Breadth of Insurance Coverage for Environmental Claims, 52 OHIO ST. L.J. 1131, 1131-32 (1991) ("Most insurance carriers . . . deny that they have any duty to pay the costs of cleaning up the environment or to pay damage claims against their insureds. Thus, insureds and insurance carriers are now litigating over myriad issues with respect to insurance carriers' obligations to defend and indemnify their insureds against claims relating to environmental contamination."); Reidy & Carter, supra note 325, at 24 (suggesting that "[t]he main defense the insurance industry is likely to litigate is whether the tobacco-related suits constitute an 'accident' or 'occurrence' so as to be covered under liability insurance" and that other likely issues include trigger date for coverage and pollution exclusion).
430. See supra notes 301-15 and accompanying text.
431. See supra notes 331-34 and accompanying text.
432. See ABRAHAM, supra note 306, at 60 ("Once coverage has been provided . . . policy defenses are perhaps the most workable tool for enforcing compliance with the insurer's risk management standards."); L. William Caraccio, Comment. Void Ab Initio: Application Fraud as Grounds for Avoiding Directors' and Officers' Liability Insurance Coverage, 74 CAL. L. REV. 929, 991-98 (1986) (discussing alternatives to insurers' current use of preexisting knowledge clause as basis for coverage).
433. See ABRAHAM, supra note 306, at 60 ("Once coverage has been provided . . . policy defenses are perhaps the most workable tool for enforcing compliance with the insurer's risk management standards."); L. William Caraccio, Comment. Void Ab Initio: Application Fraud as Grounds for Avoiding Directors' and Officers' Liability Insurance Coverage, 74 CAL. L. REV. 929, 991-98 (1986) (discussing alternatives to insurers' current use of preexisting knowledge clause as basis for coverage).
434. See supra note 313.
435. See, e.g., N.Y. INS. LAW § 3420(c) (McKinney 1985) (providing that burden of proof shall be on insurer when insurer defends against liability on ground that insured failed or refused to cooperate with insurer in violation of any provision in policy); see also Cohen & Co. v. North River Ins. Co., No. 93-1680, 1994 U.S. Dist. LEXIS 3646 (E.D. Pa. Mar. 25, 1994) (holding that failure of accounting firm, sued by writ of summons, to notify its insurer of claim within one-year duration of "claims-made" policy or within 60 days thereafter resulted in forfeiture of insurance), off'd, 39 F.3d 1168 (3d Cir. 1994). But see Bousquet, supra note 5, at 17 ("[M]any lawyers know of a potential claim but fail to disclose it because of their reluctance to accept responsibility for their acts - thereby creating another potential roadblock to compensation for clients who are harmed.").
436. See, e.g., N.Y. INS. LAW § 3420(c) (McKinney 1985) (providing that burden of proof shall be on insurer when insurer defends against liability on ground that insured failed or refused to cooperate with insurer in violation of any provision in policy); see also Cohen & Co. v. North River Ins. Co., No. 93-1680, 1994 U.S. Dist. LEXIS 3646 (E.D. Pa. Mar. 25, 1994) (holding that failure of accounting firm, sued by writ of summons, to notify its insurer of claim within one-year duration of "claims-made" policy or within 60 days thereafter resulted in forfeiture of insurance), off'd, 39 F.3d 1168 (3d Cir. 1994). But see Bousquet, supra note 5, at 17 ("[M]any lawyers know of a potential claim but fail to disclose it because of their reluctance to accept responsibility for their acts - thereby creating another potential roadblock to compensation for clients who are harmed.").
437. See Cheek, supra note 327, at 159; Steven A. Kunzman, The Insurer as Surrogate Regulator of the Hazardous Waste Industry: Solution or Perversion?, 20 FORUM 469, 483-84 (1985) (arguing that direct liability under CERCLA effectively strips insurer of its ability to deny coverage for failure to comply with terms of policy and thereby strips insurer of much of its control over insured's conduct). Kunzman bases his arguments on those developed by Cheek, supra note 327. See also ABRAHAM, supra note 306, at 61-62 (suggesting that insurers in compulsory liability insurance system control policy holders by compelling them to indemnify insurers against their own wrongdoing). Of course, the technique no longer works when insureds are judgment proof.
