The case for symmetry in creditors' rights

Yale Law Journal

Volumn 118, Issue 5, 2009, Pages 806-867

  Squire, Richard ^a  

^a FORDHAM UNIVERSITY   (United States)

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EID: 66849141841     PISSN: 00440094     EISSN: None     Source Type: Journal    
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References (228)

1. Henry Hansmann, Reinier Kraakman & Richard Squire, Law and the Rise of the Firm, 119 HARV. L. REV. 1333, 1343-48 (2006).
2. See Lucian Arye Bebchuk & Jesse M. Fried, The Uneasy Case for the Priority of Secured Claims in Bankruptcy, 105 YALE L.J. 857, 898-902 (1996);
3. Hansmann et al., supra note 1, at 1351.
4. See, e.g., Henry Hansmann & Reinier Kraakman, The Essential Role of Organizational Law, 110 YALE L.J. 387, 398-405, 423-27 (2000) (describing the economic benefits of various rules of asset partitioning).
5. For example, the corporation divides a business owner's creditors into two groups and gives each group the first claim to a distinct asset pool. In contrast, the secured loan gives one creditor a prior claim to one asset pool but confers no similar advantage on the debtor's remaining creditors. Yet previous scholarship contends that both arrangements make it easier for creditors to appraise and monitor debtors, and does not consider whether one structure provides these benefits more than the other. See Thomas H. Jackson & Anthony T. Kronman, Secured Financing and Priorities Among Creditors, 88 YALE L.J. 1143, 1149 (1979) (discussing the secured loan);Richard A. Posner, The Rights of Creditors of Affiliated Corporations, 43 U. CHI. L. REV. 499, 508-09 (1975) (discussing the corporation).
6. Under current law, the corporation, common law partnership, limited liability company, and Delaware business trust are symmetrical. See infra note 14 and accompanying text.
7. Under current law, the secured loan, American general partnership, and guaranty contract are asymmetrical. See infra note 15 and accompanying text.
8. See Elizabeth Warren & Jay Lawrence Westbrook, Contracting Out of Bankruptcy: An Empirical Intervention, 118 HARV. L. REV. 1197, 1222 (2005) (finding that more than 60% of the liabilities of bankrupt commercial debtors are owed to secured creditors).
9. To help distinguish among the parties, I will refer to Creditor 1 as a "he," Creditor 2 as a "she" and Debtor as an "it."
10. Debtor also has a claim to the asset pools, but it is an equity claim and therefore is subordinate to the creditors' claims.
11. One might imagine a fourth version, in which Creditor 1 has a prior claim to both asset pools. Such a configuration could result, for example, from a subordination agreement between the creditors. I do not analyze this possibility here because strictly speaking it is not an example of a partitioning arrangement: there is no practical distinction between the asset pools, and-when there is a subordination agreement - the impairment of Creditor 2's claim is consensual. A nonconsensual analog to this structure exists, however, in the form of the "blanket lien," which is a secured claim to a debtor's entire estate. I address the blanket lien in my discussion of secured lending in Subsection II.F.2, infra.
12. See, e.g., 11 U.S.C. § 726(b) (2000) (providing for pro rata payment of unsecured claims).
13. This method of computing creditor recoveries under asymmetry reflects the common law rule of marshaling and is expressly required by the Bankruptcy Code for the secured loan. 11 U.S.C. § 506(a);see also William H. Widen, Corporate Form and Substantive Consolidation, 75 GEO. WASH. L. REV. 237, 303-04 (2007) (describing the marshaling rule). Under an alternative approach, which one might call the "anti-marshaling" rule, Creditor 1's pro rata recovery from Asset 2 remains capped at the deficiency in Asset 1, but subject to that cap is calculated using the amount of his original claim rather than the deficiency. Applying this rule to my numerical example causes Creditor 1 to recover (in addition to the full value in Asset 1) half the value of Asset 2, due to the fact that his original claim of $100 is equal to Creditor 2's claim. Thus, Creditor 1's total recovery becomes $95, and Creditor 2's becomes $45. As this example illustrates, the anti-marshaling rule results in a more extreme form of asymmetry, as it further increases Creditor 1's percentage recovery relative to Creditor 2's (unless Asset 1 drops to nothing, in which case the two again recover pro rata). Although the anti-marshaling rule contradicts the common law principle that a creditor may not "double prove" the same claim, Widen, supra, at 304, it is expressly required by the Bankruptcy Code for calculating a partnership creditor's recovery when both the partnership and an individual partner are bankrupt.
14. See infra note 15.
15. The disadvantaged creditors in asymmetrical arrangements usually enjoy subordinated deficiency claims. For example, unsecured creditors can levy on any surplus in the secured assets, and personal creditors of partners in an American general partnership may seize the partners' equity interest in the partnership assets. But not all asymmetrical arrangements follow this pattern. See infra note 20.
16. See Hansmann et al., supra note 1, at 1397 (describing modern commercial entities as combining "entity shielding," whereby firm creditors enjoy the first claim to firm assets, and limited liability);
17. see also Ex parte Crowder, (1715) 23 Eng. Rep. 1064 (Ch.) (establishing the "jingle rule" for partnership bankruptcies, so named because its symmetry makes it easy to remember);
18. UNIF. P'SHIP ACT § 40(h), 6 U.L.A 902 (1914) (codifying the jingle rule in the United States).
19. See Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, § 723(c), 92 Stat. 2606 (codified as amended at 11 U.S.C. § 723(c)) (overriding the jingle rule to provide for payment of partnership creditor deficiency claims on parity with claims of personal creditors);
20. UNIF. P'SHIP ACT § 807(a) (amended 1997), 6 U.L.A. 206 (2001) (same). In addition to rejecting the jingle rule, Congress also ignored the common law's preference for marshaling, instead providing that a partnership creditor may "double prove" the full amount of his claim against the estates of both a bankrupt partnership and a bankrupt individual partner, with the qualification that the recovery from the partner's estate cannot exceed the deficiency in the partnership estate.
21. U.S.C. § 723(c)-(d). For a numerical example using this anti- marshaling rule, see supra note 12.
22. 11 U.S.C. §§ 506(a)(1), 726(a)-(b).
23. See Marshall E. Tracht, Insider Guaranties in Bankruptcy: A Framework for Analysis, 54 U. MIAMI L. REV. 497, 517 (2000) (observing that approximately half of small business loans are personally guarantied).
24. See Phillip I. Blumberg, Intragroup (Upstream, Cross-Stream, and Downstream) Guaranties Under the Uniform Fraudulent Transfer Act, 9 CARDOZO L. REV. 685, 686-87 (1987).
