Confirmation and claims trading

Northwestern University Law Review

Volumn 90, Issue 4, 1996, Pages 1684-1753

  Tung, Frederick ^a  

^a UNIVERSITY OF SAN FRANCISCO   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 0346688159     PISSN: 00293571     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (358)

1. 11 U.S.C. §§ 1101-1174 (1994). The Bankruptcy Code may be referred to herein as the "Code."
2. See, e.g., Jaye Scholl, Joy in Sorrow: A Pair of Young Money Managers Profit from Failure, BARRON'S, Feb. 20, 1995, at 19. "[T]he investment strategy took hold in the 'Eighties, a decade whose financial history can be summed up in superlatives: a bumper crop of mergers and acquisitions, financed by mountains of high-yielding debt, followed by a record number of bankruptcies and an unprecedented amount of defaulted paper." Id. at 21.
3. See Diana B. Henriques, The Vulture Game, N.Y. TIMES, July 19, 1992, § 6 (Magazine), at 18.
4. Id. at 20 (quoting Herb Stiles, President of T. Rowe Price Recovery Fund).
5. Floyd Norris, Market Watch: Investors Love Loans to Deadbeats, N.Y. TIMES, Aug. 6, 1995, § 3, at 1 (commenting on proposed borrowing of $5.4 billion by Westinghouse Electric Corp. to finance acquisition of CBS Inc. and noting that the amount of borrowing exceeds total value of Westinghouse stock).
6. See, e.g., Book Review: The 1995 Bankruptcy Yearbook and Almanac, BANKR. CT. DEC. WKLY. NEWS & COMMENT (LRP), May 30, 1995, at A9. The dramatic increase in high yield bond issuance, coupled with an apparent loosening of standards by bank lenders, has created a large pool of potential corporate bankruptcies. While the coming wave of big bankruptcies will be nowhere near the magnitude of the last bulge in 1987-1992, it should represent a significant increase from current levels. Whether the upturn in large filings occurs in 1995 or in 1996 may depend on the strength of the economy in the coming months.
7. Id. at A9 (quoting George Putnam III of New Generation Research, Inc., publisher of the 1995 Bankruptcy Yearbook and Almanac); see also Scholl, supra note 2, at 21 ("Studies indicate there's a three-year lag between issue and default rates. Bankruptcies should return in big numbers beginning in 1995.").
8. Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, 92 Stat. 2549 (current version at 11 U.S.C. §§ 1101-1174 (1994)).
9. See infra subpart II.A.
10. See infra section I.B.1.
11. See infra subpart II.B.
12. See infra section II.B.3.
13. David E. Van Zandt, The Market as a Property Institution: Rules for the Trading of Financial Assets, 32 B.C. L. REV. 967 (1991).
14. See supra notes 110-112 and accompanying text. There has been a surprising dearth of academic commentary focused specifically on claims trading. The major articles include Chaim J. Fortgang & Thomas M. Mayer, Trading Claims and Taking Control of Corporations in Chapter 11, 12 CARDOZO L. REV. 1 (1990)
15. [hereinafter Fortgang & Mayer, Trading Claims];
16. Herbert P. Minkel, Jr. & Cynthia A. Baker, Claims and Control in Chapter 11 Cases: A Call for Neutrality, 13 CARDOZO L. REV. 35 (1991);
17. Chaim J. Fortgang & Thomas M. Mayer, Developments in Trading Claims and Taking Control of Corporations in Chapter 11, 13 CARDOZO L. REV. 1 (1991)
18. [hereinafter Fortgang & Mayer, 1991 Developments];
19. Chaim J. Fortgang & Thomas M. Mayer, Developments in Trading Claims: Participations and Disputed Claims, 15 CARDOZO L. REV. 733 (1993)
20. [hereinafter Fortgang & Mayer, 1993 Developments].
21. See infra note 112 and accompanying text.
22. See infra note 96 and accompanying text.
23. See infra note 101 and accompanying text.
24. See infra sections I.B.3, III.C.2. For a comprehensive summary of judicial intervention in the claims trading context, see Fortgang & Mayer, Trading Claims, supra note 13.
25. See infra notes 306-09 and accompanying text.
26. See infra section I.B.2.
27. See infra note 329 and accompanying text.
28. While trading certainly occurs in contexts other than reorganizations of large public companies, the large cases probably account for most of the trading, and the ripple effects from the failure of large public companies suggest that much is at stake in their successful reorganization. See infra notes 22-23 and accompanying text.
29. This not only maximizes creditor recoveries, but also addresses a multiplicity of other interests implicated when a company faces the prospect of failure. While debtor-creditor issues are central to the proceedings, the complex web of relationships with which the company is involved includes noncreditor parties as well. For example, suppliers, customers, employees, local governments, or taxing authorities may or may not be creditors of the debtor, but may nonetheless be interested in the debtor's continuing viability. E.g., Elizabeth Warren, Bankruptcy Policymaking in an Imperfect World, 92 MICH. L. REV. 336, 355 (1993) (noting Congress's recognition of the effect of business failure on the surrounding community and parties with no formal legal entitlements vis-a-vis the debtor, and the indirect way in which the Bankruptcy Code addresses this concern).
30. The purpose of a business reorganization case . . . is to restructure a business's finances so that it may continue to operate, provide its employees with jobs, pay its creditors, and produce a return for its stockholders. The premise of a business reorganization is that assets that are used for production in the industry for which they were designed are more valuable than those same assets sold for scrap. Often, the return on assets that a business can produce is inadequate to compensate those who have invested in the business. Cash flow problems may develop, and require creditors of the business, both trade creditors and long-term lenders, to wait for payment of their claims. If the business can extend or reduce its debts, it often can be returned to a viable state. It is more economically efficient to reorganize than to liquidate, because it preserves jobs and assets. H.R. REP. NO. 595, 95th Cong., 1st Sess. 220 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6179
31. [hereinafter HOUSE REPORT].
32. Id. at 224. The floor of liquidation value is implemented through the requirement of § 1129(a)(7)(A) of the Code, which requires that any dissenting member of an accepting class receive no less under the plan than it would in liquidation. 11 U.S.C. § 1129(a)(7)(A) (1994). The ceiling of going concern value is implemented through § 1129(b), which embodies the Chapter 11 absolute priority rule. 11 U.S.C. § 1129(b) (1994).
33. 11 U.S.C. § 1129 (1994).
34. 11 U.S.C. § 1141 (1994).
35. Consent of equity interest holders may also be required. As a practical matter, however, their consent is rarely an issue at confirmation, either because their interests have been adequately represented by the debtor's management - in which case they will consent to the plan - or because the plan can usually be confirmed over their dissent via cramdown. See infra notes 39-45 and accompanying text. For this reason, the discussion of confirmation requirements that follows, while generally applicable to equity interests as well as claims, will refer only to claims.
36. 11 U.S.C. § 1121(b) (1994). The court may, upon the request of a party in interest and for cause, shorten the initial 120-day exclusivity period, id. § 1121(d), but this rarely happens, especially in larger cases.
37. Lynn M. LoPucki & William C. Whitford, Corporate Governance in the Bankruptcy Reorganization of Large, Publicly Held Companies, 141 U. PA. L. REV. 669, 693 (1993). "In most jurisdictions, . . . exclusivity is almost always maintained for the duration of the reorganization of a large, publicly held company." Id. at 693 n.90. Even after exclusivity terminates, in the large cases the plan that ultimately gets confirmed is almost exclusively a debtor-sponsored plan.
38. See generally Lynn M. LoPucki, The Debtor in Full Control - Systems Failure Under Chapter 11 of the Bankruptcy Code? Second Installment, 57 AM. BANKR. L.J. 247, 253 (1983) (discussing creditors' practical inability to propose credible operating plans).
39. 11 U.S.C. § 1107(a) (1994). The Code provides for appointment of a trustee to replace the debtor's management in certain situations, e.g., "fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case." Id. § 1104(a)(1). However, especially in the cases involving large publicly held companies, appointment of a trustee is rare. E.g., LoPucki & Whitford, supra note 29, at 699.
40. 11 U.S.C. § 1123(a)(1) (1994). Certain types of priority claims, primarily administrative expense claims and qualifying tax claims, are not required to be classified, id., and their treatment under a plan is explicitly prescribed in the Code. Id. § 1129(a)(9)(A), (C).
41. 11 U.S.C. § 1122(a) (1994). The Code permits a fair amount of discretion in classifying claims, since even though claims that are "substantially similar" may be classified together, there is no explicit requirement that substantially similar claims be placed in the same class. Courts have, however, enunciated certain limitations on debtors' strategic use of classification. E.g., Phoenix Mut. Life Ins. Co. v. Greystone III Joint Venture (In re Greystone III Joint Venture), 995 F.2d 1274, 1278-79 (5th Cir. 1991), cert. denied, 113 S. Ct. 72 (1992) (holding that "ordina7 rily," substantially similar claims should be classified together, and that separate classification must be motivated by reasons independent of debtor's desire to create consenting impaired class); Teamsters Nat'l Freight Indus. Negotiating Comm. v. U.S. Truck Co. (In re U.S. Truck Co.), 800 F.2d 581, 586 (6th Cir. 1986) (stating that "there must be some limit" to debtor's power to gerrymander creditor classes).
42. 11 U.S.C. § 1126(c), (d) (1994).
43. Id. § 1123(a)(4). The holder of a claim may always consent to less favorable treatment of its claim than the rest of the class. Id.
44. See id. § 1129(a)(8).
45. See id. § 1124. See infra note 57 and accompanying text for a discussion of the strategic significance of the impairment concept.
46. 11 U.S.C. § 1126(f) (1994). A class that will receive nothing under a proposed plan also does not vote, but is deemed to have rejected the plan. Id. § 1126(g).
47. 11 U.S.C. § 1126(c) (1994). A class of interests accepts if two-thirds in amount of interests vote to accept. Id. § 1126(d).
48. Id. § 1129(a)(8).
49. Id. § 1129(b).
50. Id. § 1129(b)(1).
51. Id. § 1129(b)(2)(B)(i).
52. Id. § 1129(b)(2)(B)(ii).
53. In this situation, the only alternative for the plan proponent - usually the debtor - is to modify the proposed treatment of the objecting class to render the class unimpaired, in which case the class is deemed to have accepted the plan.
54. No class may be paid more than the amount of its claims. HOUSE REPORT, supra note 23, at 414.
55. See supra note 24.
56. One additional significant confirmation requirement exists, which must be satisfied regardless of the outcome of class voting. It is the feasibility requirement, 11 U.S.C. § 1129(a)(11) (1994), which goes to the question whether the plan will work. See 5 COLLIER ON BANKRUPTCY ¶ 1129.02, at 1129-60 to 1129-64 (15th ed. 1995). Because a feasibility finding is required regardless of overwhelming creditor approval of the plan, it is an oft-litigated issue in contested confirmations.
57. 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, 137-38 (1990). In their seminal study of large public company reorganizations, Professors LoPucki and Whitford found a very high level of plan acceptance. Of all classes of claims and interests for the 43 reorganizations studied, only 5.6% (21 of 377 classes) failed to vote in favor of the plan, and of those, almost all (17 of the 21) were deemed rejections, i.e., those classes were to receive nothing under the plan. Id. at 141; see supra note 37. Only 0.8% (3 of 377 classes) actively contested confirmation. LoPucki & Whitford, supra, at 141. LoPucki & Whitford, supra note 29, also came from the LoPucki and Whitford study.
58. "[T]he conventional wisdom was that contested cramdown hearings were to be avoided." LoPucki & Whitford, supra note 48, at 144.