438. See Cheek, supra note 327, at 159; Steven A. Kunzman, The Insurer as Surrogate Regulator of the Hazardous Waste Industry: Solution or Perversion?, 20 FORUM 469, 483-84 (1985) (arguing that direct liability under CERCLA effectively strips insurer of its ability to deny coverage for failure to comply with terms of policy and thereby strips insurer of much of its control over insured's conduct). Kunzman bases his arguments on those developed by Cheek, supra note 327. See also ABRAHAM, supra note 306, at 61-62 (suggesting that insurers in compulsory liability insurance system control policy holders by compelling them to indemnify insurers against their own wrongdoing). Of course, the technique no longer works when insureds are judgment proof.
439. See Cheek, supra note 327, at 159; Steven A. Kunzman, The Insurer as Surrogate Regulator of the Hazardous Waste Industry: Solution or Perversion?, 20 FORUM 469, 483-84 (1985) (arguing that direct liability under CERCLA effectively strips insurer of its ability to deny coverage for failure to comply with terms of policy and thereby strips insurer of much of its control over insured's conduct). Kunzman bases his arguments on those developed by Cheek, supra note 327. See also ABRAHAM, supra note 306, at 61-62 (suggesting that insurers in compulsory liability insurance system control policy holders by compelling them to indemnify insurers against their own wrongdoing). Of course, the technique no longer works when insureds are judgment proof.
440. See Cheek, supra note 327, at 159; Steven A. Kunzman, The Insurer as Surrogate Regulator of the Hazardous Waste Industry: Solution or Perversion?, 20 FORUM 469, 483-84 (1985) (arguing that direct liability under CERCLA effectively strips insurer of its ability to deny coverage for failure to comply with terms of policy and thereby strips insurer of much of its control over insured's conduct). Kunzman bases his arguments on those developed by Cheek, supra note 327. See also ABRAHAM, supra note 306, at 61-62 (suggesting that insurers in compulsory liability insurance system control policy holders by compelling them to indemnify insurers against their own wrongdoing). Of course, the technique no longer works when insureds are judgment proof.
441. See, e.g., MO. REV. STAT. § 379.195 (West Supp. 1996) (providing that no contract of liability insurance shall be "cancelled or annulled by any agreement between the insurance company and the assured after the said assured has become responsible for such loss or damage"); PA. STAT. ANN. tit. 40, § 117 (West 1988) (requiring that policies provide that insolvency or bankruptcy of insured shall not release insurer and permitting direct actions against insurers); Mandeville v. Shelby Mut. Plate Glass & Casualty Co., 5 Conn. Supp. 306, 309 (C.P. 1937) ("The statute, to effectuate its manifest purpose to safeguard the rights of the injured person, prohibits any cancellation or annulment of the policy by any agreement between the insurance company and the assured after the injury." (quoting Guerin v. Indemnity Ins. Co., 107 Conn. 649, 653 (1928))); Storm v. Nationwide Mut. Ins. Co., 97 S.E.2d 759, 762 (Va. 1957) (finding that "an injured party is a beneficiary under the policy from the moment of injury" regardless of subsequent judgments, agreements, or releases between the policy holder and the insurer). But see MacArthur Co. v. Johns-Manville Corp., 837 F.2d 89 (2d Cir. 1988) (upholding Manville's ability to settle with its insurer during bankruptcy case and thereby cut off rights of subsequent injured parties).
442. The system permits liability insurance, nevertheless, because liability insurance does more than simply transfer risk; liability insurance reduces total risk by offsetting particular risks against similar ones. The reduction of total risk by aggregation in the hands of an insurance company creates net wealth.
443. That is, where losses are most difficult to control because they are largely within the control of the insured, insurers refuse coverage because such risks are not "insurable." See GREENE ET AL., supra note 200, at 45.
444. See, e.g., Boston Hous. Auth. v. Atlanta Int'l Ins. Co., 781 F. Supp. 80, 83 (D. Mass. 1992) (explaining that Massachusetts public policy bars insurance coverage tor indemnity and defense where policyholder intentionally committed racial discrimination in housing); Ranger Ins. Co. v. Bal Harbour Club, Inc., 549 So. 2d 1005 (Fla. 1989), aff'd, 570 So. 2d 1043 (Fla. Dist. Ct. App. 1990) (finding Florida public policy prohibits indemnification for loss resulting from intentional act of religious discrimination).