25. A guaranty on a loan gives the lender the option upon the borrower's default to proceed against the borrower, the guarantor, or both. At the same time, the equitable right of contribution enables the guarantor to assert a claim against the borrower for any amount paid on the guaranty. See Avery Wiener Katz, An Economic Analysis of the Guaranty Contract, 66 U. CHI. L. REV. 47, 60 (1999). The lender's claim against the guarantor is therefore the economic equivalent of a deficiency claim, as its net impact on the guarantor is capped at the amount of the deficiency in the borrower's estate. If the guarantor is insolvent when the lender asserts his claim on the guaranty, the rule favored by the common law (and reflected in the doctrine of marshaling) computes the lender's pro rata recovery from the guarantor based on the deficiency in the borrower's estate.
26. See, e.g., In re Wilson, 9 B.R. 723, 726 (Bankr. E.D.N.Y. 1981) (reducing a claim against a guarantor by amounts paid by the primary obligor).
27. A cross-guaranty within a corporate group is a type of asymmetrical arrangement where the creditors in the position of Creditor 2 lack a deficiency claim to Asset 1. Those creditors are the guarantor's other creditors, who lack a claim against the borrower (unless the guarantor owns the borrower).
28. See discussion infra Section II.G.
29. Although I examine the primary benefits of asset partitioning emphasized in the literature, other potential efficiencies have been noted in specific contexts. For example, Henry Hansmann and Reinier Kraakman have observed that many commercial entities exhibit "liquidation protection," meaning that personal creditors of owners cannot force dissolution of the entity to levy on its assets. Hansmann & Kraakman, supra note 3, at 394. Liquidation protection can generate wealth by protecting a firm's going-concern value and permitting investment diversification and transferable shares.
30. Hansmann et al., supra note 1, at 1348-50. I do not analyze liquidation protection here because its benefits are unlikely to depend on whether the commercial entity is symmetrical or asymmetrical.
31. Other important considerations will be the debtor's credit history and amount of current indebtedness.
32. Posner, supra note 4, at 516-17.
33. Id. at 517 ("Acquiring the necessary information will become even more complicated if we allow not only the subsidiary's creditors to reach the assets of the parent, but the parent's creditors to reach the assets of the subsidiary . . . .").
34. See, e.g., F.H. Buckley, The Bankruptcy Priority Puzzle, 72 VA. L. REV. 1393, 1424-25 (1986).
35. See Katz, supra note 19, at 85.
36. See Hansmann & Kraakman, supra note 3, at 427-28;
37. see also Hansmann et al., supra note 1, at 1392-93;
38. Henry Hansmann, Reinier Kraakman & Richard Squire, The New Business Entities in Evolutionary Perspective, 2005 U. ILL. L. REV. 5, 10 (arguing that the American partnership rule, whereby partnership creditors enjoy first claim to partnership assets, is a source of informational efficiencies).
39. In theory, symmetry might also allow creditors to pay less attention to the amounts owed other creditors. For example, the size of Creditor 2's overall claim is less likely to affect Creditor 1's recovery under symmetry than under the pro rata rule. But the process of appraising a debtor's liabilities may not be subject to efficiencies in the same way that the appraisal of asset values is. Debt amounts are usually specified contractually, and therefore - once discovered-not as difficult to valuate as are assets.
40. This is true regardless of whether the marshaling or anti-marshaling rule is used to compute Creditor 2's recovery, because in either case Creditor 1's recovery from Asset 2 is capped at the amount of the deficiency in Asset 1.
41. See supra note 12.
42. Larry E. Ribstein, The Illogic and Limits of Partners' Liability in Bankruptcy, 32 WAKE FOREST L. REV. 31, 66 (1997).
43. See, e.g., sources cited supra note 28 (arguing contra Ribstein that monitoring efficiencies also arise under the rule of asymmetry now applied to the American general partnership).
44. See, e.g., Jackson & Kronman, supra note 4, at 1149-50 (arguing that the secured loan encourages unsecured creditors to monitor);
45. Saul Levmore, Monitors and Freeriders in Commercial and Corporate Settings, 92 YALE L.J. 49, 56 (1982) (arguing instead that the secured loan encourages the secured creditor to monitor).
46. Katz, supra note 19, at 84 (discussing guaranty contracts).
47. Alan Schwartz, Security Interests and Bankruptcy Priorities: A Review of Current Theories, 10 J. LEGAL STUD. 1, 11 (1981).
48. Debt dilution can also occur, albeit to a lesser extent, even if a contract creditor contributes recoverable assets to the debtor's estate that are worth as much as the creditor's claim. This is because such a loan adds another claim against the debtor's equity interest in its estate, causing the debtor's assets-to-debt ratio to fall if the debtor is solvent. See Alan Schwartz, A Theory of Loan Priorities, 18 J. LEGAL STUD. 209, 228-34 (1989).
49. See Clifford W. Smith, Jr. & Jerold B. Warner, On Financial Contracting: An Analysis of Bond Covenants, 7 J. FIN. ECON. 117, 118-19 (1979).
50. See Bebchuk & Fried, supra note 2, at 899. This cost can be seen as a special case of overinvestment, because an expectation that tort creditors will not recover in full may lead to excessive investment in hazardous activities.
51. In particular, a debtor will fail to borrow if the increase in its borrowing costs due to misconduct risk is greater than the expected profits from the project that the loan will fund plus the utility the debtor expects to derive from misbehaving. Importantly, if the debtor borrows anyway, its higher borrowing costs will not deter misconduct after the loan is extended. To the contrary, the higher interest rate will make misconduct more likely by increasing the debtor's chance of insolvency.
52. See Buckley, supra note 26, at 1443.
53. Cf. Frank H. Easterbrook & Daniel R. Fischel, Limited Liability and the Corporation, 52 U. CHI. L. REV. 89, 100 (1985) (observing that the corporate rule of limited liability may create social wealth by shifting the risk of managerial misconduct onto the corporation's creditors, who may have an advantage over shareholders in monitoring the managers).
54. The benefits of appraisal efforts may not be fully internalized, however, because the mere fact (if discovered) that one creditor is willing to lend at a particular interest rate constitutes information to others about the debtor's creditworthiness.
55. No assumption about the liquidation value of Asset 2 is required except that it is not greater than the original value of $100.
56. In particular, this would happen if the expected benefit to Debtor of engaging in asset substitution plus the expected profits from the project were less than $2.
57. See supra note 39.
58. Saul Levmore has also observed that the pro rata rule can lead to duplicative creditor monitoring.
59. See Levmore, supra note 33, at 54.
60. Several commentators have focused on the alternative possibility under the pro rata rule that creditors whose private monitoring benefits exceed their monitoring costs might refrain from monitoring in hopes of free riding on the efforts of others.