59. Even in the case of insolvent debtors, shareholders usually received some distribution under the plan. Id. at 142-43. Insolvency in these cases was not seriously contested. Id. at 144. Therefore, an absolute priority distribution would have left shareholders with nothing. Senior classes in these cases willingly gave up value to junior classes in order to achieve consensus: "[T]he creditors' agreements to the equity distributions . . . were in no significant part the reflection of either real or supposed legal entitlements." Id. However, the actual deviations from strict absolute priority were found to be small in percentage terms. Id. at 178. According to the conventional wisdom, senior creditors' holdout power under the absolute priority rule is tempered by a desire to avoid extensive litigation over the panoply of cramdown and other confirmation requirements. In the cramdown situation, the court may have to determine, among other things, a valuation of the debtor and any securities proposed to be issued under a plan, in order to determine whether the absolute priority rule has been satisfied as to each rejecting impaired class. This valuation will generally involve a battle of expert testimony, with teams of investment bankers and accountants attempting to justify result-oriented projections of the debtor's future earnings and arguing over an appropriate multiplier in order to reach a desirable discounted cash flow valuation. See generally 5 COLLIER ON BANKRUPTCY, supra note 47, ¶ 1129.03, at 1129-102 to 1129-116 (describing valuation standards in detail). Junior claimants have an additional incentive to avoid forcing this valuation. They run the risk that an unfavorable valuation may eliminate entirely their chance to participate in any distribution under the plan. Given the complexities of valuation, the expense of litigation, and the uncertainty of the outcome, all parties have incentives to settle. A premium is thus placed on obtaining the consent of all impaired classes in order to avoid application of the fair and equitable rule as embodied in section 1129(b). Thus, there is the incentive for the holders of the senior interests to share the distribution with junior interest holders so that the junior classes will accept the plan and avoid the necessity of a full-scale going-concern valuation of the debtor. There is, similarly, an incentive for the junior classes to accept the plan rather than run the risk of a valuation hearing under section 1129(b)(2)(B) or (C), which could result in a determination that they are not entitled to participate under the plan at all. Lawrence P. King, Chapter 11 of the 1978 Bankruptcy Code, 53 AM. BANKR. L.J. 107, 130 (1979);
60. see also Kenneth N. Klee, All You Ever Wanted to Know About Cramdown Under the New Bankruptcy Code, 53 AM. BANKR. L.J. 133, 171 (1979) ("[T]he complexity of cramdown should encourage the debtor to bargain with creditors to gain acceptance of a plan in the majority of cases."). In the LoPucki and Whitford study, numerous interviews with attorneys and judges elicited the general sentiment that every class had to receive some consideration in order to achieve consensus. LoPucki & Whitford, supra note 48, at 144. Among the reasons given for the overwhelming preference for consensual plans was the desire to avoid the expense of and delay associated with litigating a contested cramdown. Id. The authors question the factual basis for the perception that cramdown is economically undesirable. They assert that the costs of cramdown litigation do not fully explain the tendency toward consensual plans. Instead, they suggest that bankruptcy culture exerts significant influence. Id. at 154.
61. Professors LoPucki and Whitford have shown the difficulty of attempting to generalize about whom management represents in the large reorganization cases. LoPucki & Whitford, supra note 29, at 742-47 (finding that such factors as the debtor's solvency and the presence of significant shareholders on the debtor's board of directors affect management loyalties, and that management might not align with any faction, but instead might pursue an independent policy of preserving the company or maximizing the estate).
62. In the LoPucki and Whitford study, management of insolvent debtors were very likely to align themselves with creditors. Id. at 745. From the management self-preservation perspective, this makes sense, as creditors would stand to receive significant blocks of equity in the reorganized company. See generally J. Bradley Johnston, The Bankruptcy Bargain, 65 AM. BANKR. L.J. 213, 218 (1991) (noting the potential divergence of interests as between management and old equity). Fiduciary duties of management also shift from equityholders to creditors upon a corporation's insolvency. See infra note 238. As an empirical matter, management of solvent companies always aligned with equity. LoPucki & Whitford, supra note 29, at 745. Given the general preference for consensual plans, even when management aligns with creditor interests, this would not generally preclude some attempt by management to effect some distribution to equity. In any event, management's objectives in plan formulation generally include a scaling down of claims of senior classes from their absolute priority due in favor of junior classes.
63. E.g., Thomas H. Jackson & Robert E. Scott, On the Nature of Bankruptcy: An Essay on Bankruptcy Sharing and the Creditors' Bargain, 75 VA. L. REV. 155, 192 (1989) ("Studies on agenda influence confirm the substantial leverage [exclusivity] provides the debtor (and existing management) in negotiating over any proposal to restructure the firm.")
64. (citing Michael E. Levine & Charles R. Plott, Agenda Influence and Its Implications, 63 VA. L. REV. 561 (1977)); Johnston, supra note 52, at 275 ("The chance to be 'first out of the gate' with the initial plan in most cases allows the debtor to 'anchor' the terms of the final plan in its favor.").
65. The party that proposes the initial plan, even if it is just the first negotiating draft, will always prepare it in a way that strongly favors whatever positions can be proposed on behalf of that party or its constituents. Because it is likely that the initial draft will become the starting point from which the final plan will flow, the proponent-biased draft serves to shift the entire bargaining set of the parties toward the side favoring the "proponent" of the plan and insures that the final agreement will be more favorable to the party that proposes the plan than if the terms of the initial draft had been more even-handed. Johnston, supra note 52, at 275.
66. See supra notes 31-38 and accompanying text.
67. "[D]etermining when a claim or interest is 'substantially similar' to others . . . is a major and strategically important task" because it allows the plan proponent some "ability to separate or combine certain claims to increase the chance of obtaining class acceptances." Peter F. Coogan, Confirmation of a Plan Under the Bankruptcy Code, 32 CASE W. RES. L. REV. 301, 329 (1982).
68. See supra note 36 and accompanying text. For example, the debtor may wish simply to reinstate a particular loan at its contract rate of interest. This may be cheaper for the debtor than attempting to cramdown the creditor if the contract rate of interest is below the market rate. Provided that all defaults are cured, and the claimant is compensated for any damages incurred, reinstatement renders such a claim unimpaired, 11 U.S.C. § 1124(2) (1994), and that creditor is deemed to have accepted the plan.
69. 11 U.S.C. § 502(b)(2) (1994). The oversecured creditor accrues interest on its claim during the pendency of the case, but only up to the value of its collateral. Id. § 506(b). The allowance of this interest as part of the oversecured creditor's claim does not necessarily mean that the interest is paid currently, although it is not uncommon for the debtor to agree to do so in exchange for postpetition financing from the secured creditor. A secured creditor may also be entitled to adequate protection payments to the extent the estate's use or retention of the secured creditor's collateral results in a decrease in value of such collateral. Id. § 361(1).
70. "When management of a marginally solvent debtor is firmly in equity's camp, and particularly when pendency interest is unavailable, considerations of timing can be an especially important reason for creditor concessions to equity." LoPucki & Whitford, supra note 48, at 166.
71. 11 U.S.C. § 1107 (1994).
72. While such a proposal requires notice and a hearing, 11 U.S.C. § 363(b)(1) (1994), and courts have scrutinized such proposed sales in light of their potential to circumvent plan confirmation requirements (e.g., Lionel Corp. v. Committee of Equity Sec. Holders (In re Lionel Corp.), 722 F.2d 1063, 1070 (2d Cir. 1983) (requiring "some articulated business justification" for sale); Braniff Airways, Inc. v. Pension Benefit Guar. Corp. (In re Braniff Airways, Inc.), 700 F.2d 935 (5th Cir. 1983) (disapproving sale agreement that purported to dictate some terms of future plan)), even the threat may generate concessions.
73. For example, management may agree to grant priming liens to the postpetition financer, which would have priority over existing liens of prepetition creditors. See 11 U.S.C. § 364(d)(1) (1994). Again, this requires notice and a hearing, but the threat itself may have some impact.
74. LoPucki & Whitford, supra note 29, at 683-84. For example, for the marginally solvent debtor, gains from a risky investment strategy will inure primarily to shareholders, while losses will be borne primarily by creditors.
75. Equity, as the most junior class, wields little leverage with its class vote because it does not enjoy priority over anyone. For the insolvent debtor, even a plan that provides no distribution to equity satisfies the absolute priority rule. The best the rejecting equity class could do is force a valuation. However, if the equity class opposes a plan, it may find other avenues for leverage. See infra notes 77-83 and accompanying text.
76. See supra notes 28-29 and accompanying text.
77. See supra note 30.
78. "CEO turnover frequently resulted from creditor pressure." LoPucki & Whitford, supra note 29, at 737. LoPucki and Whitford found that the rate of CEO turnover was much higher for distressed companies than for large public companies generally, and that in terms of timing, changes were concentrated around the filing of the petition and the confirmation date. Id. at 723-26.
79. Id. at 701.
80. 11 U.S.C. § 1102(a)(1) (1994). The United States trustee appoints the committee, which ordinarily consists of the seven largest unsecured creditors. Id. § 1102(a)(1), (b)(1). The committee may hire attorneys, accountants, and other professional advisers, id. § 1103(a), who are compensated by the estate. Id. § 330(a)(1). In many cases, especially smaller cases outside of large metropolitan areas, the committee is never formed because of a dearth of creditors willing to serve. 5 COLLIER ON BANKRUPTCY, supra note 47, ¶ 1103.07, at 1103-28. However, this is rarely a problem in the large cases. See LoPucki & Whitford, supra note 48, at 160 (noting that with only one exception, an unsecured creditors' committee was formed in every case studied).
81. See 11 U.S.C. § 1103(c) (1994).
82. Id. § 1102(a).
83. LoPucki & Whitford, supra note 48, at 161. When the debtor is insolvent, its equityholders are usually playing only for some small share in the new equity of the reorganized debtor.
84. See supra note 64.
85. LoPucki & Whitford, supra note 48, at 161.
86. See, e.g., Manville Corp. v. Equity Sec. Holders Comm. (In re Johns-Manville Corp.), 801 F.2d 60 (2d Cir. 1986) (holding that shareholders' meeting could not be enjoined absent finding of clear abuse and irreparable injury).
87. Id.; see also LoPucki & Whitford, supra note 29, at 694-95 (discussing "clear abuse" standard).
88. LoPucki & Whitford, supra note 29, at 697-98.
89. Wilson v. Brooks Supermarket, Inc. (In re Missionary Baptist Found, of Am., Inc.), 667 F.2d 1244 (5th Cir. 1982) (holding that store that had cashed payroll checks for debtors' employees was assignee of employees' priority wage claims); Dorr Pump & Mfg. Co. v. Heath (In re Dorr Pump & Mfg. Co.), 125 F.2d 610 (7th Cir. 1942) (determining that priority wage claim remained priority claim after assignment to director and shareholder); In re Zipco, Inc., 157 F. Supp. 675, 677 (S.D. Cal. 1957), aff'd sub nom. Bass v. Shutan, 259 F.2d 561, 563 (9th Cir. 1958) (noting that priority wage claim remained priority claim after assignment to stockholder); In re Stultz Bros., 226 F. 989 (S.D.N.Y. 1915) (A. Hand, J.) (stating that claimant who cashed checks given by debtor to his employee is entitled to preference as assignee of wage claim); Fortgang & Mayer, Trading Claims, supra note 13, at 13 n.74 (citing Shropshire, Woodliff & Co. v. Bush, 204 U.S. 186 (1907) (holding that priority wage claims remained priority claims in purchaser's hands)). But cf. Holt v. FDIC (In re CTS Truss, Inc.), 868 F.2d 146 (5th Cir. 1989) (determining that debtor could not equitably subordinate bank claim now held by FDIC as successor to insolvent bank, though bank acted inequitably); SEC v. Albert & Maguire Sec. Co., 560 F.2d 569 (3d Cir. 1977) (noting that co-obligor on debt to securities customer was not entitled to customer's priority when it paid customer's claim). The claim will generally also suffer the same infirmities and limitations in the hands of the buyer as it had in the seller's hands. For example, if the claim is subject to avoidance because its original holder received a preference or a fraudulent transfer of property of the estate, see 11 U.S.C. § 502(d) (1994), or the claim is subject to equitable subordination based on the seller's inequitable conduct, see 11 U.S.C. § 510(c) (1994), or if the claim is for damages resulting from the termination of a lease of real property the allowable amount of which is limited by 11 U.S.C. § 502(b)(6) (1994), the claim in the purchaser's hands will be subject to the same infirmities and limitations. See Goldie v. Cox, 130 F.2d 695, 720 (8th Cir. 1942) (stating that assignee is subject to all equitable claims against assignor).
