Bankruptcy fire sales

Michigan Law Review

Volumn 106, Issue 1, 2007, Pages 1-60

  LoPucki, Lynn M ^a   Doherty, Joseph W ^a  

^a UNIVERSITY OF CALIFORNIA   (United States)

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EID: 35348993272     PISSN: 00262234     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (62)

1. Bank of Am. Nat'l Trust & Sav. Ass'n v. 203 N. LaSalle St. P'ship, 526 U.S. 434, 457 (1999).
2. Transcript of Hearing Before the Honorable Peter J. Walsh United States Bankruptcy Judge at 71, In re Network Plus Corporation, No. 02-10341, (Bankr. D. Del. Apr. 25, 2002). The witness testified that "the 55 million dollar receivable is an included asset so the purchaser is taking over those receivables, and it's our best estimate that 20 million dollars will be collected by the purchaser."
3. Id.
4. Douglas G. Baird & Robert K. Rasmussen, The End of Bankruptcy, 55 STAN. L. REV. 751, 751 (2002) [hereinafter Baird & Rasmussen, End of Bankruptcy].
5. In a later essay they clarified that they claim only the disappearance of "traditional reorganizations." Douglas G. Baird & Robert K. Rasmussen, Chapter 11 at Twilight, 56 STAN. L. REV. 673, 674 (2003) [hereinafter Baird & Rasmussen, Chapter 11 at Twilight] ("As we claimed in The End of Bankruptcy, traditional reorganizations have largely disappeared.").
6. Baird & Rasmussen, End of Bankruptcy, supra note 3, at 756.
7. Id. at 789.
8. Douglas G. Baird, The New Face of Chapter 11, 12 AM. BANKR. INST. L. REV. 69, 71 (2004).
9. These percentages are calculated using the raw values of the underlying variables. Consequently they are skewed positive. The resulting mean values are systematically higher than the medians. The natural logs of the percentages (the ratios) are used in the regression analysis in order to compensate for the skew and to provide more reliable estimates. The corresponding values of these percentages, using the logged variables and not controlling for Earnings Before Interest, Taxes, Depreciation, and Amortization ("EBITDA"), are 26% for sale value, 67% for fresh start value, and 76% for market capitalization value.
10. See infra note 163.
11. Baird & Rasmussen, Chapter 11 at Twilight, supra note 3, at 69 ("Bankruptcy scholars for years have viewed the choices facing a corporation as either to reorganize consensually in order to preserve going-concern value or have its assets sold piece by piece for a fraction of their value."). The legislative history of the current Bankruptcy Code takes an equally dismal view of piecemeal liquidation: The purpose of a business reorganization case, unlike a liquidation 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.
12. H.R. REP. NO. 95-595, at 220 (1977), as reprinted in 1978 U.S.C.C.A.N. 5963, 6179.
13. Until recently, going-concern sales of companies were not even considered among the alternatives. See, e.g., supra note 9.
14. Douglas G. Baird, The Uneasy Case for Corporate Reorganizations, 15 J. LEGAL STUD. 127, 128 (1986) [hereinafter Baird, Uneasy Case] ("In this paper I ask whether corporate reorganizations should exist at all"). Baird explains as follows: The question is ... whether [third parties] are so apt to undervalue a firm's value or so apt to find the valuation process itself costly that they are likely to be unwilling to pay an amount that is at least equal to the value of the firm in the hands of the existing investors.
15. Id. at 136;
16. see also Douglas G. Baird, Revisiting Auctions in Chapter 11, 36 J.L. & ECON. 633, 653 (1993) [hereinafter Baird, Revisiting Auctions] ("The case for mandatory auctions is hard to make precisely because it depends crucially on a new player entering the picture who does not exist now.").
17. THOMAS H. JACKSON, THE LOGIC AND LIMITS OF BANKRUPTCY LAW 223 (1986) ("There is no reason why chapter 7 could not be used as the vehicle to sell the firm as a going concern in the same way that companies go public").
18. E.g., N. Pac. Ry. Co. v. Boyd, 228 U.S. 482, 504 (1913).
19. The absolute priority rule is reflected in state statutes prohibiting the payment of dividends to shareholders that would render the company unable to pay the full amount of its obligations to shareholders. See, e.g., MODEL BUS. CORP. ACT §6.40 (2005) ("No distribution may be made if, after giving it effect: (1) the corporation would not be able to pay its debts as they become due in the usual course of business; or (2) the corporation's total assets would be less than ... its total liabilities ....").