445. See, e.g., ABRAHAM, supra note 306, at 62 ("[A]ppointing the [insurance] industry as a frontline risk manager would require it to play an authoritative role - perhaps even an authoritarian one - in making decisions about the way other businesses conduct their operations.").
446. See, e.g., Abraham, supra note 311, at 954-55 (describing "surrogate regulation" by insurance companies as device for controlling incentives of insureds). But see ABRAHAM, supra note 306, at 57 (noting that compensation funds would make insurers "surrogate regulators," that role "would be a new one and would place unconventional demands on insurers," and that he was "not necessarily advocating such a role"); id. at 62-63 (referring to surrogate regulator as "insurer's new role" and arguing that direct regulation would be preferable). Cheek has argued that: Insurers can function as an important adjunct to public regulation of safety if they are left free to do what they are in business to do: spread the economic consequences of the risks they have contracted to assume. Any attempt to enlist insurers to control or eliminate these risks will inevitably impair their willingness and ability to perform their appropriate function in society and undermine the efficacy of public safety regulation. Cheek, supra note 327, at 177-78.
447. See, e.g., Abraham, supra note 311, at 954-55 (describing "surrogate regulation" by insurance companies as device for controlling incentives of insureds). But see ABRAHAM, supra note 306, at 57 (noting that compensation funds would make insurers "surrogate regulators," that role "would be a new one and would place unconventional demands on insurers," and that he was "not necessarily advocating such a role"); id. at 62-63 (referring to surrogate regulator as "insurer's new role" and arguing that direct regulation would be preferable). Cheek has argued that: Insurers can function as an important adjunct to public regulation of safety if they are left free to do what they are in business to do: spread the economic consequences of the risks they have contracted to assume. Any attempt to enlist insurers to control or eliminate these risks will inevitably impair their willingness and ability to perform their appropriate function in society and undermine the efficacy of public safety regulation. Cheek, supra note 327, at 177-78.
448. See, e.g., Abraham, supra note 311, at 954-55 (describing "surrogate regulation" by insurance companies as device for controlling incentives of insureds). But see ABRAHAM, supra note 306, at 57 (noting that compensation funds would make insurers "surrogate regulators," that role "would be a new one and would place unconventional demands on insurers," and that he was "not necessarily advocating such a role"); id. at 62-63 (referring to surrogate regulator as "insurer's new role" and arguing that direct regulation would be preferable). Cheek has argued that: Insurers can function as an important adjunct to public regulation of safety if they are left free to do what they are in business to do: spread the economic consequences of the risks they have contracted to assume. Any attempt to enlist insurers to control or eliminate these risks will inevitably impair their willingness and ability to perform their appropriate function in society and undermine the efficacy of public safety regulation. Cheek, supra note 327, at 177-78.
449. All existing systems do. See, e.g., supra notes 331-33 and accompanying text. Whether they should is an issue that goes beyond the scope of this Article. Theory as to the reasons for the existence of policy limits is sparse. For some speculation as to the reasons for the existence of policy limits, see Alan O. Sykes, "Bad Faith" Refusal to Settle by Liability Insurers: Some Implications of the Judgment-Proof Problem, 23 J. LEGAL STUD. 77, 86 (1994) ("[T]he fact that insureds have finite assets affords a standard explanation."). Other possible explanations include adverse selection, moral hazard, and the pricing of insurance higher than is "actuarially fair." Id. at 86 n.25.
450. The system would have a greater capacity for deterrence because no participant would be judgment proof. Today, most individuals and small businesses are judgment proof or capable of becoming so before a judgment could be entered against them. See supra note 5 and accompanying text.
451. See infra note 365 and accompanying text.
452. See, e.g., Patricia D. Gugin, Note, Conditioning Access to the Public Forum on the Purchase of Insurance, 17 GA. L. REV. 815, 836 (1983) (suggesting that "mandatory insurance may function as a form of censorship").
453. See JOEL S. MOSKOWITZ, ENVIRONMENTAL LIABILITY AND REAL PROPERTY TRANSACTIONS 338 (2d ed. 1995) ("Although a limited market exists now for environmental liability coverage, premiums and deductibles are high, and coverage is restricted."); supra note 315 (discussing availability of insurance in biotechnology field).