61. See id. at 53-54;
62. Randal C. Picker, Security Interests, Misbehavior, and Common Pools, 59 U. CHI. L. REV. 645, 665 (1992).
63. Creditors may try to "privatize" the benefits of their monitoring efforts by removing assets from the debtor's estate before the debtor enters bankruptcy. See Picker, supra note 46, at 670. The prevention of such creditor misconduct is the province of bankruptcy law and especially the doctrine of voidable preferences. By ignoring this possibility here, the implicit assumption in my hypothetical is that these areas of law are operating effectively.
64. In theory, a debtor could try to overcome the pro rata rule's collective action problem by hiring one creditor to monitor on behalf of all creditors. Under such a monitoring contract, the designated monitor would promise to police the debtor's estate for misconduct, and the promise would be enforceable by the debtor's trustee in bankruptcy. Such a contract would, however, present several difficulties. First, creditors would have to incur costs to observe such a contract and verify its ongoing enforceability. Second, creditors would have to incur costs confirming the creditworthiness of the monitor. And third, a bankruptcy court may be unable to distinguish losses in the debtor's estate due to misconduct from losses due to normal business risk. This last possibility creates the risk that the monitor will in essence be treated as the guarantor of all the debtor's obligations - a risk the monitor may be unwilling to undertake at any interest rate the debtor is willing to pay. In the alternative, unsecured creditors could hire a "bondholders' trustee" to monitor on their behalf-an arrangement that has some precedent as a matter of practice.
65. See Levmore, supra note 33, at 72-73. Such arrangements present problems of their own, however, as the costs of contracting among numerous unsecured creditors may be high, especially because individual creditors will prefer to stay out of the contract but free ride on the benefits it provides. In addition, the arrangement substitutes the risk that the trustee will misbehave for the risk that the debtor will.
66. See id.
67. In analyzing both symmetry and asymmetry, I will continue to assume that Creditors 1 and 2 are owed the same amount. A debtor could reduce the collective action problem under both symmetry and asymmetry by increasing the degree to which it borrows from a single creditor-just as it could under the pro rata rule. But this strategy will often be impracticable, and it also precludes the efficiencies of specialization. By assuming that the two creditors are owed the same amount, I focus the analysis on the relevant question for my purposes: does asset partitioning improve monitoring incentives in situations where the pro rata rule performs poorly-that is, where a debtor cannot easily borrow from just one creditor, or the debtor's assets are differentiated enough to make specialization attractive?
68. The only exception to this conclusion is when Debtor is insolvent but depletion occurs in an asset pool that has remained above water. For example, when Debtor is insolvent but Asset 2 is worth more than Creditor 2's claim, depletion of Asset 2 under symmetry is absorbed entirely by Creditor 1 (unless Creditor 1 lacks a deficiency claim, in which case it is absorbed by Debtor). Conversely, in the insolvency outcome where Asset 1 is above water, depletion of Asset 1 under symmetry is suffered by Creditor 2. In those situations, the creditor who usually will be better at detecting the depletion will have less incentive to do something about it. There are, however, several reasons to believe that this problem will be relatively minor. First, it never arises in the insolvency outcome where both pools are underwater. Second, in the outcomes where only one pool is underwater, it arises only with respect to depletion of the above-water pool. And third, the problem is self-limiting because the act of depletion tends to push the pool underwater, at which point the impact of any further depletion shifts to the "right" creditor.
69. See, e.g., DOUGLAS G. BAIRD & THOMAS H. JACKSON, CASES, PROBLEMS, AND MATERIALS ON SECURITY INTERESTS IN PERSONAL PROPERTY 324-28 (2d ed. 1987) (arguing that the secured loan encourages the secured creditor to specialize in monitoring the secured assets);
70. Katz, supra note 19, at 85 (arguing that a guaranty on a loan is efficient when the lender can monitor the borrower more cheaply than the guarantor's other creditors can).
71. a will equal C1 whenever C1 is less than or equal to a1. Otherwise.
72. a will equal a2 + (a1 - C1) if a1 > C1. Otherwise.
73. Ya = a2*( C2 / (C1 - a1 + C2)). The curves in Figure 1 chart the first derivatives with respect to a1 of Xa and Ya, which are as follows:
74. 2;
75. 2.
76. Figure 1 assumes the common law rule for asymmetrical arrangements, which is expressly required by the Bankruptcy Code for secured loans. See supra note 12. For the general partnership, the Bankruptcy Code instead dictates an anti-marshaling rule when both the partnership and a partner are bankrupt.
77. See supra note 15. Under this alternative rule, and assuming the two creditors are owed the same amount, Creditor 1's recovery from Asset 2 is equal to the lesser of the deficiency in Asset 1 and 50% of the value of Asset 2. Charting the impact of depletion of Asset 1 under this rule would produce a figure qualitatively similar to Figure 1 but with more extreme differences in the relative positions of the creditors. Thus, when the value of Asset 1 was above the crossover point, $1 in its depletion would harm Creditor 2 by $1 and Creditor 1 by $0. Below the crossover point the creditors would again switch places, with further marginal depletion reducing Creditor 2's recovery by $0 and Creditor 1's by $1. Finally, the crossover point would be at $50 rather than (as in Figure 1) $59, reflecting an increase in the overall burden of depletion borne by Creditor 2.
78. For example, on the assumptions used in Figure 1, one dollar of marginal depletion reduces Creditor 2's recovery by $0.91 and Creditor 1's recovery by $0.09, when Asset 1 is worth $95. These results are computed using equations (3) and (4) in note 52.
79. When the value of Asset 1 is at the crossover point, the two creditors divide the marginal impact of depletion based on the ratio between the amounts of their original claims, just as they do under the pro rata rule.
80. The deficiency claims creditors enjoy under symmetry also have an insulating effect, but it is weaker, discouraging monitoring only when Debtor is solvent. Thus, in the limited liability alternative, Creditor 1 has no deficiency claim to Asset 2 and consequently absorbs the full impact of depletion of Asset 1 whenever Asset 1 is underwater. By contrast, in the version of symmetry where Creditor 1 has a deficiency claim, underwater depletion of Asset 1 does not harm him as long as there is a surplus in Asset 2 large enough to keep Debtor solvent. In that case, Creditor 1 is insulated from the impact of marginal depletion, which instead is borne by Debtor.
81. The relative strengths of the insulating and focusing effects determine the location of the crossover point, which can be shifted by changing the values of the asset pools. For example, the insulating effect would be weaker if depletion of Asset 1 occurred when Asset 2 were underwater. Like any insurance policy, Creditor 1's deficiency claim will provide less protection if the assets backing the policy drop in value. Devaluation of Asset 2 would thus shift the crossover point in Figure 1 to the left, reflecting a transfer from Creditor 2 to Creditor 1 of the impact of depletion of Asset 1. Conversely, if Asset 2 were above water, the insulating effect would be stronger, shifting the crossover point to the right. Assuming that Asset 2 is above water would also cause Debtor to be solvent at the higher values of Asset 1 depicted in the figure, in which case Debtor rather than the creditors would suffer the impact of marginal depletion. These observations are equally true under the anti-marshaling rule applied to the American general partnership.
