Business liquidation

American Bankruptcy Law Journal

Volumn 81, Issue 1, 2007, Pages 65-85

  Lubben, Stephen J ^a  

^a SETON HALL UNIVERSITY   (United States)

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EID: 34548132423     PISSN: 00279048     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (78)

1. Michael J. Herbert & Domenic E. Pacitti, Down and Out in Richmond, Virginia: The Distribution of Assets in Chapter 7 Bankruptcy Proceedings Closed During 1984- 1987, 22 U. RICH. L. REV. 303 (1988) (reporting results for both consumer and business cases).
2. See Arturo Bris et al. The Costs of Bankruptcy: Chapter 7 Cash Auctions vs. Chapter 11 Bargaining, 61 J. FIN. 1253 (2006) (sample of small and large corporate bankruptcies in Arizona and New York from 1995 to 2001).
3. State law alternatives-like assignments for the benefit of creditors-are also widely used, especially by smaller firms. See Ronald J. Mann, An Empirical Invesfigation of Liquidation Choices of Failed High-Tech Firms, 82 WASH. U. L.Q. 1375 (2005);
4. Melvin G. Shimm, The Impact of State Law on Bankruptcy, 1971 DUKE L. J. 879. But see Sherwood Partners, Inc. v. Lycos, Inc., 394 F.3d 1198 (9th Cir. 2005) (holding that portions of the Bankruptcy Code preempt California's assignment for the benefit of creditors statute, even when no bankruptcy case is pending).
5. See, e.g., OLIVER HART, FIRMS, CONTRACTS AND FINANCIAL STRUCTURE 156 (1995) ("Chapter 7 calls for a bankruptcy company to be sold off for cash. In contrast, Chapter 11 is an attempt to allow companies to reorganize."). The dichotomy was more common in older articles, although it sometimes appears to result from oversimplification, rather than misunderstanding.
6. See, e.g., Douglas G. Baird, The Uneasy Case for Reorganizations, 15 J. LEGAL STUD. 127 (1986).
7. See Stephen J. Lubben, Railroad Receiverships and Modern Bankruptcy Theory, 89 CORNELL L. REV. 1420 (2004).
8. 11 U.S.C § 1123(b)(4); see also 11 U.S.C. § 1123(a)(5)(D) (A plan of reorganization shall "provide adequate means for the plan's implementation such as . . . sale of all or any part of the property of the estate."); § 1129(a)(1) (Court must find that "[confirmation of the plan is not likely to be followed by the liquidation ... of the debtor or any successor to the debtor under the plan, unless such liquidation or reorganization is proposed in the plan."); § 1141(d)(3) ("The confirmation of a plan does not discharge a debtor if... the plan provides for the liquidation of all or substantially all of the property of the estate.").
9. See Section 216(10) of the 1898 Bankruptcy Act. Ch. 541, 30 Stat. 544, amended by Act of June 22, 1938, (known as the "Chandler Act"), ch. 575, 52 Stat. 840, repealed by Bankruptcy Reform Act of 1978 (the "Bankruptcy Code"), Pub. L. No. 95-598, 92 Stat. 2549. Railroads had a similar power under section 77 of the Act, although the power to completely liquidate was clouded by issues of public policy. See Section 77(o) of the 1898 Bankruptcy Act, enacted by Reorganization of Railroads Engaged in Interstate Commerce (known as ASection 77"), Pub. L. No. 72-420, 47 Stat. 1474 (1933), repealed by Bankruptcy Reform Act of 1978 (the "Bankruptcy Code"), Pub. L. No. 95-598, 92 Stat. 2549. Notably, unlike Chapter X, Chapter XI of the Bankruptcy Act of 1898, after amendment by the Chandler Act, did not provide for liquidation of businesses. In re Pure Penn Petroleum Co., 188 F.2d 851, 854-44 (2d Cir. 1951);
10. see also Recent Case, Bankruptcy - in General ?Sale of Entire Assets Not Permitted in Chapter XI Arrangement, 65 HARV. L. REV. 686, 687 (1952) ("While only Chapter X permits sale as part of a plan, both chapters authorize sale "upon cause shown." 52 Stat. 885, 907 (1938), 11 U.S.C. §§ 516(3), 713(2) (1946). The [Pure Penn Petroleum] court construed "cause" as limited to emergency situations such as the deterioration of perishable assets, relying on Chapter X decisions.").