90. Kremer v. Clarke (In re Frank Fehr Brewing Co.), 268 F.2d 170, 180 (6th Cir. 1959), cert. denied, 362 U.S. 963 (1960); Lorraine Castle Apartments Bldg. Corp. v. Machiewich (In re Lorraine Castle Apartments Bldg. Corp.), 149 F.2d 55, 57-58 (7th Cir.), cert. denied, 326 U.S. 728 (1945); In re Executive Office Ctrs., Inc., 96 B.R. 642 (Bankr. E.D. La. 1988); In re Automatic Equip. Mfg. Co., 106 F. Supp. 699, 707 (D. Neb. 1952), appeal dismissed sub nom. Automatic Equip. Mfg. Co. v. Goodall, 202 F.2d 955 (8th Cir. 1953)); Fortgang & Mayer, Trading Claims, supra note 13, at 14 n.76 (citing Moulded Prods., Inc. v. Barry (In re Moulded Prods., Inc.), 474 F.2d 220, 225 (8th Cir.), cert. denied, 412 U.S. 940 (1973).
91. The purchasers typically are investors who believe they can make a profit by buying the claims and shares for less than they will yield after confirmation of a reorganization plan. Some of these investors buy substantial holdings in a particular creditor class. They then use those holdings to participate aggressively in the reorganization case, either as a committee member representing that class's position or as a holder of claims whose votes will be necessary if that class is to approve the plan. By acquiring a large amount of claims that will be exchanged for stock as part of the plan, an investor might even gain control of the emerging company. LoPucki & Whitford, supra note 48, at 162.
92. If claims such as publicly held debentures are widely dispersed, no one holder may have the incentive to ensure that the interests of the class are fully asserted. By aggregating the claims, an investor acquires an interest sufficient to warrant exploitation of the bargaining leverage of the class and the realization of its potential under the reorganization plan. Id. at 163. The prospects for appointment of official committees to represent widely dispersed unsecured creditors, see supra notes 72-78 and accompanying text, may possibly provide comparable economy of scale advantages. But see LoPucki, supra note 29, at 249 (discussing the limitations of committees in Chapter 11).
93. In many cases, the cramdown and non-impairment alternatives may simply not be viable strategies for the debtor.
94. E.g., Fortgang & Mayer, Trading Claims, supra note 13, at 4-9; Minkel & Baker, supra note 13, at 35-37.
95. Of course, the bankruptcy investor does not provide liquidity for the sake of the market and has no obligation to do so. The liquidity is incidental to the bankruptcy investor's pursuit of profit. Compare the specialist's role in the stock exchange: The specialists' responsibilities to trade . . . require them . . . to temper sudden price movements and keep any general price movements orderly. In this regard, the specialists are expected to buy for their own accounts to offset order imbalances when the price of their stock is falling and to sell when the price is rising. This proprietary specialist activity is expected to alleviate temporary disparities between supply and demand so that advances and declines will occur smoothly. SEC STAFF REPORT, THE OCTOBER 1987 MARKET BREAK 4-3 (Feb. 1988). See infra notes 265-66 and accompanying text.
96. On the other hand, if on balance, trading imposes higher costs on debtors and nonselling creditors than it avoids for selling claimants, claims trading may increase borrowing costs overall.
97. All claims in a class must receive the same treatment, absent consent of any particular holder to less favorable treatment. See supra note 34 and accompanying text. Situations may arise in which small claimants are unable to share the potential class-wide benefit created by the bankruptcy investor. For example, the plan consideration negotiated by the bankruptcy investor may not be in a form that is useful to small claimants and that cannot easily be liquidated. For small claimants, equity in the reorganized debtor may not be an attractive form of plan consideration, whereas the bankruptcy investor receiving a controlling block of equity may have a rosier view.
98. See infra note 329 and accompanying text.
99. See, e.g., 12 U.S.C. §§ 24, 1843(a), (c)(2) (1994); 12 C.F.R. §§ 1.1-1.140, 225.21 (1995) (stating general requirement that nationally chartered banks, bank holding companies, and subsidiaries of bank holding companies must dispose of stock received in exchange for debt previously contracted within two years).
100. Fortgang & Mayer, Trading Claims, supra note 13, at 8; Minkel & Baker, supra note 13, at 36.
101. FED. R. BANKR. P. 3001(e)(2).
102. Id. This requirement applies only as to outright transfers (not merely for security) after proof of claim has been filed. Id. For such transfers made before proof of claim is filed, only the transferee may file the proof of claim. FED. R. BANKR. P. 3001(e)(1). The "evidence of transfer" requirement also does not apply to any claim based on a publicly traded note, bond, or debenture. FED. R. BANKR. P. 3001(e)(2). Other rules apply to transfer of claims for security. FED. R. BANKR. P. 3001(e)(3), (4).
103. FED. R. BANKR. P. 3001(e)(2).
104. H.R. DOC. NO. 102-80, 102d Cong., 1st Sess. 306-10 (1991) (as amended August 1, 1991).
105. A hearing and court order are still required if the alleged transferor files a timely objection. FED. R. BANKR. P. 3001(e)(2).
106. Before August 1, 1991, Rule 3001(e)(2) stated: If a claim other than one based on a bond or debenture has been unconditionally transferred after the proof of claim has been filed, evidence of the terms of the transfer shall be filed by the transferee. The clerk shall immediately notify the original claimant by mail of the filing of the evidence of transfer and that objection thereto, if any, must be filed with the clerk within 20 days of the mailing of the notice or within any additional time allowed by the court. If the court finds, after a hearing on notice, that the claim has been unconditionally transferred, it shall enter an order substituting the transferee for the original claimant, otherwise the court shall enter such order as may be appropriate. FED. R. BANKR. P. 3001(e)(2) (amended as of August 1, 1991).
107. For example, in In re Revere Copper & Brass, Inc., 58 B.R. 1 (Bankr. S.D.N.Y. 1985) and In re Allegheny Int'l, Inc., 100 B.R. 241 (Bankr. W.D. Pa. 1988), courts concerned about potential informational asymmetries as between assignors and assignees conditioned approval of proposed claim assignments on the taking of remedial measures to provide full disclosure to assignors. Another court, concerned that claim splitting - assignments that did not transfer assignors' entire interest in particular claims - would increase administrative burdens on the estate, refused to approve assignments until remedial measures were taken. In re Ionosphere Clubs, Inc., 119 B.R. 440 (Bankr. S.D.N.Y. 1990).
108. See generally Fortgang & Mayer, 1991 Developments, supra note 13, at 2; Minkel & Baker, supra note 13, at 38.
109. 11 U.S.C. § 1126(e) (1994).
110. In re Allegheny, 118 B.R. at 289. See infra section III.C.2.
111. In re MacLeod Co., Inc., 63 B.R. 654 (Bankr. S.D. Ohio 1986). See generally Fortgang & Mayer, Trading Claims, supra note 13, at 91-99;
112. Andrew Africk, Comment, Trading Claims in Chapter 11: How Much Influence Can Be Purchased in Good Faith under Section 1126?, 139 U. PA. L. REV. 1393 (1991).
113. "Based on the fundamental principle that a fiduciary cannot profit from the trust, courts have historically held that the claims or interests purchased by fiduciaries may be limited to the discounted amount paid rather than the full face value of the purchased claim or interest." Scott K. Charles, Trading Claims in Chapter 11 Cases: Legal Issues Confronting the Postpetition Investor, 1991 ANN. SURV. AM. L. 261, 264 (citing In re Gladstone Glen, 739 F.2d 1233, 1236-37 (7th Cir. 1984); Monroe v. Scofield, 135 F.2d 725, 728 (10th Cir. 1943)); see also In re Papercraft Corp., 187 B.R. 486 (Bankr. W.D. Pa. 1995) (holding that allowed amount of claims purchased by insider was limited to purchase price because of insider's failure to disclose its status prior to purchase).
114. See generally Fortgang & Mayer, Trading Claims, supra note 13, at 25 (discussing historical treatment of fiduciary trading and uncertainties under the Code).
115. See infra section III.C.1.
116. "The assignability of intangible rights is the general rule, non-assignability the exception." In re Marin Town Ctr., 142 B.R. 374, 382 (Bankr. N.D. Cal. 1992) (quoting 7 Cal. Jur. 3d (Rev.), Assignments § 3 (1989)) (holding that stipulation in single asset bankruptcy, granting relief from stay to senior secured lender should debtor fail to refinance by a date certain, may be assigned along with lender's claim).
117. Fortgang & Mayer, 1993 Developments, supra note 13, at 759 (citing U.C.C. § 9-318(4) (1992); RESTATEMENT (SECOND) OF CONTRACTS § 322(1) (1981)).
118. Minkel & Baker, supra note 13, at 43.
119. Id. at 44.
120. See generally Douglas G. Baird, Loss Distribution, Forum Shopping, and Bankruptcy: A Reply to Warren, 54 U. CHI. L. REV. 815 (1987) (arguing that because of the problem of forum shopping, bankruptcy rules should depart from nonbankruptcy rules only if justified by some specific bankruptcy policy).
121. Butner v. United States, 440 U.S. 48 (1979).
122. Id. at 55 (quoting Lewis v. Manufacturers Nat'l Bank, 364 U.S. 603, 609 (1961)).
123. "Until relatively recently, absent the existence of fraud, misrepresentation, overreaching or violation of fiduciary obligations, courts generally refused to interfere with the transfer of claims." Charles, supra note 101, at 272 (citing Butner and In re Lorraine Castle Apartments Bldg. Corp., 149 F.2d 55, 57-58 (7th Cir.), cert. denied, 326 U.S. 728 (1945)).
124. Fashioning judicial "remedies" to deal with the perceived inequities of claims trading chills the market for claims. . . . In an efficient market, the transaction costs and economic risk imposed on claims purchasers will be shifted to claims sellers through lower prices for claims. . . . The imposition of ad hoc rules on claims trading to "protect" selling creditors effectively taxes those creditors who would like to convert their claims into ready cash. Absent a complaint of fraud, misrepresentation, or other cognizable wrong from a party with standing, or a clear congressional mandate, courts should not deprive creditors of the advantages of claims trading based on judges' personal views of its merits or demerits. Regulation of the marketplace is within the sound discretion of Congress and not an appropriate subject for judicial "legislation." Minkel & Baker, supra note 13, at 52-53.
125. See, e.g., Fortgang & Mayer, Trading Claims, supra note 13. [T]he best protection for the unwitting claims seller is an efficient market. The widow from Dubuque can sell her General Motors stock at a fair price on the New York Stock Exchange . . . primarily because there is an active and deep market for her stock. . . . [T]he market for claims against chapter 11 debtors is growing stronger. Id. at 56. See also id. at 46 ("The time may come when this entire area of bankruptcy jurisprudence melts into the securities laws, which would make sense. If claims trade like securities, regulations of such trading should mimic the securities laws.").
126. Bankruptcy Act of 1898, Pub. L. No. 62-57, 30 Stat. 544-66 (1898) (amended 1938) (repealed 1978) [hereinafter the Bankruptcy Act], reprinted in COLLIER ON BANKRUPTCY, supra note 47, §§ 1-7031 app. 1.
127. See generally Fortgang & Mayer, Trading Claims, supra note 13.
128. Id. at 93.
129. Id. at 25.
130. Fortgang & Mayer, 1993 Developments, supra note 13, at 759 (citation omitted).
131. See infra Part II.
132. Act of June 22, 1938, ch. 575, 52 Stat. 840-940 (repealed by Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, 92 Stat. 2549).