82. See supra note 52.
83. An exception, not shown in the graph, is that Creditor 2 bears the full impact of depletion of Asset 1 when it is above water but Debtor is insolvent. The difference with symmetry is that, once depletion pushes Asset 1 underwater, under symmetry the impact of further depletion shifts entirely to Creditor 1. See supra note 50. In contrast, Creditor 2 continues to bear the brunt of depletion of Asset 1 under asymmetry, as Figure 1 shows.
84. This defect of asymmetry is less severe under the anti-marshaling rule applied to the American general partnership, which causes one creditor or the other to suffer the full impact of marginal depletion as long as the depletion range does not include the crossover point. But when depletion does cause the value of Asset 1 to cross that point, its impact is split between the creditors, precluding the efficiencies of full loss internalization. See supra note 52.
85. This problem is even worse under the anti-marshaling rule applied to the American general partnership, which further increases Creditor 1's percentage recovery on his deficiency claim and hence the degree to which Creditor 2 suffers the impact of depletion of Asset 1. See supra note 52.
86. These results are rounded to the nearest penny, and are computed using equation (3) in note 52.
87. For example, in the scenario used previously to analyze monitoring under both the pro rata rule and symmetry, the impact of a $20 drop in Asset 1 on both creditors would not have depended on whether Asset 1 depreciated from $90 to $70 or from $50 to $30. In either case, the impact would have been split between the creditors equally under the pro rata rule, and would have been borne entirely by Creditor 1 under symmetry. A qualification is that the marginal impact of depletion under symmetry depends not only on whether Debtor is insolvent, but also on whether the pool being depleted is underwater.
88. Under symmetry, the creditor must also consider the probability that the asset pool to which the creditor enjoys a prior claim will fall underwater.
89. This problem also arises under the anti-marshaling rule applied to the American general partnership, which causes the marginal impact of depletion on each creditor to depend not only on whether Debtor falls insolvent, but also on whether the depletion occurs when Asset 1 is above or below the crossover point. See supra note 53.
90. See sources cited supra notes 28 and 51.
91. Figure 2 assumes that each creditor is owed $100. No assumption is made about the value of Asset 2 save that it is not above water. The results in the figure are derived as follows: Equations (1) and (2) in supra note 52 give creditor recoveries under asymmetry. Figure 2 graphs the first derivatives of these equations with respect to a2, which are as follows: (5) dXa / da2 = (C1 - a1) / (C1 - a1 + C2); (6) dYa / da2 = C2 / (C1 - a1 + C2).
92. As was true of Figure 1, Figure 2 reflects the rule for asymmetrical arrangements preferred by the common law and explicitly required by the Bankruptcy Code for the secured loan. once again, a chart showing the impact of the anti-marshaling rule that the Bankruptcy Code applies to the general partnership would reflect a more severe version of asymmetry. See supra notes 12, 15. In that case, and with the other assumptions used in Figure 2, $1 in depletion of Asset 2 would harm Creditor 2 by $1, and Creditor 1 by $0, as long as the value of Asset 2 were more than twice the amount of the deficiency in Asset 1. But if that crossover point were passed because of a decrease in the value of either asset pool, further marginal depletion of Asset 2 would reduce each creditor's recovery by $0.50.
93. These conclusions are equally true under the anti-marshaling rule applied to the American general partnership. See supra note 67.
94. See Hansmann et al., supra note 1, at 1346 (arguing that creditors who have prior claims to a firm's assets but only subordinated claims to the owners' other assets will monitor to prevent excessive borrowing by the firm's managers).
95. Assume under asymmetry that Assets 1 and 2 are worth $100 each and Creditors 1 and 2 are owed $100 each. Assume further that a tort victim who is owed $80 is given a claim equivalent to Creditor 1's: a prior claim to Asset 1 plus a pro rata deficiency claim to Asset 2. on these assumptions, and using the anti-marshaling rule applied to the American general partnership, see sources cited supra note 12, Creditor 1 would recover $91 while Creditor 2 would recover only $36 (with the rest of the value in Debtor's estate - $73 - going to the tort claimant).
96. Assume that Assets 1 and 2 are worth $100 each, Creditors 1 and 2 are owed $100 each, and Debtor incurs a tort liability of $50. Under the pro rata rule, that tort liability would reduce the recoveries of each of Creditors 1 and 2 in a liquidation proceeding by $20, from $100 to $80. But if the tort claim were doubled to $100, the recoveries of each of Creditors 1 and 2 would further decline from $80 to $67, for a marginal impact of $13. In other words, the marginal impact of the tort claim falls as the amount of the claim rises.
97. For example, assume under symmetry that Asset 1 is worth $100 and Creditor 1 is owed $100. If a $50 tort claim were assigned to Asset 1 and then Debtor's assets were liquidated, Creditor 1 would recover $67, which would mean that the marginal impact on him of the tort claim would be $33. But if the tort claim were doubled to $100, Creditor 1 would recover $50, making the marginal impact of the additional $50 in tort liability only $17.
98. Hansmann et al., supra note 1, at 1346. Although we focused on speedier bankruptcies as a benefit of entity shielding, we noted how rules that shield owner assets (such as limited liability) can provide similar benefits.
99. Id. at 1381-82.
100. For example, bankruptcy subjects the debtor to court oversight and distracts managers by making them fear for their jobs. Steven L. Schwarcz, The Easy Case for the Priority of Secured Claims in Bankruptcy, 47 Duke L.J. 425, 454 (1997).
101. Most bankruptcies end in liquidation. See Warren & Westbrook, supra note 7, at 1212 (finding that two-thirds of federal bankruptcies are liquidations rather than reorganizations). Asset partitioning is less likely to matter to the speed of a reorganization since the goal is to salvage the debtor as a going concern rather than divide its assets. Nevertheless, symmetry may expedite reorganizations by permitting the assignment of asset pools to different courts, such as when a corporate reorganization is handled separately from the bankruptcy of individual shareholders. In that situation, the corporation's symmetry would reduce the reorganization's informational complexity, which might speed its resolution.
102. Verification of creditor claims is time consuming because, for example, the claims might be challenged as fraudulent conveyances.
103. If Asset 2 is above water, its surplus will be distributed to Creditor 1 after his claim is verified, unless Debtor enjoys limited liability. And the converse is true if Asset 1 is above water.
104. This would be true regardless of whether the marshaling or anti-marshaling rule were used to determine recoveries from Asset 2. See supra note 12.+
105. Indeed, the opportunity to divide up partnership bankruptcies in this fashion was probably the impetus for the creation of the jingle rule by English courts after Parliament introduced a formal bankruptcy system in the sixteenth century. See Hansmann et al., supra note 1, at 1381-82.