11. 11 U.S.C. § 1112(a) (debtor's right to convert from chapter 11 to chapter 7); see also 11 U.S.C. § 706(a) (debtor's right to convert to chapter 11 from chapter 7). But see Marrama v. Citizens Bank, 127 S. Ct. 1105 (2007) (limiting the ability to convert in the personal bankruptcy context by reference to § 706(d)).
12. 11 U.S.C. §§ 701-702. See also In re Hagerstown Fiber Ltd. P'ship, 226 B.R. 353, 359 (Bankr. S.D.N.Y. 1998).
13. U.S.C. § 1107.
14. 11 U.S.C. § 1112(a). The debtor's power to exercise this choice is apparently unique to American bankruptcy law. See, e.g., Jason Harris & Bruce Gordon, Lost In Transition: Section 447A And The Question Of Members' Rights When A Company Transitions From Voluntary Administration To A Creditors' Voluntary Liquidation, 13 INSOLVENCY L.J. 96 (2005) (discussing Australian law).
15. Cf. Robert J. Art, The Case for the "Mad-Plus" Posture, in THE USE OF FORCE: MILITARY POWER & INTERNATIONAL POLITICS 378 (Robert J. Art & Kenneth N. Waltz ed. 3d Ed. 1988) (discussing the then prevailing theories of nuclear strategy, including mutually assured destruction or "MAD"). Of course, the threat inherent in the power to convert may be the source of much of the debtor's bargaining power in chapter 11. The question is whether the threat gives the debtor too much bargaining power.
16. "See Douglas G. Baird, A World Without Bankruptcy, 50 L. & CONTEMP. PROBS. 173, 182 (1987). Baird and Morrison argue that owner liability issues motivate an entity's bankruptcy, but their story centers on small businesses that file chapter 11.
17. Baird, Douglas G. and Morrison, Edward R., Serial Entrepreneurs and Small Business Bankruptcies, Working Paper (2005) (http://ssm.com/abstract= 660301).
18. Cf. Stephen J. Lubben, The New and Improved Chapter 11, 93 KY. L.J. 839, 850 (2005).
19. 11 U.S.C. § 704(a)(1).
20. 11 U.S.C. § 701.
21. In most districts, the interim trustee is appointed from a group of pre-qualified trustees.
22. 11 U.S.C. § 702.
23. 11 U.S.C. § 726.
24. See, e.g., Michelle J. White, Corporate Bankruptcy As a Filtering Device: Chapter 11 Reorganizations and Out-of-Court Debt Restructurings, 10 J.L. ECON. & ORG. 268, 270-71 (1994).
25. See, e.g., §§ 507, 523, 724(b). Section 507, for example, entitles various entities to priority repayment of what would otherwise be ordinary unsecured claims.
26. 11 U.S.C. § 1126.
27. 11 U.S.C. § 1101. See also Kenneth N. Klee, One Size Fits Some: Single Asset Real Estate Bankruptcy Cases, 87 CORNELL L. REV. 1285, n.31 (2002);
28. Robert M. Lawless et al, A Glimpse at Professional Fees and Other Direct Costs in Small Firm Bankruptcies, 1994 U. III. L. REV. 847, 873.
29. The districts selected were Massachusetts, Southern District of New York, New Jersey, Maryland, Northern District of Texas, Eastern District of Michigan, Northern District of Illinois, Minnesota, Central District of California, Colorado, Middle District of Florida, New Hampshire, Connecticut, Delaware, Eastern District of North Carolina, Eastern District of Louisiana, Western District of Tennessee, Eastern District of Wisconsin, Nebraska, Western District of Oklahoma, Hawaii, and the Middle District of Georgia.
30. For further information on the Business Bankruptcy Project, and its methodology, see Elizabeth Warren & Jay Lawrence Westbrook, Financial Characteristics of Businesses in Bankruptcy, 73 AM. BANKR. L.J. 499 (1999).
31. Because of these selection rules in the main sample, it is fair to assume that my sub-sample underweights chapter 7 cases relative to chapter 11 cases, since the two types of cases do not appear with equal probability in practice.
32. See Robert M. Lawless & Elizabeth Warren, The Myth of the Disappearing Business Bankruptcy, 93 CAL. L. REV. 743 (2005).
33. This was accomplished by simple review of the debtor's name and removing, for example, debtors with names like "Orleans Plaza Associates" or "Jackson & Jackson."
34. Although the general partner in a limited partnership retains unlimited liability, this problem is easily avoided through use of a corporation as the general partner. The precise number of limited partnerships is unknown, since entities with names ending in "Limited" or "Ltd." may be either limited partnerships or corporations. See, e.g., Del. Gen. Corp. Law § 102(a)(1); Del. Rev. Unif. Ltd. P'ship Act § 17-102(4).