20. Douglas G. Baird & Thomas H. Jackson, Bargaining After the Fall and the Contours of the Absolute Priority Rule, 55 U. CHI. L. REV. 738, 740 (1988) (considering whether adverse consequences flow from allowing a creditor entitled to payment under the absolute priority rule to give part of its recovery to one subordinate party with no entitlement while freezing out a more senior party with no entitlement);
21. Bruce A. Markell, Owners, Auctions, and Absolute Priority in Bankruptcy Reorganizations, 44 STAN. L. REV. 69 (1991) (considering whether the new value exception is harmful to the absolute priority rule's purposes).
22. But see Douglas G. Baird & Donald S. Bernstein, Absolute Priority, Valuation Uncertainty, and the Reorganization Bargain, 115 YALE L.J. 1930, 1935 (2006) (arguing that difficulty of appraisal, not lack of commitment to the absolute priority rule, is the cause of many if not most deviations from absolute priority).
23. This aspect of the absolute priority rule is expressed in 11 U.S.C. §1129(b)(2)(B): (2) [T]he condition that a plan be fair and equitable ... includes the following requirements: (B) With respect to a class of unsecured claims-(i) the plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or (ii) the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property .... 11 U.S.C.A. §1129(b)(2)(B) (West 2004 & Supp. 2007).
24. E.g., Baird & Bernstein, supra note 15, at 1935 ("Applying the absolute priority rule in the context of a corporate reorganization requires the enterprise to be valued.").
25. ACCOUNTING STANDARDS EXECUTIVE COMM., AM. INST, OF CERTIFIED PUB. ACCOUNTANTS, STATEMENT OF POSITION 90-7: FINANCIAL REPORTING BY ENTITIES IN REORGANIZATION UNDER THE BANKRUPTCY CODE (1990) [hereinafter SOP 90-7],
26. reprinted in 2 AM. INST, OF CERTIFIED PUB. ACCOUNTANTS, AICPA TECHNICAL PRACTICE AIDS §10,460, at 19,273 (1997).
27. H.R. REP. NO. 95-595, at 222 (1977), as reprinted in 1978 U.S.C.C.A.N. 5963, 6181;
28. Peter F. Coogan, Confirmation of a Plan Under the Bankruptcy Code, 32 CASE W. RES. L. REV. 301, 313 n.62 (1982). Apparently, the guess is at the amounts of future earnings and the estimate is of the appropriate discount rate.
29. SOP 90-7, supra note 18, at 19,273 ("Reorganization value and the terms of the plan are determined only after extensive arms-length negotiations or litigation between the interested parties. Before the negotiations, the debtor-in-possession, creditors, and equity holders develop their own ideas on the reorganization value of the entity that will emerge from Chapter 11.").
30. See infra text accompanying notes 34-38.
31. An alternative means for relieving the pressure on the debtor to pay would be to reschedule payment of the $600,000 debt to a time when the debtor can pay it. Parties use both the conversion of debt to equity and the extension of repayment schedules in reorganization cases.
32. See JACKSON, supra note 12, at 218-24.
33. See Michael C. Jensen, Corporate Control and the Politics of Finance, 4 J. APPLIED CORP. FIN., Summer 1991, at 13, 31-32 (proposing that reorganizations be eliminated and that all bankruptcy filings lead to mandatory auctions).
34. JACKSON, supra note 12, at 219.
35. See 11 U.S.C.A. § 363(b)(1), (f) (West 2004 & Supp. 2007) (authorizing trustees to sell assets free and clear of liens outside the ordinary course of business "after notice and a hearing").
36. Baird & Rasmussen, End of Bankruptcy, supra note 3, at 756.
37. See also Donald S. Bernstein, U.S. Chapter 11 Today: A Funny Thing Happened On the Way to the Courthouse, in GLOBAL LEGAL GROUP, THE INTERNATIONAL COMPARATIVE LEGAL GUIDE TO: CORPORATE RECOVERY AND INSOLVENCY 2007, at 5, 6 (2007), http://www.iclg.co.uk/khadmin/Publications/pdf/1215.pdf. ("The breadth and depth of today's M&A and financing markets means the size of the distressed business no longer operates as a constraint on sale . . . [and] buyers have become less likely to impose an 'insolvency' discount in connection with such a sale.").
38. Baird, Revisiting Auctions, supra note 11, at 653;
39. Baird, Uneasy Case, supra note 11, at 147 ("This paper has suggested that the premise underlying Chapter 11 of the Bankruptcy Code may be unsound.") (emphasis added).
40. Baird, Revisiting Auctions, supra note 11, at 653.