106. See 11 U.S.C. § 723(c) (2000) (providing that courts handling the estates of individual partners must make pro rata distributions based on "the full amount of all claims of creditors allowed in the case concerning such partnership").
107. See id § 723(d) (providing that the final distribution of personal assets to personal creditors is not made until the amount of each partnership creditor's deficiency claim is determined).
108. Frank Kennedy noted that under the American rule, "distribution of any dividends in the partner's case would be hazardous in view of the uncertainty pending the arrival of that time when the amount of what will ordinarily be the largest claim against the estate [that is, the partnership creditors' claim] has been determined." Frank R. Kennedy, Partnerships and Partners Under the Bankruptcy Code: Claims and Distribution, 40 WASH. & LEE L. REV. 55, 71 (1983).
109. Despite this disadvantage, Kennedy endorsed the American rule, arguing that the jingle rule constitutes "a serious departure from the basic rule of the common law of partnerships that the separate property of each partner is as fully liable for the payment of partnership debts as for his individual debts."
110. Frank R. Kennedy, A New Deal for Partnership Bankruptcy, 60 COLUM. L. REV. 610, 631 (1960). Kennedy's characterization of the jingle rule is misleading. A partner's personal property is "fully liable" for partnership debt under both the jingle rule and the American rule. The only difference is in how the shortfall is apportioned among creditors when that rule of full liability causes the claims against the property to exceed its value.
111. Secured creditors in fact often do agree to waive their deficiency claims, making their loans nonrecourse. See infra Section II.G.
112. UNIF. P'SHIP ACT § 202(a) (amended 1997), 6 U.L.A. 92 (2001).
113. See Delaware Limited Liability Company Act § 18-201(b), DEL. CODE ANN. tit. 6, § 18-201 (2005)
114. DEL. CODE ANN. tit. 8, § 103 (2001) (detailing the filing, fee, and tax requirements for incorporation); Franchise, 1 St. Tax Guide: All Sts. (CCH)*[*[ 5-200 to -955 (2006) (summarizing franchise fees for incorporation in each state).
115. The term "nonadjusting creditor" was coined by Lucian Bebchuk and Jesse Fried. See Bebchuk & Fried, supra note 2, at 864. But the idea has roots in the works of others.
116. See, e.g., BAIRD & JACKSON, supra note 51, at 327; Lynn M. LoPucki, The Unsecured Creditor's Bargain, 80 VA. L. REV. 1887, 1897 (1994).
117. See Bebchuk & Fried, supra note 2, at 884;
118. Warren & Westbrook, supra note 7, at 1216.
119. Bebchuk & Fried, supra note 2, at 885-87.
120. In particular, Warren and Westbrook found that more than a quarter of unsecured debt was owed to creditors whom the authors deemed likely to be nonadjusting. Warren & Westbrook, supra note 7, at 1236. The actual percentage may be higher because the authors excluded all trade debt, even though trade creditors are the most common type of unsecured creditor, id. at 1224, and at least some of them are likely to be nonadjusting.
121. UNIF. FRAUDULENT TRANSFER ACT § 5(a), 7A U.L.A. 129 (2006) (allowing an obligation to be set aside if the debtor was insolvent when it was incurred and did not receive "reasonably equivalent value" in exchange).
122. See Steven L. Harris & Charles W. Mooney, Jr., A Property-Based Theory of Security Interests: Taking Debtors' Choices Seriously, 80 VA. L. REV. 2021, 2030 (1994) (summarizing literature which argues that secured borrowing reduces unsecured creditors' expected recoveries).
123. See Bebchuk & Fried, supra note 2, at 919 (arguing that the secured loan causes overinvestment).
124. A third form of opportunism is caused by limited liability in particular, which gives business organizers incentive to form corporations (and other limited liability entities) to reduce tort claimant recoveries. See Henry Hansmann & Reinier Kraakman, Toward Unlimited Shareholder Liability for Corporate Torts, 100 YALE L.J. 1879, 1882 (1991). I do not focus on this form of opportunism here because I do not advocate that asymmetrical arrangements be reformed to provide limited liability as a default rule.
125. on the other hand, Creditor 1 by appraising only Asset 1 might learn somewhat more about his overall risk exposure than he would in a balanced arrangement, because the imbalance in his favor makes it less likely that he will have to resort to his deficiency claim. This efficiency may be offset, however, by the fact that Asset 1 is larger and thus potentially more expensive to appraise.
126. The impact of the asset shift on bankruptcy speed is ambiguous. If Creditor 1's claim can be verified more quickly, then shifting value into Asset 1 speeds the distribution of assets; otherwise, the asset shift slows it.
127. Asymmetry presents an opportunism problem only when it is a default rule, because in that case it enables a debtor to transfer wealth away from creditors without their consent. Under a regime where symmetry is the default rule, debtors could still opt into asymmetry by contracting for it expressly. But the need to obtain consent from the disadvantaged creditors would eliminate the opportunism problem. In the terms of the simple model, Debtor cannot use asymmetry to transfer wealth away from Creditor 2 if Debtor needs her express consent to create an asymmetrical arrangement, because in that case Creditor 2 can demand up-front compensation for the impairment of her claim.
128. This is not to imply that asset shifting will not occur under asymmetry; the point is that it will occur on a larger scale under symmetry.
129. Overinvestment costs are borne by the debtor's non adjusting creditors, and by third parties who are denied access to the capital that has been diverted to the wealth-destroying project. A deadweight loss is borne by debtors who would be able to invest in profitable projects but for the increase in their borrowing costs due to opportunism risk.
130. There is another reason that reforming asymmetrical arrangements to be symmetrical should create wealth notwithstanding an increase in asset shifting: bankruptcy speed. To see this, imagine an asymmetrical version of the simple model where Assets 1 and 2 are worth $100 each and Creditors 1 and 2 are owed $100 each. As I have noted, the arrangement's asymmetry prevents a court from distributing value from Asset 2 before verifying the amount of Creditor 1's claim, which is inefficient whenever Creditor 2's claim can be verified more quickly. Now, assume that the arrangement is reformed to be symmetrical, and Debtor reacts by shifting $20 from Asset 2 to Asset 1. If Creditor 2's claim can be verified more quickly, the change to symmetry permits the court to distribute value from Asset 2 before verifying Creditor 1's claim. And if Creditor 1's claim can be verified more quickly, the asset shift means that there is more value in Asset 1 to distribute to him. In either case, the switch from a balanced asymmetrical arrangement to an imbalanced symmetrical one speeds the distribution of debtor assets. But because debtors might not fully capture such efficiencies, they will discount them when choosing between opportunism mechanisms. For this reason, it is likely that asset shifting is the lesser of the two social evils, even if we hold constant the volume of opportunistic wealth transfers.