35. A similar sample drawn today would undoubtedly include many more Limited Liability Companies, but use of "LLCs" for small businesses was just becoming common in 1994.
36. It seems reasonable to assume that the chapter 7 debtors intended liquidation from the outset.
37. I use SPSS and Stata in this paper. The vast majority of the analysis was done in Stata. 33 In particular, in some instances Stata does not support the use of probability weights, which forces the use of analytical weights, which leads to somewhat greater imprecision in calculating the standard errors. The basic version of SPSS is even less helpful in its treatments of weighted data, as it assumes the use of frequency weights, which can lead to even greater problems in the calculation of standard errors.
38. Using the average annual CPI to adjust for inflation, $1 in 2005 would have been the equivalent of about $0.78 in 1994 or, stated alternatively, $1 in 1994 would now be worth about $1.28.
39. Standard errors and standard deviations are frequent sources of confusion. The standard deviation describes the variability among individual cases in a sample; the standard error of the mean describes the uncertainty of how the sample mean represents the population mean. That is, standard errors help us understand the degree of uncertainty associated with our estimate of the mean - estimate, because we are calculating the mean from a sample rather than the entire population - whereas standard deviations explain how dispersed the data under consideration is, using the familiar rule most (about 95%) of the data should be within about two standard deviations of the mean.
40. For an extensive and very readable discussion of the matching techniques described herein, see Lee Epstein et al. The Supreme Court During Crisis: How War Affects only Non-War Cases,' 80 NYU L. REV. 1, 65-69 (2005).
41. See also E. Michael Foster, Propensity Score Matching: An Illustrative Analysis of Dose Response, 41 MED. CARE 1183, 1184-85 (2003) (http://www.unc.edu/~emfoster/papers/doser2.pdf);
42. Xianghong Li &, Shelly Zhao, Propensity Score Matching and Abnormal Performance After Seasoned Equity Offerings, Working Paper, at 7-11 (2005) (http://ssrn.com/abstract=451740).
43. The classic article is Rajeev H. Dehejia & Sadek Wahba, Causal Effects in Nonexperimental Studies: Reevaluating the Evaluation of Training Programs, 94 J. AM. STAT. ASS'N 1503 (1999).
44. For a good, plain English, discussion of the issues discussed in this paragraph, see Zhong Zhao, Sensitivity of Propensity Score Methods to the Specifications, IZA Discussion Paper No. 1873 (2005) (http://ftp.iza.org/ dp1873.pdf).
45. See Foster, supra note 36.
46. I am referring to quantitative, rather than qualitative, social science work. "Small" here is used relative to the standard sample sizes used in the social sciences, which often include thousands of cases. See, e.g., James E. Lubben et al. Performance of an Abbreviated Version of the Lubben Social Network Scale among Three European Community-Dwelling Older Adult Populations, 46 GERONTOLOGIST 503 (2006) (study of three groups totaling more than 7,500 observations, with smallest of the three sub-samples containing 2,000 observations).
47. That is, because matching is typically based on the "closeness" of the propensity scores, a small sample could result in matched pairs that have very different scores.
48. In particular, I used nearest-neighbor matching, with no replacement (i.e., each case is only used once) and common support in the tails (essentially dropping certain extreme matches, which reduces the risk of an inappropriate match). See generally A. COLIN CAMERON & PRAVIN K. TRIVEDI, MICROEOONOMETRICS: METHODS AND APPLICATIONS 871-78 (2005).
49. In all instances this information is obtained from the debtor's schedules. I implicitly assume that errors in these figures are uniformly distributed among the sample.
50. Stephen J. Lubben, Some Realism About Reorganization: Explaining the Failure of Chapter 11 Theory, 106 DICK. L. REV. 267, 295-96 (2001).
51. 11 U.S.C. § 362.
52. 11 U.S.C. § 554.
53. This could arguably be seen as a violation of the automatic stay, 11 U.S.C. § 362(a)(6), but bankruptcy courts may have a difficult time discerning the motive for the price increase.
54. To be sure this ignores the effects of payments made under the so-called "necessity of payment" doctrine, Lubben, Railroad Receiverships, supra note 5 at 1148, but there are few very large cases in the sample, so the effect is arguably trivial.
55. No cases in the sample converted from chapter 7 to chapter 11.
56. See Arturo Bris et al., supra note 2, at 1287-89.
57. See Oscar Couwenberg & Abe de Jong, Costs and Recovery Rates in the Dutch Liquidation-Based Bankruptcy System (Draft of June 2006) (Working Paper on file with author).