133. Eugene V. Rostow & Lloyd N. Cutler, Competing Systems of Corporate Reorganization: Chapters X and XI of the Bankruptcy Act, 48 YALE L.J. 1334, 1335 (1939).
134. Coogan, supra note 56, at 311.
135. Rostow & Cutler, supra note 120, at 1336. Prior to enactment of the Chandler Act, public company reorganizations under the then-prevailing structures were perceived to have allowed corporate insiders to divert to themselves reorganization values that rightly belonged to public investors, primarily public bondholders. At that time, senior bonds were the most common publicly held corporate securities, with equity more often privately held. HOUSE REPORT, supra note 23, at 222. In reorganization, public bondholders could not effectively organize to protect their rights against insider equityholders, who along with their investment bankers generally controlled the reorganizations.
136. See generally SECURITIES & EXCH. COMM'N, 1 REPORT ON THE STUDY AND INVESTIGATION OF THE WORK, ACTIVITIES, PERSONNEL & FUNCTIONS OF PROTECTIVE AND REORGANIZATION COMMITTEES 243-670 (1937). This control allowed insiders to propose plans of reorganization that favored equityholders at the expense of creditors, who should have enjoyed priority over equityholders. Id. at 87. In addition, insider control of a reorganization avoided serious scrutiny of the pre-reorganization conduct of management and any lucid accounting with respect to the company's assets. Id. at 870-71. Chapter X instituted elaborate procedures and oversight by both the court and the SEC for the protection of public investors.
137. HOUSE REPORT, supra note 23, at 225. As a result of the dominant role of public officers, "management and committees controlled either by management or by the house of issue find the area within which they may act to press their interests correspondingly reduced in size and importance." Rostow & Cutler, supra note 120, at 1336.
138. Bankruptcy Act § 156, 11 U.S.C. § 556 (repealed 1978). For a debtor with liquidated, noncontingent indebtedness not exceeding $250,000, appointment of a trustee was discretionary. Id. However, by 1977, such small cases were "exceedingly rare." HOUSE REPORT, supra note 23, at 224 n.23.
139. Bankruptcy Act § 167, 11 U.S.C. § 567(g) (repealed 1978).
140. Id. § 169, 11 U.S.C. § 569 (repealed 1978).
141. HOUSE REPORT, supra note 23, at 224.
142. Securities & Exch. Comm'n v. American Trailer Rentals Co., 379 U.S. 594 (1965).
143. 6A COLLIER ON BANKRUPTCY ¶ 11.06, at 210-11 (14th ed. 1976) (citing Consolidated Rock Prods. Co. v. DuBois, 312 U.S. 510 (1941)).
144. "The valuation consists of an estimate of the earning power of the reorganized debtor, and the appropriate market capitalization rate of that estimated income stream." HOUSE REPORT, supra note 23, at 225.
145. Rostow & Cutler, supra note 120, at 1346.
146. Bankruptcy Act § 172, 11 U.S.C. § 572 (repealed 1978). Referral to the SEC was mandatory for a debtor with indebtedness exceeding $3 million, and discretionary otherwise. Id.
147. HOUSE REPORT, supra note 23, at 225.
148. 6 COLLIER ON BANKRUPTCY Pt. 2, ¶ 7.31, at 1285 (14th ed. 1976) (emphasis in original). Also, unlike Chapter 11, in Chapter X classification of claims was up to the judge. Bankruptcy Act § 197, 11 U.S.C. § 597 (repealed 1978).
149. See supra notes 51-52 and accompanying text.
150. See supra note 24 and accompanying text.
151. See supra section I.A.1.
152. This is not to suggest that valuation is not a speculative process or that widely dispersed creditors were as effective at asserting their absolute priority entitlements as sophisticated investors. Professor Coogan's famous bon mot describes the valuation process as "an estimate compounded by a guess." HOUSE REPORT, supra note 23, at 225. However, the likely range of deviation from "strict" absolute priority was certainly much narrower under Chapter X than under the Bankruptcy Code.
153. Any creditor class rejecting the plan was entitled to "adequate protection for the realization by them of the value of their claims." Bankruptcy Act § 216(7), 11 U.S.C. § 616(7) (repealed 1978). This latter determination was of course up to the judge. For example, a rejecting class of creditors could simply be cashed out at the appraised value of its claims. Bankruptcy Act § 216(7)(c), 11 U.S.C. § 616(7)(c) (repealed 1978).
154. Cf. infra note 168 and accompanying text.
155. HOUSE REPORT, supra note 23, at 235 (explaining relative inactivity of creditors' committees in Chapter X compared to Chapter XI, in part because of limited creditor influence in Chapter X).
156. ELIZABETH WARREN & JAY L. WESTBROOK, THE LAW OF DEBTORS AND CREDITORS 189 (2d ed. 1991).
157. HOUSE REPORT, supra note 23, at 222. Less than ten percent of all business reorganizations were in Chapter X. Id.
158. HOUSE REPORT, supra note 23, at 233. Congress did not foresee that major industrial enterprises would attempt to reorganize under Chapter XI. Quite the opposite. Chapter X included a provision limiting access to those cases in which "adequate relief" was not obtainable under Chapter XI. Bankruptcy Act §§ 141, 146(2), 11 U.S.C. §§ 541, 546(2) (repealed 1978). Chapter XI, however, was the preferred reorganization vehicle. Corporate managers disfavored the cumbersome Chapter X process, including the SEC's participation and oversight. The attendant delay might ensure the demise of the business. In addition, corporate managers were reluctant to relinquish their positions of control, especially to a court-appointed trustee unfamiliar with the business. Corporate lawyers also had some influence as to this trend: The reason underlying the preference of lawyers for Chapter XI is obvious, although not often stated. A debtor initiates a Chapter XI proceeding, and only the debtor can propose a plan under Chapter XI. The debtor is normally allowed to operate the business. A concomitant of continued management is the continuation of the employment of the debtor's attorney. On the other hand, if a Chapter X proceeding is initiated, a disinterested trustee is appointed and counsel for the debtor has a greatly reduced function. Although proponents of the Chapter XI generally talk about speed and economy, control and the "best interests" test obviously are the dominating reasons for the preference.
159. REPORT OF THE COMMISSION ON THE BANKRUPTCY LAWS OF THE UNITED STATES, July 1973, at 247.
160. Formally, only unsecured debt could be affected in Chapter XI. Rights of secured creditors and equityholders were not subject to modification. Bankruptcy Act § 356, 11 U.S.C. § 756 (repealed 1978). This formal limitation in Chapter XI ultimately did not prevent debtors from modifying the substantive rights of equityholders by diluting their holdings through issuance of additional equity to creditors as part of their arrangements. HOUSE REPORT, supra note 23, at 226.
161. Bankruptcy Act § 323, 11 U.S.C. § 723 (repealed 1978).
162. Id. § 363, 11 U.S.C. § 763 (repealed 1978).
163. Walter J. Blum & Stanley A. Kaplan, Affecting Rights to Equity Interests Under Chapter XI of the Bankruptcy Act, 1972 WIS. L. REV. 978, 982.
164. HOUSE REPORT, supra note 23, at 225.
165. Bankruptcy Act §§ 361, 362, 11 U.S.C. §§ 761, 762 (repealed 1978).
166. HOUSE REPORT, supra note 23, at 223 (citing Bankruptcy Act § 366(2), 11 U.S.C. § 766(2) (repealed 1970)).
167. See id. at 235 (comparing creditor committee activity in Chapter X and Chapter XI and significance of creditor influence). Unlike Chapter X, Chapter XI explicitly provided for an official creditors' committee, whose counsel was compensated from the estate. Id. (citing FED. R. BANKR. P. 11-29 (1978)).
168. [C]hapter XI gives the debtor the exclusive right to propose a plan. Creditors are excluded. The exclusive right gives the debtor undue bargaining leverage, because by delay he can force a settlement out of otherwise unwilling creditors, and they have little recourse except to move for conversion of the case to [C]hapter X. That is contrary to their interests as it is to the debtor's, and thus is rarely done. The debtor is in full control, often to the unfair disadvantage of creditors. HOUSE REPORT, supra note 23, at 231. Likewise, while unsecured creditors could move to dismiss a Chapter XI petition, this was hardly an attractive alternative, especially in the large cases. Dismissal would simply allow secured creditors to capture the lion's share of the debtor's remaining value, leaving little for unsecured creditors.
169. Perhaps the Chapter XI debtor's worst fear came not from the prospect of recalcitrant creditors but from the SEC. While the SEC had no formal role in Chapter XI as it did in Chapter X, a common SEC response to the filing of a Chapter XI petition by a large public company was to move for conversion to Chapter X. E.g., Securities & Exch. Comm'n v. American Trailer Rentals Co., 379 U.S. 594 (1965). Ultimately, the SEC developed the practice of using this credible threat of conversion to negotiate with the debtor over the treatment of public debt- and equityholders in the Chapter XI arrangement. HOUSE REPORT, supra note 23, at 223.
170. Klee, supra note 50; Coogan, supra note 56. Chapter 11, like one of its predecessors, [C]hapter XI, allows and almost compels the parties to negotiate with each other. While [C]hapter X turned over the reorganization problem to outside experts - the trustee, the judge, and the SEC - Chapter 11, like [C]hapter XI, leaves the problem in the hands of those financially interested - the debtor, the creditors, the equityholders, and their committees. Coogan, supra note 56, at 348.
171. See infra subpart II.C.
172. See infra section II.B.3.
173. In single-asset cases, the debtor's primary asset is overencumbered real estate. The undersecured mortgage holder is the dominant creditor, and general unsecured creditors are relatively few and their claims relatively small. The debtor and mortgage holder dominate negotiations in these cases, and general unsecured claims do not exercise much influence. Those claims are small enough that some nontrivial consideration can usually be allocated to them under any plan to assure their assent. In this context, the structure of negotiation is relatively uncomplicated. The possibility of disruption of the process from trading of claims is minimal. Therefore, single-asset cases under the Act supply particularly weak authority for the proposition that claims should be freely traded in Chapter 11.
174. See supra notes 78-79 and cases cited therein.
175. E.g., In re Executive Office Ctrs., Inc., 96 B.R. 642, 649 (Bankr. E.D. La. 1988).
176. E.g., In re Marin Town Ctr., 142 B.R. 374, 383 (Bankr. N.D. Cal. 1992); Executive Office Ctrs., supra note 159, at 642. In fairness, these two Code cases involved small real estate debtors with simple capital structures. Claim assignments in those cases did not implicate potential disruption or cost issues. See infra Part II. However, for this same reason, those cases are not helpful to our inquiry. Small real estate cases do not resemble "megacases" in the structure of the debtor or the complexity of plan negotiation.
177. See supra section I.B.2.
178. See, e.g., discussion, supra note 111 and accompanying text.
179. In regulating the sale of claims in situations like Revere [see supra note 96], the courts should strike a proper balance. They should preserve the integrity of the bankruptcy process through the zealous protection of those who need it without chilling the markets for [C]hapter 11 claims by judicially freezing transactions between responsible parties who can take care of themselves. Fortgang & Mayer, Trading Claims, supra note 13, at 56.
180. See supra section I.B.2.
181. See supra section I.A.2.
182. For example, once the debtor has defaulted on its obligations to its senior secured lender, the fate of its unsecured creditors to a great extent depends on whether the senior lender responds by foreclosing on its collateral or by working out new terms.
183. Of course, ultimately the winner in the race of the diligent under state law depends on the field of contestants. See generally Lynn M. LoPucki, A General Theory of the Dynamics of the State Remedies/Bankruptcy System, 1982 WIS. L. REV. 311, 314-52 (describing various functions performed by state law collection regime).
184. See, e.g., James W. Bowers, Groping and Coping in the Shadow of Murphy's Law: Bankruptcy Theory and the Elementary Economics of Failure, 88 MICH. L. REV. 2097, 2109 (1990) (suggesting the firm analogy and questioning whether the costs of administering the firm and mediating the conflicts among agents and owners may be so high that the firm's formation and existence cannot be justified).