131. Why Congress overrode the jingle rule is a mystery. According to the Senate report, repeal of the jingle rule "more closely tracks generally applicable partnership law." S. REP. NO. 95-989, at 95 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5881. But the opposite was the case, as state law at the time reflected the Uniform Partnership Act, which codified the jingle rule. UNIF. P'SHIP ACT § 40(h), 6 U.L.A. 901, 902 (1914). Nonetheless, to close the gap between state and federal law created by the 1978 amendments, the 1997 revision to the UPA also provides for asymmetry. UNIF. P'SHIP ACT § 807(a) (amended 1997), 6 U.L.A. 206 (2001).
132. See sources cited supra note 28.In particular, we observed that business owners who wish to give personal creditors first claim to personal assets can utilize limited liability entities such as the corporation and LLC. We then argued that remaining owners presumably wish to maximize business creditor recoveries from personal assets, and that the default rule should cater to this preference in order to reduce transaction costs.
133. See id.
134. The partnership continues to be governed by the jingle rule under English law. See Hansmann et al., supra note 1, at 1381.
135. See Warren & Westbrook, supra note 7, at 1210, 1222 n.91 (finding that the average bankruptcy debtor has assets worth 73% of liabilities, and that 51% of liabilities are fully covered by secured collateral, implying that 70% of assets are secured). The percentage of secured assets is probably somewhat lower for debtors outside bankruptcy, as debtors are more likely to issue secured debt when on the brink of insolvency.
136. See Schwarcz, supra note 74, at 448.
137. Article 9 covers secured interests in most types of property other than real estate. U.C.C. § 9-109 (2005). Secured interests in land-that is, mortgages - are covered by statutes that vary in detail from state to state. See CHARLES DONAHUE, JR., THOMAS E. KAUPER & PETER W. MARTIN, PROPERTY: AN INTRODUCTION TO THE CONCEPT AND THE INSTITUTION 590-605 (3d ed. 1993). But the principles of secured lending are the same in both contexts, with the important exception that mortgages are more likely to be nonrecourse.
138. See infra text accompanying note 154.
139. U.C.C. §§ 9-203(b), 9-310(a) (2005). Another option is for the secured creditor to take possession of the secured assets, thereby providing "constructive" notice.
140. Id. § 9-313.
141. Id. § 9-201.
142. A creditor of an American general partnership, by contrast, can be diluted by subsequent borrowing at the partnership level, even though his claim to partnership assets remains prior to claims of partners' personal creditors. Also, an exception to the rule that a secured claim is dilution-proof is the " purchase money security interest " (PMSI), which is a secured claim to goods purchased with the proceeds of the loan the claim secures. Id. § 9-103. A PMSI takes priority over previous secured interests issued by the debtor in the same assets, which can occur if a previous creditor has been given security in after-acquired assets.
143. Id. § 9-315(a)(1). An exception applies to the debtor's sale of goods that the debtor sells in the ordinary course of its business. Such goods pass to buyers free of security interests created by the debtor.
144. Id. § 9-320(a).
145. A third special right enjoyed by a secured creditor is the repossessory right, which permits him to seize secured assets without first seeking court approval. Id. § 9-609(2). The practical import of this right is limited, however, because secured creditors may not exercise it if the debtor is in bankruptcy or if doing so would breach the peace.
146. Id.; see also Douglas G. Baird & Robert K. Rasmussen, Private Debt and the Missing Lever of Corporate Governance, 154 U. PA. L. REV. 1209, 1229 (2006) (commenting on the limited practical significance of the repossessory right).
147. U.C.C. § 9-615(d)(2). An exception applies to loans secured by various types of commercial paper, which are made nonrecourse. Id. § 9-615(e).
148. Several state statutes contemplate orderly liquidations in the form of assignments for the benefit of creditors. See Benjamin Weintraub, Harris Levin & Eugene Sosnoff, Assignments for the Benefit of Creditors and Competitive Systems for Liquidation of Insolvent Estates, 39 CORNELL L.Q. 3, 14-15 (1953);
149. John Hanna, Note, Contemporary Utility of General Assignments, 35 VA. L. REV. 539 (1949). But even the most comprehensive state regimes do not address the status of secured creditor deficiency claims.
150. see, e.g., N.Y. DEBT. & CRED. LAW § 12(1) (McKinney 2001 & Supp. 2008), nor do state codes that prescribe a method for corporate liquidations.
151. see, e.g., DEL. CODE ANN. tit. 8, § 281(a)(4) (2001) (requiring liquidating corporations to pay creditor claims "according to their priority, and, among claims of equal priority, ratably," but not specifying which claims are "equal").
152. 11 U.S.C. §§ 506(a), 726(a)-(b) (2000).
153. RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW 428 (7th ed. 2007);
154. see also Jackson & Kronman, supra note 4, at 1160-61 (arguing that the secured loan reduces "informational" costs).
155. See supra Figure 1.
156. See supra section I.B.
157. See Buckley, supra note 26, at 1424-25;
158. schwartz, supra note 36, at 244.
159. See Bebchuk & Fried, supra note 2, at 898-99;
160. LoPucki, supra note 86, at 1898-99.
161. A possible objection is that unsecured contract creditors are less sophisticated than most secured creditors, see Schwartz, supra note 35, at 11 n.28, and therefore are less likely to impute tort risk into the interest rate they demand. But it should be kept in mind that the tie between borrowing costs and tort risk does not require that unsecured contract creditors be adjusting in the sense that they monitor to prevent tort liability after they extend credit. The only requirement is that they factor some estimation of the debtor's likely tort liability into their initial terms of lending.
162. Jackson & Kronman, supra note 4, at 1143; accord Barry E. Adler, An Equity-Agency Solution to the Bankruptcy-Priority Puzzle, 22 J. LEGAL STUD. 73, 89 (1993) (arguing that debtors use security to shift risk onto unsecured creditors and thus to encourage them to monitor).
163. See Schwartz, supra note 35, at 11 n.28.
164. Levmore, supra note 33, at 56-57.
165. Accord Buckley, supra note 26, at 1443 (noting that "secured parties do not in fact appear to do much actual monitoring of collateral value"). Another problem with Levmore's theory is that secured creditors do not make promises to monitor in the contracts they sign with debtors. The promises might be implied, but it is hard to believe that a debtor would transfer something as valuable as a security interest in exchange for a tacit and legally unenforceable promise, or that unsecured creditors would forgo efforts to protect themselves in reliance on such a promise.
166. The risk is not zero because of the possibility that the secured creditor will be oversecured even if the debtor falls bankrupt, in which case the excess value of the secured assets will go to the unsecured creditors.