58. See supra note 5 and text.
59. See Oscar Couwenberg, Survivial Rates in Bankruptcy Systems: Overloolpng the Evidence, 12 EUROPEAN. J. L. & E. 253, 254 (2001).
60. If independent samples are taken repeatedly from the same population, we can estimate that the true value we are seeking will fill within a range, known as the confidence interval. The confidence interval is often termed the "margin of error" in the popular press. Confidence intervals are usually calculated so that the probability of finding the desired value within the interval is 95%, and this is the standard I use throughout the paper. This interval is equal to the mean ± 1.96 times the standard error. See G. SNEDECOR & W. COCHRAN, STATISTICAL METHODS 65-67 (8th ed. 1989).
61. See Lopucki and Doherty, supra note 11, at 128 (finding that time and costs were correlated in a sample of chapter 11 reorganizations).
62. But see Daniel M. Covitiz, et al. Are Longer Bankruptcies Really More Costly? Working Paper (2006) (http://ssrn.com/abstract=891486). The latter paper emphasizes the important point that the typical assumption in bankruptcy scholarship that time correlates with cost may ignore the component of case duration which is exogenous to the debtor.
63. Cf. Stephen J. Lubben, The Microeconomics of Chapter 11, Part 2, 4 INT'L. CORP. RESCUE 87 (2007) (arguing that ex ante costs are virtually irrelevant to consideration of modern chapter 11).
64. Accord Stephen P. Ferris & Robert M. Lawless, The Expenses of Financial Distress: The Direct Costs of Chapter 11, 61 U. PITT. L. REV. 629, 637 (2000) ("Consistent with other studies, we measured time in reorganization as the time from filing through confirmation of the chapter 11 plan").
65. For example, the debtor may wish to retain its ability to assume and assign agreements in connection with a sale of assets.
66. For example, section 42.13 of the Enron's confirmed plan provided that:
67. From and after the Confirmation Date, the Reorganized Debtors shall, in the ordinary course of business and without the necessity for any approval by the Bankruptcy Court, (a) retain such professionals and (b) pay the reasonable professional fees and expenses incurred by the Debtors or the Reorganized Debtors, as the case may be, the Creditors' Committee and the ENA Examiner related to implementation and consummation of or consistent with the provisions of the Plan, including, without limitation, reasonable fees and expenses of the Indenture Trustees incurred in connection with the distributions to be made pursuant to the Plan.
68. Supplemental Modified Fifth Amended Joint Plan of Affiliated Debtors Pursuant to Chapter 11 of the United States Bankruptcy Code at page 115, In re Enron Corp. (Bankr. S.D.N.Y. July 2, 2004) (on file with author).
69. See 11 U.S.C. §§ 547-548.
70. One of these chapter 11 cases had both a fraudulent transfer and a preference action. These types of actions were rare throughout the sample - only seven cases had fraudulent transfer or preference actions; two had both. In more recent years courts have seemingly been more willing to allow debtors to transfer these types of suits to third parties, which may increase the prevalence of avoidance actions since debtors no longer face the problem of bringing suit against a valued trade creditor or lender.
71. See Ferris Sc Lawless, supra note 56, at 638 (finding median time to reorganization of 395 days). See also Steven H. Ancel & Bruce A. Markell, Hope in the Heartland: Chapter 11 Dispositions in Indiana and Southern Illinois, 1990-1996, 50 S.C.L. REV. 343 (1999).
72. See Arturo Bris et al., supra note 2, at 1270-71.
73. For example, a comprehensive reform of French bankruptcy law, known as the Business Safeguard Act was enacted on July 26, 2005 and became effective on January 1, 2006. See Eric Cafritz & James Gillespie, French Bankruptcy Law Reform Assessed, INT'L FIN. L. REV. (Dec. 2005).
74. See generally Oscar Couwenberg, Survivial Rates in Bankruptcy Systems: Overlooking the Evidence, 12 EUROPEAN. J. L. & E. 253 (2001).
75. See Lubben, Railroad Receiverships and Modern Bankruptcy Theory, supra note 5, at 1424-25.
76. See Stephen J. Lubben, Out of the Past: Railroads & Sovereign Debt Restructuring, 35 GEO. J. INT'L L. 845, 856-57 (2004).
77. R.S.C. 1985, c. C-36, s.11.
78. Available in English in STEPHEN V. BERTI, SWISS DEBT ENFORCEMENT AND BANKRUPTCY LAW - ENGLISH TRANSLATION OF THE AMENDED FEDERAL STATUTE ON DEBT (1998).