185. The divergence in risk preferences as between senior and junior claimants is discussed in LoPucki & Whitford, supra note 29, at 683.
186. "After notice and a hearing," the debtor in possession may use, sell, or lease property of the estate outside the ordinary course of business, 11 U.S.C. § 363(b)(1) (1994), or may incur debt not in the ordinary course. Id. § 364. The phrase "after notice and a hearing" is a bankruptcy term of art, which does not necessarily mean that a hearing will actually be held. Id. § 102(1). However, in the case of a debtor's proposed non-ordinary course disposition of estate property, creditors will generally be given some opportunity to object. FED. R. BANKR. P. 2002(a)(2) (stating general requirement that creditors receive 20-days' notice of proposed non-ordinary course disposition of estate property).
187. 11 U.S.C. § 363(c)(1) (1994). Cash collateral, see id. § 363(a), is subject to special supervision by the court. It may be used by the debtor only upon authorization of the court after notice ad hearing or by consent of each entity with an interest in such cash collateral. Id. § 363 (c)(2).
188. FED. R. BANKR. P. 9019(a).
189. 11 U.S.C. § 330 (1994).
190. Conversely, the debtor's management may use its control of the business to exert leverage over creditors. See supra notes 60-61 and accompanying text.
191. For a different account of relationships and community in bankruptcy, see Donald R. Korobkin, Rehabilitating Values: A Jurisprudence of Bankruptcy, 91 COLUM. L. REV. 717 (1991) (attacking economic account of bankruptcy and proposing "group therapy" value-based account).
192. See generally Oliver E. Williamson, Transaction-Cost Economics: The Governance of Contractual Relations, 22 J.L. ECON. 233, 238-45 (1979) (describing transaction-specific investment in contractual relations and its significance for determining appropriate governance structure).
193. See id. at 240 (describing transaction-specific human-capital investment in the context of idiosyncratic supply contracts). Familiarity . . . permits communication economies to be realized: specialized language develops as experience accumulates and nuances are signaled and received in a sensitive way. Both institutional and personal trust relations evolve. Thus the individuals who are responsible for adapting the interfaces have a personal as well as an organizational stake in what transpires. Where personal integrity is believed to be operative, individuals located at the interfaces may refuse to be part of opportunistic efforts to take advantage of (rely on) the letter of the contract when the spirit of the exchange is emasculated. Such refusals can serve as a check upon organizational proclivities to behave opportunistically. Other things being equal, idiosyncratic exchange relations which feature personal trust will survive greater stress and display greater adaptability. Id. Chapter 11 in essence replaces the debtor's multiple bilateral prebankruptcy obligations with a sort of multilateral relational contract. See generally Ian R. Macneil, Contracts: Adjustment of Long-term Economic Relations under Classical, Neoclassical, and Relational Contract Law, 72 NW. U. L. REV. 854 (1978). Parties' interaction in Chapter 11 exhibits the three significant factors distinguishing relational contracts from traditional discrete transactions: uncertainty, recurring exchange among the parties, and transaction-specific investment. See Williamson, supra note 176, at 239. While any prebankruptcy obligation might simply have been a discrete "right to payment" against the debtor, a Chapter 11 claim represents far more. Cf. 11 U.S.C. § 101(5) (1994). It allows participation in Chapter 11's "political and social processes" that adjust each claimant's rights. Any discrete prebankruptcy rights to payment are replaced by multiple relations that create "a minisociety with a vast array of norms beyond the norms centered on exchange and its immediate processes." Macneil, supra, at 901.
194. In a related context, Robert Axelrod made the following observation: [O]nce a manufacturer begins to go under, even his best customers begin refusing payment for merchandise, claiming defects in quality, failure to meet specifications, tardy delivery, or what-have-you. The great enforcer of morality in commerce is the continuing relationship, the belief that one will have to do business again with this customer, or this supplier, and when a failing company loses this automatic enforcer, not even a strong-arm factor is likely to find a substitute. ROBERT M. AXELROD, THE EVOLUTION OF COOPERATION 60 (1984) (emphasis added)
195. (quoting M. MAYER, THE BANKERS 280 (1974)).
196. Id. at 182.
197. A reorganization . . . involves a very complicated bargaining game in
198. The two do not necessarily happen simultaneously. A bankruptcy investor can become a major creditor in the reorganization by aggregating small claims, without having to purchase from an existing major creditor. Conversely, a major bondholder could simply liquidate its holdings in the public securities market, effectively replacing itself in the reorganization with widely dispersed new claimants. Even assuming sufficient liquidity in the public markets, the selling bondholder will almost certainly take a loss with this strategy, since with large blocks of securities in the secondary markets, the sum of the parts is generally worth less than the whole. The selling bondholder could generally achieve a higher recovery by selling its holdings in a block in a private transaction - provided a buyer could be found. Flooding the market would also cause the market price to drop, further depressing the selling bondholder's overall recovery.
199. This wasted reorganization-specific capital affects not only the exiting creditor. To the extent other parties invested in that exiting creditor's accumulated knowledge, e.g., by educating that creditor about the debtor's business, their investment is also wasted.
200. Resentments may be created, both toward any "deserter" and any late entrant. Because of the collective nature of the process, all creditors have an important stake in the composition of the community. However, they have no say in the exit of a selling claimant or the identity of any new participant, the size of its stake, or the timing of its entrance into the case.
201. See infra note 225 and accompanying text.
202. 5 COLLIER ON BANKRUPTCY, supra note 47, ¶ 1103.07, at 1103-26.
203. 11 U.S.C. § 1103(c) (1994).
204. 5 COLLIER ON BANKRUPTCY, supra note 47, ¶ 1103.07, at 1103-27.
205. See, e.g., Anthony Baldo & Everett Clayton, Hills Talks Go Silent, but Heavy Claims Trading Continues, MERGERS & ACQUISITIONS REPORT, May 4, 1992, at 1, 14 (noting that in bankruptcy of Hills Department Stores, Inc., committee members sold their claims and then resigned, and that purchasers had applied to be on committee).
206. 5 COLLIER ON BANKRUPTCY, supra note 47, ¶ 1102.01[6], at 1102-25.
207. 11 U.S.C. § 330 (1994).
208. One prominent attorney estimates that significant renegotiation occurs in 98% of the cases in which bankruptcy investors become involved. Telephone interview with Harvey R. Miller, Esq., Partner, Weil, Gotshal, and Manges (Apr. 4, 1995).
209. This effect is greater, of course, the longer the case has been going. Trading shortly after the case has been filed will generally not have the same impact as significant creditor turnover after several years of plan negotiation.
210. LoPucki & Whitford, supra note 29, at 749.
211. Id.
212. Id. at 778.
213. Id. at 749.
214. Bankruptcy sends a signal to everyone dealing with a bankrupt debtor: "Get out now with as much as you can as fast as you can." With respect to the bankrupt debtor, bankruptcy suggests that there is no long-term worth worrying about. Suppliers are less likely to ship for fear of not getting paid. Customers are less likely to order for fear of not being able to rely on the debtor's existence, much less the debtor's timely performance. Employees and managers become nervous and less faithful and may leave. Theodore Eisenberg, Bankruptcy in the Administrative State, 50 LAW & CONTEMP. PROBS., Spring 1987, at 3, 33.
215. "The evolution of cooperation requires that individuals have a sufficiently large chance to meet again so that they have a stake in their future interaction." Axelrod, supra note 178, at 20.
216. Upon initial consideration, it might appear that for holders of publicly traded debt, this "easy exit" effect exists independent of bankruptcy. That is, the public markets would provide an easy exit whether a bankruptcy system existed or not. However, as a practical matter, for any holder of a large block of public debt, exit via the public markets is less than ideal. A more profitable method of exiting would be to negotiate a private deal for the entire block. See supra note 183. Because Chapter 11 enhances the marketability of such a block, see infra subpart III.A, the attractiveness and availability of a private exit may be improved by the fact that Chapter 11 exists. Therefore, while the "easy exit" problem of reduced cooperation would exist with respect to public debtholders independent of Chapter 11, it is probably more pronounced because of Chapter 11.
217. Cf. Williamson, supra note 176, at 241 (noting that assurance of a continuing relation is necessary to encourage idiosyncratic - transaction-specific, nonmarketable - investment).
218. Theodore Eisenberg, Commentary on "On the Nature of Bankruptcy": Bankruptcy and Bargaining, 75 VA. L. REV. 205, 208 (1989). "If the foundation of cooperation is not merely trust but is also, as a cooperation theorist puts it, 'the durability of the relationship,' bankruptcy law may be seen as trying to foster 'a stable pattern of cooperation' with the attendant payoffs that cooperation yields." Id. at 217.
219. 11 U.S.C. §§ 364, 503(b)(1), 507(a)(1) (1994).
220. Id. § 507(a)(3).
221. Id. §§ 503(b), 507(a)(1).
222. Id. § 365.
223. Eisenberg, supra note 201, at 209. In the context of utility bankruptcies, Professor Eisenberg summarizes the likely effect of keeping the players in the game: The inability of the debtor's relations immediately to extricate themselves from involvement with the debtor becomes a reality unto itself. The debtor's relations must think in terms of long-term interactions because they find themselves in a long-term relation. The "get-out-now" mentality is cushioned by planning in light of the new, longer relationship with the debtor. All parties have increased incentives to discover mutually beneficial transactions. The payoff is a larger pie for all of the relations to share. Eisenberg, supra note 197, at 36.
224. 11 U.S.C. § 362 (1994).
225. Id. § 506(a).
226. Id. § 362(d).
227. "Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor's interest." 11 U.S.C. § 506(a) (1994).
228. "Bankruptcy law promotes bargaining by creating uncertainty about participant rights. The secured creditor who 'knows' that it is entitled to a particular amount in bankruptcy has little incentive to bargain. The uncertainty that bankruptcy creates about such a creditor's rights . . . brings the creditor to the bargaining table." Eisenberg, supra note 201, at 209.
229. Eisenberg, supra note 197, at 35.
230. See, e.g., DAN FOGELBERG, Changing Horses, on SOUVENIRS (Epic Records 1974) ("Changing horses in the middle of a stream gets you wet and sometimes cold.").
231. While selling claimants may sometimes be sophisticated financial institutions, selling is probably more common for trade creditors or public debt holders.
232. "The [claim] acquiror's objective of achieving a stupendous return on investment colors all of its actions." Letter from Harvey R. Miller, Esq., Partner, Weil, Gotshal and Manges, to Frederick Tung, Associate Professor of Law, University of San Francisco School of Law (Apr. 17, 1995) [hereinafter Miller Letter] (on file with author). See generally Stephen M. Bundy, Commentary on "Understanding Pennzoil v. Texaco": Rational Bargaining and Agency Problems, 75 VA. L. REV. 335 (1989) (discussing the concept of a "positive settlement gap" and the factors affecting likelihood of settlement).
233. The bankruptcy investor's business depends on its profits from investment in Chapter 11 claims. By contrast, the selling creditor and other creditors remaining in the case are unlikely to be in the bankruptcy investing business or the collections business; they operate other commercial pursuits from which they derive profit. Therefore, ordinary creditors generally will not have the bankruptcy investor's aggressive profit motive with respect to their bankruptcy claims. Instead, they will simply seek to minimize their losses.
234. It has been suggested that the bankruptcy investor entering the reorganization process may be more solicitous to the process than the exiting seller. Having invested new money, the entering investor appreciates more seriously the time value of money and is therefore more eager than its predecessor to strike a deal quickly. Because it has purchased at a discount from face, the new entrant also has a lower basis in the investment, and therefore may have more flexibility as to the terms of an acceptable deal. Fortgang & Mayer, Trading Claims, supra note 13, at 6-7. This argument fails to appreciate the selling creditor's position. While the selling creditor may have been carrying its claim on its books at par, sale of its claim at a discount clearly evidences its willingness to compromise its claim. There may be other reasons why the substitution of the new participant into the plan process moves the process forward, but the simple economics of the trading transaction do not support such an assertion.