454. The California Department of Insurance has reported: Experience under other financial responsibility and compulsory insurance systems suggests that the socially irresponsible will remain financially irresponsible with or without a financial responsibility law. Evasion of compulsory automobile insurance requirements is widespread in the twenty-six states that replaced their [financial responsibility] statutes with such requirements, and the percentage of insured motorists in these jurisdictions has stabilized at levels prevalent before these laws were enacted. CALIFORNIA DEP'T OF INS., REPORT ON AUTOMOBILE LIABILITY INSURANCE (1995) (reporting that 27.5% of California drivers do not have insurance as required by state law); see also OHIO DEP'T OF PUB. SAFETY, 1994 OHIO TRAFFIC CRASH FACTS 34 (reporting that 83% of drivers involved in automobile accidents in Ohio in 1994 were insured, 6% were uninsured, and for 11% insurance status was not stated); STANFORD RESEARCH INSTITUTE, THE ROLE OF RISK CLASSIFICATION IN PROPERTY AND CASUALTY INSURANCE: FINAL REPORT 27 (1976) (estimating that 17.5% of all drivers in United States have no automobile insurance); Brian Ford, Lawmakers Consider No-Fault Insurance, TULSA WORLD, Oct. 25, 1995, at B1 ("The state Department of Public Safety estimates that between 15 percent and 17 percent of accidents involve uninsured motorists."); Fannie Weinstein, Bane of the Highways; Uninsured Motorists, INS. REV., Nov. 199), at 32 (estimating number of uninsured motorists nationwide at 17 million in 1991).
455. The California Department of Insurance has reported: Experience under other financial responsibility and compulsory insurance systems suggests that the socially irresponsible will remain financially irresponsible with or without a financial responsibility law. Evasion of compulsory automobile insurance requirements is widespread in the twenty-six states that replaced their [financial responsibility] statutes with such requirements, and the percentage of insured motorists in these jurisdictions has stabilized at levels prevalent before these laws were enacted. CALIFORNIA DEP'T OF INS., REPORT ON AUTOMOBILE LIABILITY INSURANCE (1995) (reporting that 27.5% of California drivers do not have insurance as required by state law); see also OHIO DEP'T OF PUB. SAFETY, 1994 OHIO TRAFFIC CRASH FACTS 34 (reporting that 83% of drivers involved in automobile accidents in Ohio in 1994 were insured, 6% were uninsured, and for 11% insurance status was not stated); STANFORD RESEARCH INSTITUTE, THE ROLE OF RISK CLASSIFICATION IN PROPERTY AND CASUALTY INSURANCE: FINAL REPORT 27 (1976) (estimating that 17.5% of all drivers in United States have no automobile insurance); Brian Ford, Lawmakers Consider No-Fault Insurance, TULSA WORLD, Oct. 25, 1995, at B1 ("The state Department of Public Safety estimates that between 15 percent and 17 percent of accidents involve uninsured motorists."); Fannie Weinstein, Bane of the Highways; Uninsured Motorists, INS. REV., Nov. 199), at 32 (estimating number of uninsured motorists nationwide at 17 million in 1991).
456. The California Department of Insurance has reported: Experience under other financial responsibility and compulsory insurance systems suggests that the socially irresponsible will remain financially irresponsible with or without a financial responsibility law. Evasion of compulsory automobile insurance requirements is widespread in the twenty-six states that replaced their [financial responsibility] statutes with such requirements, and the percentage of insured motorists in these jurisdictions has stabilized at levels prevalent before these laws were enacted. CALIFORNIA DEP'T OF INS., REPORT ON AUTOMOBILE LIABILITY INSURANCE (1995) (reporting that 27.5% of California drivers do not have insurance as required by state law); see also OHIO DEP'T OF PUB. SAFETY, 1994 OHIO TRAFFIC CRASH FACTS 34 (reporting that 83% of drivers involved in automobile accidents in Ohio in 1994 were insured, 6% were uninsured, and for 11% insurance status was not stated); STANFORD RESEARCH INSTITUTE, THE ROLE OF RISK CLASSIFICATION IN PROPERTY AND CASUALTY INSURANCE: FINAL REPORT 27 (1976) (estimating that 17.5% of all drivers in United States have no automobile insurance); Brian Ford, Lawmakers Consider No-Fault Insurance, TULSA WORLD, Oct. 25, 1995, at B1 ("The state Department of Public Safety estimates that between 15 percent and 17 percent of accidents involve uninsured motorists."); Fannie Weinstein, Bane of the Highways; Uninsured Motorists, INS. REV., Nov. 199), at 32 (estimating number of uninsured motorists nationwide at 17 million in 1991).
