Document Type

Article

Publication Title

Washington University Law Quarterly

Abstract

"That we might live in a world without bankruptcy law or any similar collective procedure is not as far-fetched or as ridiculous as it might seem at first glance to those of us who are immersed in its intricacies every day." This is the conclusion of Douglas Baird in an article titled A World Without Bankruptcy. In that article, Baird imagines what the world would be like if there were no bankruptcy law. He hastens to add, however, that "[t]he reason for engaging in this thought experiment is not that it is either wise or at all likely that we abandon bankruptcy law. I think neither is the case. Rather the point of the exercise is to isolate bankruptcy issues from other issues." In this paper I borrow not only the structure of Baird's title, but the structure of his argument as well. I imagine not only a world without bankruptcy, but a world without debt. In my thought experiment, a world without either is efficient. I do not believe such a world is as far-fetched as it may at first glance seem to those of us immersed in the intricacies of bankruptcy. I do think it is wise, in principle, to do away with bankruptcy law. I believe firms might, in response, do away with debt. I agree with Baird that the abolition of bankruptcy is unlikely. But my guess is that this is unfortunate, because when I attempt to "isolate bankruptcy issues from other issues," I find no bankruptcy issues. In Part I of this essay, I give a brief description of the collective action problem that Baird identifies as the bankruptcy issue for corporate debtors.' I do so not because I believe the reader needs the refresher. Rather, I do so because a statement of the standard version collective action problem is a necessary preface to my explanation of why I think there is no such problem and, consequently, why I think there is in principle no need for corporate bankruptcy. In Part II, I explain why I believe there is no collective action problem and give what I believe is an essentially simple explanation of a world without debt. In such a world, I envision "Chameleon Equity" firms, which necessarily differ from traditional firms only in their substitution of preferred equity for debt, but may also differ in their ability to use many tranches of claims in a hierarchical capital structure. This is a brief reprise of arguments I have made elsewhere. Given recent criticisms-which, as I explain in Part III, I believe are largely misunderstandings-of my earlier work, I hope to take this opportunity to clarify my ideas. In Part III, I respond directly to the criticisms of a world without debt. These criticisms suppose that firms with traditional debt and, therefore, subject to bankruptcy provide their investors with certain benefits that a firm in a world without debt could not provide. I explain that a firm without debt might differ from a traditional firm only in the investors' inability to collect individually. Therefore, inasmuch as the sole proper role of bankruptcy reorganization of a firm with debt is to solve the collective action problem, a firm without debt could well forgo costly bankruptcy. Finally, in Part IV, I admit the limits inherent in my view of appropriate bankruptcy policy. Wholly apart from the character of initial investor contracts, bankruptcy is conceivably valuable because it serves society's distributional objectives or because it allows a judge to make decisions for a firm ex post using information that no one has ex ante. If there is great value, apart from collective action, to a bankruptcy reorganization proceeding, the elimination of debt that I propose might be counterproduc- tive, given that the principal advantage of a debtless world would be the avoidance of a bankruptcy reorganization. However, if bankruptcy offers benefits other than collective action, it is not clear to me why government does not provide these benefits outside the bankruptcy setting. Part V concludes that a world without debt would, in principle, be a world without the need for bankruptcy. Little would be lost. Although I confess that I may have gone too far in my zeal for a simple story, no argument I have seen convinces me that I have.

First Page

811

Volume

72

Publication Date

1994

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