235. See, e.g., Margaret A. Elliott, The Wonderful World of Bankruptcy, INSTITUTIONAL INVESTOR (Int'l ed.), Nov. 1988, at 66 ("You have to pick the instrument with the most leverage and be prepared to fight for your rights in a reorganization or bankruptcy.") (quoting Shelley Greenhaus, Senior Vice President of Oppenheimer & Co.);
236. John Cassidy, America's Top Stories Reopen Hostilities, SUNDAY TIMES, Jan. 9, 1994 ("My guiding philosophy is that you really need to get into a controlling position in Chapter 11 and really be able to dictate what your stakes in the outcome will be.")
237. (quoting Daniel Harmetz, Manager of Fidelity Investment's Capital and Income Fund).
238. See supra subpart I.A.
239. See, e.g., Stephen E. Clark et al., The Black Prince of Wall Street, INSTITUTIONAL INVESTOR, Aug. 1991, at 15 (explaining blocking strategy of bankruptcy investors: "Apollo (like Water Street, Icahn and others) is what's known as a blocking creditor. . . . It . . . buys enough of any one class . . . to give it so-called blocking power. . . . Apollo acquires veto power over a reorganization by buying up more than one third of a class.").
240. While confirmation based on new value is a theoretical possibility, see generally In re Bonner Mall Partnership, 2 F.3d 899 (9th Cir. 1993) (recognizing new value exception to absolute priority rule), cert. granted sub nom. U.S. Bancorp Mortgage Co. v. Bonner Mail Partnership, 114 S. Ct. 681, motion to vacate denied and dismissed, 115 S. Ct. 386 (1994), its application is unlikely in the reorganization of large public companies.
241. See Robert H. Mnookin & Lewis Kornhauser, Bargaining in the Shadow of the Law: the Case of Divorce, 88 YALE L.J. 950 (1979) (discussing effect of formal legal entitlements on informal bargaining).
242. As a veteran bankruptcy investor described, "[w]e acquire as much of the senior securities as necessary to prevent a company from reorganizing - unless we say so." Kate Campbell, Vulture Capitalists: Investment Activities Taking Advantage of Troubled Firms, CAL. BUS., Jan. 1993, at 36, 40 (quoting Martin J. Whitman).
243. See LoPucki & Whitford, supra note 48, at 163, for war stories of investors purchasing positions in junior debt, then successfully developing: (1) a fraudulent transfer action against bank creditors (Saxon Industries), and (2) a breach of indenture covenant action against a debtor (Wilson Foods), to extract improved plan consideration.
244. For example, fixed-rate, medium-term notes sell well to insurance companies and other financial institutions looking to fund payments on fixed-rate obligations such as annuities. It is not uncommon for the bankruptcy investor to be able to liquidate its new securities even before they are issued. Once the capital markets reach some level of comfort that the terms of the reorganization securities are set, it is common for reorganization securities to trade on a "when-issued" basis. See, e.g., Gautam Naik, Lone Star Industries Ready to Emerge From Chapter 11; Troubled Cement Maker Hopes Many of Its Problems Are Behind It, WALL ST. J., Mar. 4, 1994, at B4 (discussing trading of stock of reorganized debtor on when-issued basis);
245. Dana Milbank, LTV's New Common, to Begin Trading Soon, Carries More Than Just Post-Chapter 11 Risks, WALL ST. J., June 18, 1993, at C2.
246. It should be noted that not all bankruptcy-claim purchasing is done for the purpose of short-term financial speculation. Investors have also used claim purchasing as a vehicle to effect long-term investment in a reorganizing company. For example, in the bankruptcy reorganization of R.H. Macy & Co., its competitor, Federated Department Stores, Inc., purchased $500 million in face amount of secured claim against Macy's as part of Federated's strategy - ultimately successful - to acquire Macy's. See also infra note 324. See generally Cassidy, supra note 218 (describing Federated's purchase of secured claim against Macy's as part of acquisition strategy). This type of transaction raises interesting and important issues that are unfortunately beyond the scope of this Article.
247. "The acquiror generally has no long-term perspective and is not particularly concerned about economic viability after its contemplated departure from the scene from a capital markets exit or otherwise. . . . [F]rom my perspective, there are a significant number of Chapter 11 debtors compelled to emerge from Chapter 11 before the illness that precipitated the Chapter 11 case is cured." Miller Letter, supra note 215, at 2.
248. Fortgang and Mayer recount the story of the members of the First Congress buying up war bonds issued by the states to fund the Revolutionary War. Members bought at a deep discount while they were also considering legislation to have the new federal government assume these liabilities and pay the bonds in full. The legislation passed, but because the debt purchasing members were primarily from northern states, critical votes of southern congressmen were obtained only by the northerners' promise to move the capital to a site between Maryland and Virginia on the Potomac River. Fortgang & Mayer, Trading Claims, supra note 13, at 25-26
249. (citing C. BOWERS, JEFFERSON AND HAMILTON: THE STRUGGLE FOR DEMOCRACY IN AMERICA 43-48, 64-67 (1966)).
250. See supra section I.B.2.
251. See supra Part II.
252. See supra notes 107-10 and accompanying text.
253. Chapter 11 modification of state law rights are designed to defuse the conflict and resulting bargaining impasse arising under nonbankruptcy law and lead to a consensual settlement of the debtor-creditor dispute through bargaining that maximizes the value available to satisfy the claims against the firm. . . . [Chapter 11] alter[s] . . . these entitlements and . . . add[s] . . . unique reorganization entitlements . . . designed to enhance the bargaining process and produce superior resolution of debtor/creditor disputes. Johnston, supra note 52, at 257 (footnote omitted).
254. E.g., Butner v. United States, 440 U.S. 48 (1979).
255. 11 U.S.C. § 362 (1994).
256. This disability may only be temporary, of course, given the possibility that the creditor may be successful in obtaining relief from stay. Id. § 362(d).
257. Bankruptcy does, however, create priorities for certain types of claims, which will be paid ahead of general unsecured claims, e.g., administrative expense claims, 11 U.S.C. § 507(a)(1) (1994), and priority wage claims. Id. § 507(a)(3).
258. E.g., Metropolitan Life Ins. Co. v. RJR Nabisco, Inc., 716 F. Supp. 1504, 1524-25 (S.D.N.Y. 1989); Katz v. Oak Indus., Inc., 508 A.2d 873, 879 (Del. Ch. 1986). Several courts have held that once a firm becomes insolvent or approaches insolvency, the fiduciary duties of its management shift from shareholders to creditors. E.g., Geyer v. Ingersoll Publications Co., 621 A.2d 784 (Del. Ch. 1992); Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., Civ. No. 12,150, 1991 Del Ch. LEXIS 215 (Del. Ch. Nov. 6, 1991). However, creditors are given far more protection and a far greater oversight role in the debtor's operations in Chapter 11 than under nonbankruptcy fiduciary duty rules.
259. While certain creditors might exercise similar oversight over the debtor's business activities outside of bankruptcy by virtue of contractual covenants related to credit extensions, such rights in bankruptcy accrue to all creditors and other parties in interest, without regard to their particular nonbankruptcy bargains with the debtor. Moreover, these participatory rights are part of the package of the collective proceeding in Chapter 11, and do not depend on the existence or nonexistence of such rights outside of bankruptcy.
260. "By the filing of a bankruptcy case, a market in nonpublicly traded securities is created." In re Allegheny Int'l, Inc., 100 B.R. 241, 243 (Bankr. W.D. Pa. 1988) (Cosetti, J.).
261. In addition, any motion for relief from stay generally requires notice. FED. R. BANKR. P. 4001(a).
262. 11 U.S.C. § 521, (Official Bankruptcy Form 6 (Schedules) and Form 7 (Statement of Financial Affairs)) (as amended prior to Nov. 1, 1994).
263. [T]he Bankruptcy Code and rules require the debtor to file various forms of disclosure and provide dramatically liberalized access to the debtor's officers, employees, and files. . . . [T]he existence of a collectivized insolvency proceeding acts as an information forcing device which enables the parties to detect misbehavior that otherwise might have gone unnoticed . . . . The process also gives every constituency an opportunity to watch the firm during its transition period, and thus to reassess their [sic] relationship with the debtor. David A. Skeel, Jr., Markets, Courts and the Brave New World of Bankruptcy Theory, 1993 WIS. L. REV. 465, 507 (1993) (footnotes omitted).
264. Fortgang & Mayer, 1993 Developments, supra note 13, at 760 ("As is true in virtually every large case, Federated's schedules became the basis for a market in trade claims.").
265. Minkel & Baker, supra note 13, at 44 n.32.
266. The Code also empowers the debtor to reject unprofitable executory contracts. 11 U.S.C. § 365 (1994).
267. Cf. Manville Corp. v. Equity Sec. Holders Comm. (In re Johns-Manville Corp.), 801 F.2d 60, 67 (2d Cir. 1986) (recognizing that even with solvent debtor, if Equity Committee's state court action to compel shareholders' meeting to replace directors caused "real jeopardy to reorganization prospects," shareholders' right to compel such a meeting could be overridden in Chapter 11).
268. Cf. CTS Corp. v. Dynamics Corp. of Am., 481 U.S. 69 (1987), in which the court considered, inter alia, a Commerce Clause challenge to an Indiana antitakeover statute that effectively conditioned acquisition of a qualifying Indiana corporation on majority approval of disinterested shareholders. Upholding the constitutionality of the state statute, the Court noted that "[t]he very commodity that is traded in the securities market is one whose characteristics are defined by state law," and that the state statute merely defined the attributes of shares in such Indiana corporations. Id. at 94.
269. See, e.g., THOMAS H. JACKSON, THE LOGIC AND LIMITS OF BANKRUPTCY LAW (1986). Respecting [nonbankruptcy] rights in full . . . can conflict with the core role of bankruptcy to maximize the value of assets in the face of pressures to ignore the collective weal for individual gain. Thus, it is necessary to weigh the damage that recognizing a particular nonbankruptcy right would cause to collective action against the costs of any incentives that would be potentially created by upsetting that right. Because the collective damage resulting from adhering to a right may sometimes exceed any benefit, a bankruptcy statute sometimes must replace nonbankruptcy rights with something else. Id. at 28 (emphasis in original).
270. See supra note 112.
271. In the paradigmatic free market, the participants trade a standardized contract such that each unit of the contract is a perfect substitute for any other unit. The identities of the parties in any mutually agreeable transaction do not affect the terms of exchange. The organized market itself or some other institution deliberately creates a homogeneous good that can be traded anonymously by the participants or their agents. Lester G. Telser & Harlow N. Higinbotham, Organized Futures Markets: Costs and Benefits, 85 J. POL. ECON. 969, 997 (1977). The public securities markets are perceived to approximate the paradigmatic free market. See, e.g., Van Zandt, supra note 12. Of all the real world markets, the markets for secondary trading of financial assets seem most accurately to reflect th[e] ideal description [of the market]. On first glance and in the popular imagination, these markets in which large sums change hands at breakneck speed are the epitome of the free market: they consist of helter-skelter trading driven only by the avariciousness of the individual participants. Id. at 968.
272. See supra subpart I.C.
273. Cf. Victor P. Goldberg, Regulation and Administered Contracts, 7 BELL J. ECON. 426 (1976) (arguing that economists have overstated their case against economic regulation by suppressing relational aspects of contract in favor of a "paradigmatic contract" involving "a discrete transaction conveying a well-defined object (the ever popular widget) in exchange for cash," and proposing that theorists instead "open up the 'black box' of contract").
274. See supra subparts II.A-B.
275. See supra notes 105-06 and accompanying text.
276. 11 U.S.C. § 101(5) (1994).
277. Cf. Goldberg, supra note 252, at 427-28 (citation omitted): The pure discrete transaction of economic theory involves the contemporaneous exchange of claims or rights between the contracting parties. The identity of the parties and the social milieu within which the contract is consummated are irrelevant. The exchange is cloaked in anonymity with one party selling to the market and the other buying from the market.