457. See JOOST, supra note 329, at § 1:8 (Supp. 1995).
458. In California, for example, approximately 30% of all drivers are uninsured. CALIFORNIA DEP'T OF INS., COMMISSIONER'S REPORT ON UNDERSERVED COMMUNITIES at ca-1 (1995) (describing large number of uninsured motorists as indicative of failure of system to serve poor). In April, 1996, California voters defeated Proposition 200, which aimed at combatting high rates of uninsurance, by a three to two margin. See Victoria Slind-Flor, Tort Revision 'Lost Cause' in California?, NAT'L L.J., Apr. 8, 1996, at B1. The proposition would have established a no-fault automobile insurance system and required owners to show proof of insurance when they registered their cars. See Proposition 200 § 12801 (1996) ("No motor vehicle registration shall be issued or renewed unless the owner of that vehicle furnishes proof, in a form satisfactory to the Department of Motor Vehicles, that the vehicle is insured as required by this chapter"). In 1990 a California vehicle code requiring drivers to provide evidence of financial responsibility on traffic stops and in accident investigation was repealed. See CAL. VEH. CODE § 16028 (West Supp. 1996) (repealed 1990).
459. In California, for example, approximately 30% of all drivers are uninsured. CALIFORNIA DEP'T OF INS., COMMISSIONER'S REPORT ON UNDERSERVED COMMUNITIES at ca-1 (1995) (describing large number of uninsured motorists as indicative of failure of system to serve poor). In April, 1996, California voters defeated Proposition 200, which aimed at combatting high rates of uninsurance, by a three to two margin. See Victoria Slind-Flor, Tort Revision 'Lost Cause' in California?, NAT'L L.J., Apr. 8, 1996, at B1. The proposition would have established a no-fault automobile insurance system and required owners to show proof of insurance when they registered their cars. See Proposition 200 § 12801 (1996) ("No motor vehicle registration shall be issued or renewed unless the owner of that vehicle furnishes proof, in a form satisfactory to the Department of Motor Vehicles, that the vehicle is insured as required by this chapter"). In 1990 a California vehicle code requiring drivers to provide evidence of financial responsibility on traffic stops and in accident investigation was repealed. See CAL. VEH. CODE § 16028 (West Supp. 1996) (repealed 1990).
460. See Cheek, supra note 327, at 153 (arguing that states undermine financial responsibility laws by requiring insurers to provide coverage to any licensed driver and requiring good drivers to subsidize those in high risk pool). As Keeton and Kwerel point out: [Assigned-risk] rates must be approved by the state insurance commission before they can go into effect and are often held below break-even levels. The resulting losses are then spread among insurance companies in proportion to the volume of voluntary business they do in the state, so that drivers who buy insurance in the voluntary market end up paying prices above expected cost. William R. Keeton & Evan Kwerel, Externalities in Automobile Insurance and the Underinsured Driver Problem, 27 J.L. & ECON. 149, 171 (1984).
461. See Cheek, supra note 327, at 153 (arguing that states undermine financial responsibility laws by requiring insurers to provide coverage to any licensed driver and requiring good drivers to subsidize those in high risk pool). As Keeton and Kwerel point out: [Assigned-risk] rates must be approved by the state insurance commission before they can go into effect and are often held below break-even levels. The resulting losses are then spread among insurance companies in proportion to the volume of voluntary business they do in the state, so that drivers who buy insurance in the voluntary market end up paying prices above expected cost. William R. Keeton & Evan Kwerel, Externalities in Automobile Insurance and the Underinsured Driver Problem, 27 J.L. & ECON. 149, 171 (1984).
462. See Keeton & Kwerel, supra note 363 (arguing that subsidizing liability insurance for financially irresponsible drivers is Pareto superior when those providing subsidy benefit from increased coverage of low-asset drivers); see also GUIDO CALABRESI, THE COSTS OF ACCIDENTS: A LEGAL AND ECONOMIC ANALYSIS 59 (1970) (suggesting compulsory insurance to correct distortion in decisions to bear risk).