167. This observation necessarily applies only to voluntary unsecured creditors. No partitioning arrangement can encourage monitoring by involuntary creditors such as certain tort claimants. Also, symmetry would increase the incentive for unsecured contract creditors to monitor to prevent debt dilution. This effect may be slight, however, due to the fact that creditors are less likely to monitor to prevent debt dilution than asset depletion even under symmetry. See supra Subsection I.C.6.
168. Levmore, supra note 33, at 57 ("If the secured creditor in bankruptcy has recourse only to the collateralized asset, then the secured creditor will be unlikely to agree to an interest rate lower than that agreed to by unsecured creditors "). Of course it is this lower interest rate, rather than a promise to monitor, that the debtor receives from the secured creditor in exchange for the grant of security.
169. Id. ("[T]he secured creditor's incentive to monitor derives solely from the premium it has paid in the form of agreeing to lend at a lower interest rate ").
170. 11 U.S.C. § 506(a)(1) (2000) (providing that a secured creditor's claim is unsecured to the extent of any deficiency in the secured assets);
171. id. § 726(b) (providing for payment of unsecured claims on a pro rata basis).
172. See U.C.C. § 9-301(1) (2005) (providing that an unperfected security interest is invalid as against a creditor with a judicial lien);
173. id. §§ 9-310 to -316 (2005) (describing the requirements for perfecting a security interest).
174. See, e.g., Pearson v. Salina Coffee House, Inc., 831 F.2d 1531 (10th Cir. 1987) (involving a financing statement listing the debtor's trade name rather than its legal name); In re Bollinger Corp., 614 F.2d 924 (3d Cir. 1980) (involving an unsigned security agreement); In re Flagstaff Foodservice Corp., 16 B.R. 132 (Bankr. S.D.N.Y. 1981) (involving an alleged failure of a town clerk to index a properly submitted financing statement).
175. See supra note 120 and accompanying text.
176. See Hansmann et al., supra note 1, at 1353 (identifying de-diversification of creditor claims as a social cost of entity shielding).
177. Consistent with this analysis, George Triantis has argued that a purchase money security interest (PMSI) will not cause overinvestment in a situation where a debtor's prior creditors " hold security interests in all assets and [a subsequent] pmsi holder is subordinate with respect to all assets other than its collateral. " George G. Triantis, Financial Slack Policy and the Law of Secured Transactions, 29 J. LEGAL STUD. 35, 50 (2000). The scenario Triantis describes reflects symmetry, because each creditor enjoys a prior claim to a distinct debtor asset pool. But overinvestment will still occur because the fact that all contract creditors are secured means that none will impute the debtor's tort risk into the interest rate they demand.
178. For a partial list of such scholars and a review of their reform proposals, see infra Section II.H.
179. schwarcz, supra note 74, at 435.
180. The secured assets might also appreciate, but in that case insolvency is unlikely, and-as Schwarcz acknowledges - the benefit of the appreciation accrues to the debtor rather than the unsecured creditors. Id. at 440.
181. Indeed, Schwarcz employs a model which assumes that debtor assets lose 50% of their value when the debtor is liquidated. Id. at 441.
182. Asset shifting in the opposite direction - for the benefit of unsecured creditors - is more difficult because a debtor cannot formally reduce the scope of a secured lien without the secured creditor's consent.
183. See supra Section I.F.
184. U.C.C. § 9-103 (2005).
185. See supra note 107.
186. An exception sometimes applies to goods sold by the debtor in the ordinary course of business. See supra note 108.
187. Accord Adler, supra note 119, at 79 (observing that the secured creditor's property right in the secured assets deters asset substitution).
188. Robert E. Scott, A Relational Theory of Secured Financing, 86 COLUM. L. REV. 901, 929 (1986);
189. see also Ronald J. Mann, Explaining the Pattern of Secured Credit, 110 HARV. L. REV. 625, 664 & n.153 (1997) (observing that creditors may discourage debtors from pursuing "value-increasing risky transactions").
190. Mann, supra note 143, at 673.
191. See, e.g., Am. Fid. Co. v. Harney, 217 N.E.2d 905, 911 (Mass. 1966).
192. UNIF. FRAUDULENT TRANSFER ACT § 3 cmt. 3, 7A U.L.A 651 (1985);
193. see also Richard J. Sabella, When Enough Is Too Much: Overcollateralization as a Fraudulent Conveyance, 9 CARDOZO L. REV. 773, 777-78 (1987) (summarizing the Uniform Fraudulent Transfer Act position).
194. Schwartz, supra note 36, at 218-19. Along similar lines, Douglas Baird and Robert Rasmussen have argued that a blanket lien, by making it costly for a debtor to borrow elsewhere, enables the debtor to bind itself to the supervision of the lienholder.
195. Baird & Rasmussen, supra note 109, at 1230. But the authors do not explain why a secured claim limited to the assets purchased with the lender's loan proceeds, plus a covenant forbidding additional borrowing, would not achieve the same result. To be sure, loan covenants require monitoring to be effective, but active monitoring by the lender is already central to the supervision story that Baird and Rasmussen tell. Id.
196. See supra Section II.B.
197. Triantis, supra note 132, at 47.
198. Indeed, Schwartz effectively concedes that a blanket lien is unnecessary when he acknowledges that a prior lender is not diluted by a subsequent PMSI as long as the PMSI holder does not end up undersecured. Schwartz, supra note 36, at 242. In focusing on the possibility of undersecurity, Schwartz is evidently concerned about the PMSI holder's deficiency claim, which could dilute the prior lender if the lender were unsecured.
199. Accord Triantis, supra note 132, at 50.
200. See, e.g., James J. White, Efficiency Justifications for Personal Property Security, 37 VAND. L. REV. 473, 491 (1984) ("[I]t is probably efficient to give security to those creditors displaying the greatest risk aversion.").
201. If blanket liens were prohibited, debtors could still prioritize claims through devices such as subordination agreements and preferred stock in lieu of debt, which are more efficient because they subordinate consensually and hence do not generate opportunism costs.
202. Another potential social benefit of the blanket lien has been suggested by Steven Schwarcz. Distressed debtors often use blanket liens to raise capital, and Schwarcz argues that this practice can benefit nonadjusting creditors if the debtor's business is fundamentally sound but is in distress due to a lack of liquidity. Schwarcz, supra note 74, at 442. Schwarcz acknowledges that the new lenders in such situations refuse to extend credit except in exchange for a blanket lien, id. at 449, but he does not acknowledge how this fact is in tension with his theory. A debtor whose business is fundamentally sound is able to earn returns on invested capital high enough to service a competitive interest rate. Therefore, even if such a debtor were illiquid, it would be able to offer an interest rate high enough to induce long-term creditors to lend either unsecured or with security limited to assets purchased with the loan proceeds. By contrast, a debtor who cannot undertake socially worthwhile projects must subsidize its borrowing by transferring wealth from nonadjusting creditors to the lender. And a blanket lien provides that subsidy, writ large.