278. Nor is a claim the ideal standardized contract to trade in the free market. Claims are neither homogeneous nor fungible. Claims of equal face value but in different classes are not interchangeable. With the exception of claims based on public debt securities, even claims in the same class are not necessarily interchangeable. For example, the debtor may have defenses to one trade claim but not another. See supra note 78. Moreover, the value to the bankruptcy investor of the last claim needed to amass a blocking position is worth proportionally more than the first claim purchased. See, e.g., In re Allegheny Int'l Inc., 118 B.R. 282, 290 (Bankr. W.D. Pa. 1990) (noting that bankruptcy investor paid proportionally more for last bank claim necessary to create blocking position in that class than it did for prior and subsequent purchases). The same observation could be made with respect to the last share of stock necessary to take control of a company. However, this does not suggest that the claims market resembles the public securities markets, but may suggest an analogy to the market for corporate control. See infra note 264. Nor is the market impersonal. The identities of the purchaser and seller matter. See supra Part II.
279. See Goldberg, supra note 252, at 426-27 ("[The] discrete transactional mold is apt to be singularly inappropriate for representing relations which are to take place over a long period of time and in which the parties will have to deal with each other regularly over a wide range of issues (many of them unknown in advance).").
280. Richard A. Epstein, Why Restrain Alienation?, 85 COLUM. L. REV. 970, 990 (1985). Professor Epstein presents two examples of common-law restraints on alienation intended to control imposition of external costs in a common pool situation. The common pool in Chapter 11 is similarly susceptible to externalities from claims trading. Professor Epstein's first example involves restraint on the rights of riparian landowners to sell water rights. While the private sale presumably allocates water to a party who values it more highly, and "the two parties to that sale will both be gainers," the buyer's use "may also be a more intensive use, which means that any sale of riparian rights may diminish the correlative rights of other claimants to the common pool." Id. at 981. Partial restrictions on alienation serve to preserve the common pool while allowing transactions which move resources to higher-valued uses. The second example involves the Roman law of usufruct. The holder of the usufruct interest - roughly analogous to a life estate - could not alienate its interest to a third party, but could release her interest back to the owner of the property. Likewise, under English law, an easement in gross was inalienable, and any attempt to do so created a mere license between the parties. These restrictions were intended to protect property owners from abuse of their land by users not of their choosing. Id. at 983-84;
281. see also Susan Rose-Ackerman, Inalienability and the Theory of Property Rights, 85 COLUM. L. REV. 931, 938 (1985) ("Externalities figure prominently in discussions of market failure and provide the most commonly recognized rationale for inalienability rules."). Alienability of other bankruptcy-created rights is restricted. For example, "[t]he right to object to a debtor's discharge is not a marketable commodity which may be purchased by one party from another in order to inflict further punishment and discomfort on the debtor." In re Beugen, 99 B.R. 961, 965 (Bankr. 9th Cir. 1989) (emphasis added). In that case, as part of a personal vendetta against the debtor, the claim purchaser bought his claim solely to obtain standing to object to the individual debtor's discharge. Id. The debtor's right to redeem personal property in Chapter 7, 11 U.S.C. § 722 (1994), is not assignable. In re Davis, 20 B.R. 212, 214 (Bankr. CD. Ill. 1982) (citing S. REP. NO. 95-989, 95th Cong., 2d Sess. 95 (1978),
282. reprinted in 1978 U.S.C.C.A.N. 5881); In re Fitzgerald, 20 B.R. 27, 29 (Bankr. N.D.N.Y. 1982). Congress was aware of the potential for abuse of the debtor's redemption right: To prevent abuses such as may occur when the debtor deliberately allows the property to depreciate in value, the debtor will be required to pay the fair market value of the goods or the amount of the claim if the claim is less. The right is personal to the debtor and not assignable. S. REP. NO. 95-989, 95th Cong., 2d Sess. 95 (1978),
283. reprinted in 1978 U.S.C.CA.N. 5881. Assignability would do harm to consumer creditors. Undersecured consumer creditors would more frequently suffer strip down of their liens as a market developed in redemption rights and the personal property available for Chapter 7 redemption. Consumer creditors' leverage to negotiate reaffirmation agreements would also presumably suffer. A family support obligation loses its priority status and nondischargeable character if assigned. 11 U.S.C. §§ 507(a)(7)(A), 523(a)(5)(A) (1994). These examples illustrate the personal character of certain bankruptcy entitlements meant to effect specific bankruptcy policies. Such rights are meant to be exercised only by the initial holders of such rights in bankruptcy. Even though assignment of such special rights might benefit both assignors and assignees, other affected parties might suffer adverse consequences from such assignments. While these analogies are not perfect, they illustrate the general idea that certain rights subsumed within the claimholder's bundle should not trade as marketable commodities. Because trading in these entitlements would visit costs on third parties - and possibly assignors - the initial holders of such rights are not permitted to assign.
284. There is a certain irony to a market-based defense of unrestricted trading, given that bankruptcy is fundamentally antithetical to markets. Bankruptcy upsets outcomes which would otherwise be determined by competition among creditors and the debtor under decentralized state law collection regimes. Bankruptcy trumps private contractual arrangements. Bankruptcy replaces competition with collectivization and also attempts to promote cooperation. See supra subpart II.B.
285. The market for distressed securities is completely private. Says Don Gevirtz [of The Foothill Group], "We maintain regular contacts with banks' workout departments and let them know we want to buy loans or securities when they want to get rid of them." This kind of market information is strictly confidential. . . . "We're talking about a $284 billion market. . . . The market is too complicated, there are too many parties [involved], for it to ever be a retail market." Campbell, supra note 223, at 41. There may be small-scale postpetition trading in the debtor's public debt securities by passive investors. However, even the market for public debt securities is illiquid compared to equity markets. "[T]here is simply not a liquid auction market, or even continuous trading, in debt securities, at least not of the kind that is available for equity securities of the same issuers." John C. Coffee, Jr. & William A. Klein, Bondholder Coercion: The Problem of Constrained Choice in Debt Tender Offers and Recapitalizations, 58 U. CHI. L. REV. 1207, 1218 (1991).
286. See supra note 239 and accompanying text.
287. See supra notes 218-34 and accompanying text.
288. Rather than the public securities markets, the market for corporate control provides perhaps a closer analogy to the claims market. Participants in the market for corporate control purchase shares in the public equity markets, but the shares are not prized merely as passive investments. Participants acquire shares in order to aggregate controlling blocks of stock. Control is an asset distinct from other aspects of the issuer enterprise and is the actual asset being bought and sold in this market. Henry Manne, Mergers and the Market for Corporate Control, 73 J. POL. ECON. 110 (1965). Whether corporate control transactions are good or bad, and whether restrictions on these transactions are appropriate, may be the subject of some debate, but the terms of debate certainly recognize externalities as an issue.
289. See, e.g., John C. Coffee, Jr., Regulating the Market for Corporate Control, A Critical Assessment of the Tender Offer's Role in Corporate Governance, 84 COLUM. L. REV. 1145, 1248-49 (1984) (recognizing that employees, suppliers, pensioners, and lower level managers have economic stake in a corporation and may be adversely affected by increased leverage or other substantial shift in direction of risk preference);
290. Jeffrey N. Gordon, Corporations, Markets, and Courts, 91 COLUM. L. REV. 1931, 1972 (1991) (explaining Delaware Supreme Court's decision in Paramount Communications, Inc. v. Time Inc., 571 A.2d 1140 (Del. 1989) as a reflection of "a widely-shared social sense that self-interested, market-oriented behavior had gotten out of hand in the takeover area," and of the notion that social values such as "loyalty, community, and cultural continuity" should be protected even in corporate context);
291. Martin Lipton, Corporate Governance in the Age of Finance Corporatism, 136 U. PA. L. REV. 1 (1987).
292. Gordon relies on Karl Polanyi's broader thesis that markets require regulation in order to prevent social dislocation. KARL POLANYI, THE GREAT TRANSFORMATION (1944).
293. Cf. Jonathan Macey & Hideki Kanda, The Stock Exchange as a Firm: The Emergence of Close Substitutes for the New York and Tokyo Stock Exchanges, 75 CORNELL L. REV. 1007, 1018 (1990) ("Exchanges enhance secondary market liquidity because they serve as central producers and disseminators of information.").
294. See id. at 1014 ("Undeveloped, illiquid, thinly traded securities markets tend to be inefficient, while highly developed, liquid, thickly traded markets tend to be efficient."); see also Coffee & Klein, supra note 261, at 1219 ("A recent Wall Street Journal survey found that bonds that are not exchange-listed may be simultaneously traded at very different prices by different brokerage firms - the result one would expect from a market characterized by irregular trading and little publicly available information.") (citation omitted).
295. See supra notes 111, 163.
296. See Nicholas L. Georgakopoulos, Insider Trading as a Transactional Cost: A Market Microstructure Justification and Optimization of Insider Trading Regulation, 26 CONN. L. REV. 1, 43 (1993) (arguing that a change in transaction costs will affect the price of a good more significantly if overall transaction costs are low than if they are high and that with illiquid markets, transaction costs from illiquidity are so high that "[a]n effort to reduce transaction costs appears pointless").
297. See supra section I.C.1.
298. 11 U.S.C. § 105(a) (1994).
299. 11 U.S.C. § 1126(e) (1994) ("On request of a party in interest, and after notice and a hearing, the court may designate any entity whose acceptance or rejection of such plan was not in good faith, or was not solicited or procured in good faith or in accordance with the provisions of this title.").
300. 11 U.S.C. § 105(a) (1994).
301. HOUSE REPORT, supra note 23, at 316-17.
302. 2 COLLIER ON BANKRUPTCY, supra note 47, ¶ 105.01[1], at 105-3.
303. See Manville Corp. v. Equity Sec. Holders Comm. (In re Johns-Manville Corp.), 801 F.2d 60 (2d Cir. 1986) (holding that enjoining state court proceeding initiated by Equity Committee to compel shareholder's meeting for purpose of replacing debtor's directors was within court's equitable powers). [I]f the bankruptcy court may ever use its equitable powers under section 105(a) to enjoin actions pursued in other courts as "concerning the administration of the estate" under section 157(b)(2)(A), it may exercise that power where there is a basis for concluding that rehabilitation, the very purpose for the bankruptcy proceedings, might be undone by the other action. Id. at 64.
304. United States v. Sutton, 786 F.2d 1305, 1308 (5th Cir. 1986) (citation omitted) (finding no authority under § 105(a) for court's award of monthly support payments to debtor's spouse from debtor's Chapter 11 estate). See generally 2 COLLIER ON BANKRUPTCY, supra note 47, ¶ 105.01 (analyzing bankruptcy court's power under § 105).
305. 119 B.R. 440 (Bankr. S.D.N.Y. 1990).
306. Id. at 444. For a discussion questioning the substance of Judge Lifland's concerns, see Fortgang & Mayer, 1993 Developments, supra note 13, at 756 n.18 and accompanying text.
307. See supra notes 93-97 and accompanying text.
308. Ionosphere Clubs, 119 B.R. at 445 (citations omitted). Some have asserted that the 1991 amendment to Rule 3001(e) precludes all parties except the transferor from objecting to a claim transfer. E.g., Fortgang & Mayer, 1991 Developments, supra note 13, at 4 ("[T]he amended Rule 3001(e) will stop third parties - most notably the debtor, but occasionally other creditors - from attempting to hold up court approval of a claims transfer to further their own private agendas."). Moreover, the Advisory Committee note states the intention of the amendment "to limit the court's role to the adjudication of disputes regarding transfers of claims." FED R. BANKR. P. 3001(e) advisory committee's note. While the amendment may narrow availability of standing to challenge claim transfers under Rule 3001(e), it could hardly be read to restrict other provisions in the Code or Rules. In particular, equitable relief from trading may be appropriate in a given case, independent of Rule 3001. In that case, the contents of Rule 3001(e) would be irrelevant. Moreover, no Bankruptcy Rule or its amendment may "abridge, enlarge, or modify any substantive right." 28 U.S.C. § 2075 (1994).