41. Mark J. Roe, Bankruptcy and Debt: A New Model for Corporate Reorganization, 83 COLUM. L. REV. 527, 559 (1983) (proposing that bankruptcy courts value reorganizing firms by offering 10% of their shares in public markets and extrapolating the value obtained to the remaining 90%).
42. Barry E. Adler & Ian Ayres, A Dilution Mechanism for Valuing Corporations in Bankruptcy, 111 YALE L.J. 83, 101-03 (2001) (proposing that the bankruptcy courts value reorganizing firms by requiring claimants to submit their personal supply and demand schedules for all quantities of securities that might be issued and then determining the point or points at which the markets would clear).
43. Philippe Aghion, Oliver Hart, & John Moore, improving Bankruptcy Procedure, 72 WASH. U. L.Q. 849, 861-63 (1994) (proposing that the bankruptcy courts value reorganizing firms by soliciting both cash and noncash bids for the companies, and allowing the claimants to choose among them by majority vote).
44. E.g., Barry E. Adler, Bankruptcy and Risk Allocation, 77 CORNELL L. REV. 439, 468 n.128 (1992) (citing data suggesting that the expense of the auctions would exceed the expense of reorganization);
45. Baird, Revisiting Auctions, supra note 11, at 642 (comparing elements of cost for reorganization and liquidation). Baird concludes that "[o]nce all this is taken into account, it is hard to support the case for mandatory auctions [in Chapter 11] on the basis of the direct costs of bankruptcy."
46. Id.
47. Roe, supra note 30, at 547.
48. Jensen, supra note 24, at 31.
49. JACKSON, supra note 12, at 220.
50. Baird, Uneasy Case, supra note 11, at 137.
51. Adler & Ayres, supra note 31, at 90.
52. See infra Section III.A. 1.
53. JACKSON, supra note 12, at 220 ("Substantial evidence suggests that valuations by bankruptcy judges are systematically too high.").
54. Id. at 220 n.36. Jackson's "evidence" was primarily the opinions of two law professors that the securities issued in reorganization cases would not immediately sell for the reorganization values assigned to them. Blum seemed to think that the market value was correct and reorganization value in error, referring to "the inflation of reorganization value to exceed market value."
55. Walter J. Blum, The Law and Language of Corporate Reorganization, 17 U. CHI. L. REV. 565, 578 n.18 (1950). Brudney seemed to think reorganization value was correct and the market in error, arguing that issuance of securities to senior claimants that had an immediate market value equal to their claims "would measure the pay-out in the depressed liquidation values which the reorganization process is designed to avoid."
56. Victor Brudney, The Investment-Value Doctrine and Corporate Readjustments, 72 HARV. L. REV. 645, 679 (1959). Our finding that reorganization values are in fact higher than sale values suggests that Brudney's conceptualization is more accurate than Blum's and Jackson's.
57. See Stuart C. Gilson, Edith S. Hotchkiss, & Richard S. Ruback, Valuation of Bankrupt Firms, 13 REV. FIN. STUD. 43, 54 tbl.2, 55 (2000) (finding a mean difference in fresh start valuation from market value of -4.7% in a sample of twenty-eight cases);
58. Reuven Lehavy, Reporting Discretion and the Choice of Fresh Start Values in Companies Emerging from Chapter 11 Bankruptcy, 7 REV. ACCT. STUD. 53, 54 (2002) ("Using the market value of equity immediately after emergence from Chapter 11 as a measure of a firm's intrinsic value, I find that the fresh start equity value is, on average, understated by about 4% and that the average absolute difference between the fresh start and market values is about 11%."). We found that the fresh-start value was, on average, understated by about 11%, and that the average absolute difference between fresh-start and market values is about 18%.
59. JACKSON, supra note 12, at 220.
60. Lynn M. LoPucki & William C. Whitford, Corporate Governance in the Bankruptcy Reorganization of Large, Publicly Held Companies, 141 U. PA. L. REV. 669, 763-64 (1993) (footnotes omitted).
61. Samuel L. Bufford, What is Right About Bankruptcy Law and Wrong About Its Critics, 72 WASH. U. L.Q. 829, 846 (1994).
62. See also Lynn M. LoPucki, Strange Visions in a Strange World: A Reply to Professors Bradley and Rosenzweig, 91 MICH. L. REV. 79, 100 (1992) ("Chapter 11 addresses the deficiencies of the marketplace by offering the owners, and more importantly the creditors, an alternative to putting the debtor's assets on the auction block.").