203. See BLACK'S LAW DICTIONARY 1083 (8th ed. 2004) (defining "nonrecourse").
204. See Gregory M. Stein, The Scope of the Borrower's Liability in a Nonrecourse Real Estate Loan, 55 WASH. & LEE L. REV. 1207, 1239 (1998). Courts sometimes use the doctrine of waste to punish debtors who fail to maintain secured real estate assets. Id. at 1224-28.
205. Id. at 1209-10.
206. POSNER, supra note 113, at 96.
207. As I noted in my discussion of the American general partnership, a majoritarian default rule that generates negative externalities can be inefficient. See supra text accompanying note 101. But neither type of symmetrical secured loan would generate meaningful negative externalities.
208. 11 U.S.C. § 506(a)(1) (2000).
209. Id. § 726(a)-(b).
210. Section 726(a) provides for six tiers of nonsecured claims, to be paid in this order: (1) privileged unsecured claims, such as tax and employee salary claims; (2) general unsecured claims filed on time; (3) general unsecured claims filed late; (4) claims for punitive damages or fines that do not compensate the creditor for monetary losses; (5) interest on all claims; and (6) the debtor's equity claim. Id. § 726(a). My proposal would insert between the third and fourth tiers a new category for "payment of any allowed secured creditor deficiency claim." Situating deficiency claims at this level would achieve symmetry without upsetting Congress's objectives of subordinating punitive damages claims, and of paying the face amounts of all claims before paying interest on any.
211. Although section 726 formally applies only to Chapter 7 liquidations, Chapter 11 ties creditor voting rights in the approval of reorganization plans to the Chapter 7 priority schedule. Id. § 1129(a)(7)(A)(ii).
212. Id. § 510(a) (providing for enforcement of subordination agreements).
213. A potential concern with my proposal is that secured creditors would circumvent it by encouraging debtors to liquidate outside the bankruptcy system. As noted previously, state law is mostly silent on the priority status of secured creditor deficiency claims, see supra note 111, creating an ambiguity that secured creditors might petition state courts to resolve to their advantage. Were this to occur on a large scale, parallel state-level reform might be advisable. But there is reason to doubt that strategic circumvention would be a serious problem. Although only a small fraction of defaulting debtors pass through federal bankruptcy, the percentage jumps when the debtor has secured creditors.
214. See Edward R. Morrison, Bargaining Around Bankruptcy: Small Business Workouts and State Law 4-5 (Ctr. For Law & Econ. Studies, Columbia Law Sch., Working Paper No. 320, 2008), available at http://ssrn.com/abstract=1065543. Reform at the federal level would further boost this percentage by increasing the incentive for unsecured creditors to exercise their option to file a bankruptcy petition.
215. See 11 U.S.C. § 303(b)(1) (permitting involuntary petitions signed by at least three unsecured creditors whose claims satisfy an amount-in-controversy requirement). Finally, because creditors typically do not know prospectively whether a debtor will enter bankruptcy, the shadow of symmetry at the federal level will change appraisal and monitoring efforts even for those creditors whose debtors ultimately undergo liquidation outside bankruptcy. Cf. Lucian Arye Bebchuk & Jesse M. Fried, The Uneasy Case for the Priority of Secured Claims in Bankruptcy: Further Thoughts and a Reply to Critics, 82 CORNELL L. REV. 1279, 1342 (1997) (making the same argument in favor of the authors' bankruptcy-only "partial priority" proposal).
216. David W. Leebron, Limited Liability, Tort Victims, and Creditors, 91 COLUM. L. REV. 1565, 1643-46 (1991);
217. LoPucki, supra note 86, at 1907-16; Note, Switching Priorities: Elevating the Status of Tort Claims in Bankruptcy in Pursuit of Optimal Deterrence, 116 HARV. L. REV. 2541 (2003).
218. As noted above, supra note 103, Warren and Westbrook's study found that the average bankruptcy debtor has assets worth 73% of liabilities, and that 70% of the average debtor's assets are secured. They also found that 61% of the liabilities of the average debtor are owed to secured creditors.
219. See Warren & Westbrook, supra note 7, at 1222. These numbers imply that secured creditors on average recover 91% on their claims and unsecured creditors recover 45%. The second figure likely overstates recoveries for tort claimants in particular because the Bankruptcy Code gives priority to general unsecured claims over claims for exemplary and punitive damages. 11 U.S.C. § 726(a)(2)-(4). Also, it should be noted that Chapter 7 liquidations, which are both smaller and more numerous than Chapter 11 reorganizations, feature debtors who are more deeply insolvent.
220. See Warren & Westbrook, supra note 7, at 1210. Liquidations therefore will yield a wider disparity between secured and unsecured recoveries.
221. See Steven L. Harris & Charles W. Mooney, Jr., Measuring the Social Costs and Benefits and Identifying the Victims of Subordinating Security Interests in Bankruptcy, 82 CORNELL L. REV. 1349, 1371-72 (1997) (noting political impediments to proposals to subordinate secured claims).
222. Elizabeth Warren, An Article 9 Set-Aside for Unsecured Creditors, 51 CONSUMER FIN. L.Q. REP. 323, 325 (1997).
223. As written, Warren's set-aside would have no effect on secured creditor deficiency claims, and therefore would enable secured creditors to reclaim some of the set-aside assets to the detriment of unsecured creditors.
224. More specifically, this is the "fixed-fraction" version of partial priority. Bebchuk & Fried, supra note 2, at 909. The authors also suggest an "adjustable priority" rule that seeks to aid nonadjusting creditors specifically rather than unsecured creditors generally. Id. at 905.
225. Under partial priority, secured creditors would continue to have an incentive to oversecure their loans, because they would benefit from preventing the secured assets from depreciating to less than 75% of the amounts of their claims. But partial priority would not increase the incentive to oversecure as symmetry would, which is perhaps the proposal's primary virtue. Given, however, the proposal's relative disadvantages in terms of monitoring, appraisal, and bankruptcy efficiencies, its attractiveness as a vehicle for reducing the social costs of oversecurity is doubtful. To the extent that oversecurity is a concern worth addressing, the better approach would be symmetry combined with rules that police oversecurity directly. Cf. supra text accompanying note 145 (discussing the use of fraudulent conveyance law to scale back oversecured claims).
226. Bebchuk and Fried observe that partial priority would raise appraisal costs for secured creditors and potentially reduce incentives for creditors to monitor to prevent asset depletion. Bebchuk & Fried, supra note 2, at 914-17.
227. 11 U.S.C. § 548(b) (2000).
228. Id. §§ 362(b)(6)-(7), (17), 546(e).