309. First Amended Disclosure Statement with respect to the Revised Joint Consolidated Plan of Reorganization Proposed by the Debtors and the Official Committee of Unsecured Creditors for Pan Am Corporation and Its Affiliated Debtors, dated as of October 24, 1991, In re Pan Am Corp., Chapter 11 Case Nos. 91 B 10080 (CB) through 91 B 10087 (CB) (inclusive), at 93.
310. Section 382(a) of the Internal Revenue Code limits a corporation's use of its NOLs once there has been an ownership change - a greater than fifty percentage point change in the corporation's stock ownership over a three-year period. This limitation would normally be triggered in a large Chapter 11 reorganization, since the plan will typically distribute significant stock in the reorganized debtor to creditors who were not prepetition stockholders. Therefore, the statute also contains a special bankruptcy exception: the § 382(a) limitations will not apply if shareholders and creditors of the debtor corporation immediately before the ownership change in Chapter 11 end up holding at least fifty percent of the value of the reorganized debtor's stock following confirmation, provided that of the stock issued to creditors, only qualified "old and cold" creditors count. I.R.C. § 382(1)(5) (1994). A qualified "old and cold" creditor is one that has either held its claim for at least 18 months prior to the filing of the petition, or acquired its claim as a trade creditor and has continuously held the beneficial interest in such claim. Treas. Reg. § 1.382-9(d)(2)(i) (1992). For a complete discussion of this complex area, see 7 MERTENS LAW OF FEDERAL INCOME TAXATION § 29.110 (1994). Because of this "old and cold" creditor requirement, claims trading may make it impossible for the debtor to qualify for this exception. The bankruptcy investor will rarely qualify as an "old and cold" creditor. Trading may therefore endanger the value of the NOLs to the reorganized debtor. See generally Fortgang & Mayer, Trading Claims, supra note 13, at 111-13; Minkel & Baker, supra note 13, at 46-51 (questioning rationale of NOL preservation in several cases in which trading injunctions issued).
311. 928 F.2d 565 (2d Cir.), cert. denied sub nom. PSS Steamship Co. v. Official Comm. of Unsecured Creditors, 502 U.S. 821 (1991).
312. Property of the estate includes "all legal or equitable interests of the debtor in property as of the commencement of the case." 11 U.S.C. § 541(a)(1) (1994).
313. 11 U.S.C. § 362(a)(3) (1994).
314. Pan Am Corp. v. All Unsecured Creditors et al. (In re Pan Am Corp.), Adv. No. 91-6175A (CB) (Bankr. S.D.N.Y. Oct. 3, 1991).
315. See Fortgang & Mayer, 1993 Developments, supra note 13, at 757-58, for a discussion of Pan Am and other cases in which litigation occurred concerning the effect of claims trading on the estate's NOLs.
316. While the analysis is useful, the Pan Am decision may not be authoritative, as it was never published. Apparently, the issue was not fully litigated because no substantive objection was made. Id. at n.125.
317. "If Congress wants to preserve NOLs from accidental destruction by claims trading, Congress has the power to do so. We question, however, whether a bankruptcy court should assume such power in the absence of specific statutory authority." Fortgang & Mayer, 1993 Developments, supra note 13, at 759.
318. American United Mutual Life Ins. Co. v. City of Avon Park, 311 U.S. 138 (1940) (Douglas, J.).
319. Id. at 146 (citations omitted) (emphasis added). In that case, the fiscal agent retained by the debtor municipality purchased claims for its own account and voted them in favor of the debtor's Chapter IX composition, but failed to disclose this interest to other creditors from whom it solicited votes for the plan. The Court held that the fiscal agent's failure to disclose this interest required reversal of a lower court order confirming the plan. Id. See also Fortgang & Mayer, Trading Claims, supra note 13. "The applicable law is not in the Code and it is not in the Rules, but it does reside in the general equitable powers of the bankruptcy court. The Supreme Court has held that no specific statute is needed to punish fiduciary trading." Id. at 33 (emphasis in original) (approving Avon Park description of court's broad equitable powers in context of fiduciary trading).
320. 89 B.R. 573 (Bankr. E.D. La. 1988).
321. Id. at 574.
322. Id. at 575; see also In re Heritage Village Church & Missionary Fellowship, Inc., 87 B.R. 17, 19 (Bankr. D.S.C. 1988) (affirming court's equitable power under § 105 to deny unconditional transfer where court deems transfer inappropriate).
323. See supra notes 98-102 and accompanying text.
324. In re Allegheny Int'l, Inc., 118 B.R. 282 (Bankr. W.D. Pa. 1990).
325. As part of the debtor's plan, the certificate of incorporation of the reorganized debtor contained a control provision, which basically stated that if any person acquired 30% voting control in the reorganized debtor within two years after the effective date of the plan, all other holders of common stock were entitled to put their shares to such person at a price equal to the highest per share price paid by such person for its shares. Responding to Japonica's express intent not to comply with this control provision, and relying on its equitable powers under § 105(a), the court ordered Japonica's shares held in trust for three years unless Japonica established its willingness and ability to comply with the control provision. Id. at 300-04.
326. See Minkel & Baker, supra note 13, at 75.
327. Allegheny, 118 B.R. at 286.
328. Id.
329. Id.
330. See 11 U.S.C. § 1121(c) (1994).
331. After approval of the debtor's disclosure statement, the filing of a competing plan would generally have been time barred. FED. R. BANKR. P. 3016(a).
332. Allegheny, 118 B.R. at 286.
333. Id. at 290. Japonica had requested that the court delay the confirmation hearing on the debtor's plan in order to allow approval of Japonica's disclosure statement and joint balloting for the competing plans. The court refused this request. Id. at 286.
334. Id. at 289 (citations omitted).
335. Id. at 290.
336. Id.
337. Id. at 293.
338. This interpretation of "good faith" comports with the legislative history of § 1126(e) and its predecessor provision in the Bankruptcy Act. "[S]ection 1126(e) . . . is intended to forestall the 'nuisance blocker' - that is, the investor who waits for a plan of reorganization to be fully negotiated and only then invests in a 'hold-up' to extract more (even if on a class-wide basis) by the threat of delay." Fortgang & Mayer, Trading Claims, supra note 13, at 97 (citation omitted). Cf. David A. Skeel, Jr., The Nature and Effect of Corporate Voting in Chapter 11 Reorganization Cases, 78 VA. L. REV. 461, 513-18 (1992) (arguing for replacement of § 1126(c) supermajority creditor voting requirement with simple majority voting in order to diminish threat of holdup by blocking claim acquirer).
339. For contrasting views on the ultimate holding in the case, compare Fortgang & Mayer, 1991 Developments, supra note 13, at 27 (approving holding that bankruptcy investor was "insider" but offering alternative analysis) with Minkel & Baker, supra note 13, at 71 (disagreeing with holding and both court's analysis and Fortgang & Mayer alternative analysis).
340. Fortgang & Mayer, 1991 Developments, supra note 13, at 33.
341. 133 B.R. 827 (Bankr. W.D. Tex. 1991).
342. Id. at 836. In the context of competing plans, an affiliate of the debtor purchased unsecured claims at face value, voting them in favor of the debtor's plan and against the creditor's. These claim purchases were not disclosed in the debtor's disclosure statement. The debtor defended such purchases as necessary to preempt the creditor proponent from purchasing the claims to assure confirmation of its own plan. Relying on § 1126(e), the court designated the debtor affiliate's votes against the creditor plan because such votes were neither acquired nor voted in good faith. Id.
343. See supra section II.B.3.
344. This problem could possibly be avoided by having parties bring their § 1126(e) motions early on in the confirmation process, or as early as the time trades are proposed. Perhaps preemptive use of § 1126(e) would spare the estate from having to cover costs of professional fees - both its own and those of the creditors' committee - for a contested confirmation. Application of this practice to publicly traded debt claims, however, may be problematic, since no court filing is required with respect to such trades. See supra note 91. It might therefore be difficult for any movant to bring its § 1126(e) motion until after such a trade has already occurred. On the other hand, it is not uncommon for a major claims acquiror to petition the court for clarification of its voting and distribution rights prior to consummating proposed transfers, even those based on public debt. See infra note 329.
345. See supra section I.B.2.
346. The approach described below is by no means offered as an exclusive approach. Other circumstances as well may justify equitable relief. For example, no attempt is made herein to describe a workable approach to dealing with the effects of the bankruptcy investor's new money perspective or strategic purchasing in reorganization. When the bankruptcy investor enters a case by aggregating a large block of small, widely dispersed trade claims, it will undoubtedly affect the course of the reorganization, sometimes to the detriment of the debtor and competing creditors. The bankruptcy investor's acquired position will simply enable it to demand more from the collective than the creditors it replaced. However, no suggestion is intended herein that the debtor and other creditors are generally entitled to preservation of the happenstance of widely dispersed trade creditors - weaker combatants in the negotiation - and that assignment to the bankruptcy investor should be enjoined on that basis alone. In any event, availability of equitable relief should depend on the particular case at hand. Any prescription for equitable relief must by definition remain general and flexible.
347. See supra section II.B.2.
348. See supra section II.B.3.
349. Any significant secondary trading would have to occur during the initial trading period.
350. Limitations on trading will to some extent reduce the consideration obtainable by selling claimants.
351. 11 U.S.C. § 1121(d) (1994).
352. Id. § 1104(a)(1).
353. Id. § 362(d)(1).
354. [T]he court should consider the adequacy of the capital structure, the earning power of the business, economic conditions, the ability of management, the probability of a continuation of the same management, and any other related matters which determine the prospects of a sufficiently successful operation to enable performance of the provisions of the plan. 5 COLLIER ON BANKRUPTCY, supra note 47, ¶ 1129.02[11], at 1129-62.
355. E.g., 11 U.S.C. § 109(c)(5)(B) (1994) (municipality may qualify for Chapter 9 filing although it failed to obtain agreement of required creditor majorities, if it negotiated with them in good faith); id. § 303(i)(2) (involuntary petitioner liable for bad faith filing); id. § 1126(e) (designation of votes not cast, solicited, or procured in good faith); id. § 1129(a)(3) (Chapter 11 plan must be proposed in good faith); id. § 1325(a)(3) (Chapter 13 plan must be proposed in good faith).
356. See supra section III.C.1. Bankruptcy reorganization more closely resembles an administrative process than it does the traditional model of judicial resolution of bilateral disputes over rights. "Bankruptcy itself could be regarded as a form of regulation and there are occasional proposals to have the bankruptcy system run by an administrative agency." Eisenberg, supra note 197, at 5 n.11. The sort of discretion proposed is consistent with this idea. Granted, several of these areas of judicial discretion have pre-Code antecedents - or at least legislative history - that help inform the exercise of discretion. The trading injunction's pedigree, however, is a bit less well-documented. As discussed previously, the negative effects of claims trading in Chapter 11 had no close pre-Code analog. Courts are only beginning to recognize and articulate the types of claims trading activity that justify equitable relief. See supra subpart III.C.
357. For example, in the bankruptcy reorganization of Carter Hawley Hale Stores, the Zell-Chilmark Fund made a public tender for the debtor's trade claims and public debt claims. Prior to making its tender, it obtained the bankruptcy court's blessing with respect to, inter alia, allowance of and voting privileges with respect to the tendered claims, and its good faith in making the tender offer. See Joint Motion for an Order Authorizing Transfer of Claims and Approval of Compromise (July 29, 1992) (Case No. LA-91-64140 JD). This tender was part of Zell-Chilmark's overall strategy to invest in the debtor, pursuant to which it ultimately received a controlling interest in the equity of the reorganized debtor. See Gregory A. Patterson, Carter Hawley Files a Proposal To Reorganize, WALL ST. J., July 8, 1992, at A3.
358. Allowing claims only in the amount of the consideration paid - for voting, or distribution, or both - might also be appropriate in a given context.