463. See Keeton & Kwerel, supra note 363 (arguing that subsidizing liability insurance for financially irresponsible drivers is Pareto superior when those providing subsidy benefit from increased coverage of low-asset drivers); see also GUIDO CALABRESI, THE COSTS OF ACCIDENTS: A LEGAL AND ECONOMIC ANALYSIS 59 (1970) (suggesting compulsory insurance to correct distortion in decisions to bear risk).
464. See, e.g., Jeffrey Kehne, Note, Encouraging Safety Through Insurance-Based Incentives: Financial Responsibility for Hazardous Wastes, 96 YALE L.J. 403, 417 (1986) ("[R]equired levels of coverage [under the Resource Conservation and Recovery Act of 1976] fall far short of potential third-party damages. Current regulations also allow facilities to operate with third-party liability coverage that applies only to claims filed during a specified policy period - typically one year." (footnote omitted)). Furthermore, "[i]n 1982, twenty-eight states had compulsory liability insurance laws. However, none of these states required more than $25,000 coverage per person injured, and sixteen required $15,000 or less." Keeton & Kwerel, supra note 363, at 151; see, e.g., ALA. CODE § 32-7-6 (1975) (requiring automobile liability insurance to limit of not less than $20,000 because of bodily injury to or death to one person in any one accident, and $40,000 because of bodily injury to or death of two or more persons in any one accident); DEL. CODE ANN. tit. 21, § 2118(a)(2)(b) (1995) (requiring liability insurance coverage of not less than $15,000 for one person and $30,000 for all persons injured in any one accident).
465. See, e.g., Jeffrey Kehne, Note, Encouraging Safety Through Insurance-Based Incentives: Financial Responsibility for Hazardous Wastes, 96 YALE L.J. 403, 417 (1986) ("[R]equired levels of coverage [under the Resource Conservation and Recovery Act of 1976] fall far short of potential third-party damages. Current regulations also allow facilities to operate with third-party liability coverage that applies only to claims filed during a specified policy period - typically one year." (footnote omitted)). Furthermore, "[i]n 1982, twenty-eight states had compulsory liability insurance laws. However, none of these states required more than $25,000 coverage per person injured, and sixteen required $15,000 or less." Keeton & Kwerel, supra note 363, at 151; see, e.g., ALA. CODE § 32-7-6 (1975) (requiring automobile liability insurance to limit of not less than $20,000 because of bodily injury to or death to one person in any one accident, and $40,000 because of bodily injury to or death of two or more persons in any one accident); DEL. CODE ANN. tit. 21, § 2118(a)(2)(b) (1995) (requiring liability insurance coverage of not less than $15,000 for one person and $30,000 for all persons injured in any one accident).
466. Experience in the enforcement of California's mandatory automobile liability insurance law demonstrates that it is a political hot potato. About 30% of California's drivers violate the law by driving without insurance. The state could drastically reduce that number by requiring proof of insurance to register an automobile, as some other states do. Instead, the California Insurance Commissioner reports data showing that it is minorities and poor who drive without insurance. The report refers to the communities in which they live as "underserved" by the insurance industry, implying that it is the insurance industry rather than the uninsured drivers who are to blame. See CALIFORNIA DEP'T OF INS. STATISTICAL ANALYSIS BUREAU, COMMISSIONER'S REPORT ON UNDERSERVED COMMUNITIES (Feb. 1995).
467. See Cheek, supra note 327, at 159 ("To the extent that the states give guaranteed insurance availability a higher priority than loss prevention through active regulation, the ability of [financial responsibility] insurers to advance the public interest in environmental safety will be diminished."); id. at 159-60 (quoting "basic principle" developed by American Insurance Association that "[m]andatory residual markets (i.e., assigned risk plans) should be avoided, in order to prevent subversion of safety regulation and subsidization of uninsurable facilities by the owners of responsibly managed risks"). But see Keeton & Kwerel, supra note 363, at 151 (arguing that subsidizing liability insurance for financially irresponsible drivers may be Pareto optimal when those providing subsidy would otherwise go uncompensated).
468. See Cheek, supra note 327, at 159 ("To the extent that the states give guaranteed insurance availability a higher priority than loss prevention through active regulation, the ability of [financial responsibility] insurers to advance the public interest in environmental safety will be diminished."); id. at 159-60 (quoting "basic principle" developed by American Insurance Association that "[m]andatory residual markets (i.e., assigned risk plans) should be avoided, in order to prevent subversion of safety regulation and subsidization of uninsurable facilities by the owners of responsibly managed risks"). But see Keeton & Kwerel, supra note 363, at 151 (arguing that subsidizing liability insurance for financially irresponsible drivers may be Pareto optimal when those providing subsidy would otherwise go uncompensated).
469. For a frightening analogy, see 13 C.F.R. § 121.601 (1995), which classifies businesses into about 800 SIC categories as part of an effort to define a "small business."
470. See, e.g., Health Security Act, H.R. 3600, 103d Cong. (1993) (totalling 1342 printed pages in length).
471. See supra text accompanying notes 10, 20-36.
472. See, e.g., SOLOMON & SARET, supra note 148; SPERO, supra note 142.
473. The rules expressed in written law can be almost infinitely complex. But, as I have explained elsewhere, the rules expressed in written law are not the rules by which the system operates. See LoPucki, The Law in Lawyers' Heads, supra note 12, at 1517-21.
474. For a description of a nation's conscious effort to create a legal culture, see Frances H. Foster, Parental Law, Harmful Speech, and the Development of Russian Legal Culture: Russian Judicial Chamber Discourse and Narrative, 22 YALE J. INT'L L. (forthcoming 1997) (describing efforts to create a legal culture in post-Soviet Russia).
475. See Stanley Fish, Fish v. Fiss, 36 STAN. L. REV. 1325, 1327-30 (1984) (attributing agreement on what a rule "is" to constraints of context in which it is applied because knowledge "informs rules rather than follows from them").
476. See generally Richard B. Stewart, Environmental Regulation and International Competitiveness, 102 YALE L.J. 2039 (1993) (arguing that U.S. environmental liability may put U.S. producers at disadvantage in international trade).
477. See supra Section II.D.
478. See generally GEORGE EADS & PETER REUTER, DESIGNING SAFER PRODUCTS: CORPORATE RESPONSES TO PRODUCT LIABILITY LAW AND REGULATION vii (1983) (arguing that product liability sends "indistinct signal"); Gary T. Schwartz, Reality in the Economic Analysis of Tort Law: Does Tort Law Really Deter?, 42 UCLA L. REV. 377 (1994) (examining empirical evidence from variety of sources and concluding that tort law probably provides sufficient deterrent to warrant cost of system); John A. Siliciano, Corporate Behavior and the Social Efficiency of Tort Law, 85 MICH. L. REV. 1820, 1864 (1987) (arguing that "tort law does not necessarily push producers towards a socially efficient level of product safety"); Stephen D. Sugarman, Doing Away with Tort Law, 73 CAL. L. REV. 558, 559-609 (1985) (arguing that tort law has failed to deter wrongful conduct, failed to compensate at acceptable costs, and failed to do meaningful justice).
479. See generally GEORGE EADS & PETER REUTER, DESIGNING SAFER PRODUCTS: CORPORATE RESPONSES TO PRODUCT LIABILITY LAW AND REGULATION vii (1983) (arguing that product liability sends "indistinct signal"); Gary T. Schwartz, Reality in the Economic Analysis of Tort Law: Does Tort Law Really Deter?, 42 UCLA L. REV. 377 (1994) (examining empirical evidence from variety of sources and concluding that tort law probably provides sufficient deterrent to warrant cost of system); John A. Siliciano, Corporate Behavior and the Social Efficiency of Tort Law, 85 MICH. L. REV. 1820, 1864 (1987) (arguing that "tort law does not necessarily push producers towards a socially efficient level of product safety"); Stephen D. Sugarman, Doing Away with Tort Law, 73 CAL. L. REV. 558, 559-609 (1985) (arguing that tort law has failed to deter wrongful conduct, failed to compensate at acceptable costs, and failed to do meaningful justice).
480. See generally GEORGE EADS & PETER REUTER, DESIGNING SAFER PRODUCTS: CORPORATE RESPONSES TO PRODUCT LIABILITY LAW AND REGULATION vii (1983) (arguing that product liability sends "indistinct signal"); Gary T. Schwartz, Reality in the Economic Analysis of Tort Law: Does Tort Law Really Deter?, 42 UCLA L. REV. 377 (1994) (examining empirical evidence from variety of sources and concluding that tort law probably provides sufficient deterrent to warrant cost of system); John A. Siliciano, Corporate Behavior and the Social Efficiency of Tort Law, 85 MICH. L. REV. 1820, 1864 (1987) (arguing that "tort law does not necessarily push producers towards a socially efficient level of product safety"); Stephen D. Sugarman, Doing Away with Tort Law, 73 CAL. L. REV. 558, 559-609 (1985) (arguing that tort law has failed to deter wrongful conduct, failed to compensate at acceptable costs, and failed to do meaningful justice).
481. See generally GEORGE EADS & PETER REUTER, DESIGNING SAFER PRODUCTS: CORPORATE RESPONSES TO PRODUCT LIABILITY LAW AND REGULATION vii (1983) (arguing that product liability sends "indistinct signal"); Gary T. Schwartz, Reality in the Economic Analysis of Tort Law: Does Tort Law Really Deter?, 42 UCLA L. REV. 377 (1994) (examining empirical evidence from variety of sources and concluding that tort law probably provides sufficient deterrent to warrant cost of system); John A. Siliciano, Corporate Behavior and the Social Efficiency of Tort Law, 85 MICH. L. REV. 1820, 1864 (1987) (arguing that "tort law does not necessarily push producers towards a socially efficient level of product safety"); Stephen D. Sugarman, Doing Away with Tort Law, 73 CAL. L. REV. 558, 559-609 (1985) (arguing that tort law has failed to deter wrongful conduct, failed to compensate at acceptable costs, and failed to do meaningful justice).
482. Theoretically, sophisticated information systems might rescue the liability system by advising the public of companies' judgment proofing efforts and thus raising the publicity cost of those efforts. In practice, however, the pubic would be better served by information about the risks of loss companies are imposing on them than by information about the public's ability to recover damages in the unlikely event losses occur.
483. See 15 U.S.C. § 1681b (1994) (restricting reasons for which credit reports may be issued); Joel Brinkley, The Furor Over Data on Doctors, N.Y. TIMES, May 29, 1994, § 4, at 4 (reporting that, in response to complaints from American Medical Association, federal government declined to offer public access to its database of 62,183 doctors, dentists, nurses and other medical professionals who have been sued, sanctioned, or otherwise penalized for crimes, mistakes, or incompetence); Amy Stevens, A List of Bad Lawyers to Go On Line, WALL ST. J., Aug. 26, 1994, at B1 (reporting that American Bar Association's National Discipline Data Bank, listing "names, addresses, aliases and violations" of 25,000 lawyers, will be made available on Westlaw, but only to disciplinary authorities).
484. See 15 U.S.C. § 1681b (1994) (restricting reasons for which credit reports may be issued); Joel Brinkley, The Furor Over Data on Doctors, N.Y. TIMES, May 29, 1994, § 4, at 4 (reporting that, in response to complaints from American Medical Association, federal government declined to offer public access to its database of 62,183 doctors, dentists, nurses and other medical professionals who have been sued, sanctioned, or otherwise penalized for crimes, mistakes, or incompetence); Amy Stevens, A List of Bad Lawyers to Go On Line, WALL ST. J., Aug. 26, 1994, at B1 (reporting that American Bar Association's National Discipline Data Bank, listing "names, addresses, aliases and violations" of 25,000 lawyers, will be made available on Westlaw, but only to disciplinary authorities).
485. See 15 U.S.C. § 1681b (1994) (restricting reasons for which credit reports may be issued); Joel Brinkley, The Furor Over Data on Doctors, N.Y. TIMES, May 29, 1994, § 4, at 4 (reporting that, in response to complaints from American Medical Association, federal government declined to offer public access to its database of 62,183 doctors, dentists, nurses and other medical professionals who have been sued, sanctioned, or otherwise penalized for crimes, mistakes, or incompetence); Amy Stevens, A List of Bad Lawyers to Go On Line, WALL ST. J., Aug. 26, 1994, at B1 (reporting that American Bar Association's National Discipline Data Bank, listing "names, addresses, aliases and violations" of 25,000 lawyers, will be made available on Westlaw, but only to disciplinary authorities).