22 Recent Business Bankruptcy-Related Articles of Interest Available on SSRN

The following business bankruptcy-related articles, arranged by abstract ID number, are available for downloading from the Social Science Research Network:

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Chapman University School of Law's Daniel B. Bogart: "Liability of Directors of Chapter 11 Debtors in Posession: 'Don't Look Back - Something May Be Gaining on You'." (Abstract ID: 918814)

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ASU's Michael G. Hertzel and Zhi Li, USC's Micah S. Officer, and NYU's Kimberly J. Rodgers: "Inter-firm LInkages and the Wealth Effects of Financial Distress along the Supply Chain." (Abstract ID: 912795)

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UCLA Law School's Lynn M. LoPucki and Joseph W. Doherty: "Rise of the Financial Advisors: An Empirical Study of the Division of Professional Fees in Large Bankruptcies." (Abstract ID: 913841)

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Mathias Hild and University of Virginia's Matthew R. McBrady: "A Managerial Primer on the US Bankruptcy Code."  (Abstract ID 912038)

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Bennett Stewart: "The Real Reasons Enron Failed." (Abstract ID: 911690)

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3d Circuit Judicial Law Clerk Adam Levitin: "Finding Nemo: Rediscovering the Virtues of Negotiability in the Wake of Enron." (Abstract ID: 910571)

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University of Virginia's Gerry Yeman and Marian Chapman Moore and UT-Austin's Geraldine R. Henderson: "Snibbie®: Spit Happens(B)." (Abstract ID: 910114)

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Yair Jason Listokin: "Is Secured Debt Used to Redistribute Value from Tort Claimants in Bankruptcy? An Empirical Analysis."  (Abstract ID: 909225)

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University of Virginia's Patricia H. Werhane and Julie Stocker: "Dow Corning Corportation(A): Breast Implant Design." (Abstract ID: 908143)

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University of Virginia's Patricia H. Werhane:  "Dow Corning Corportation(B): Making A Decision." (Abstract ID: 908725)

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University of Virginia's Patricia H. Werhane: "Dow Corning Corportation(C): Closure?" (Abstract ID: 908726)

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UCLA School of Law's Lynn M. LoPucki and Joseph W. Doherty: "The Determinants of Professional Fees in Large Bankruptcy Reorganization Cases Revisted." (Abstract ID: 906184)

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Seton Hall University School of Law's Stephen Lubben: "The Other Liquidation Decision."  (Abstract ID: 903399)

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Univ. of Kentucky College of Law's Rutherford B. Campbell Jr. and Christopher W. Frost: "Managers' Fiduciary Duties in Financially Distressed Corporations: Chaos in Delaware (and Elsewhere)." (Abstract ID: 900904)

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3d Circuit Judicial Law Clark Adam Levitin: "Rough Justice? The Nature and Limits of Equitable Subordination." (Abstract ID: 900444)

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Lousiana State Univ.'s Susan Kalinka: "In Re Ehmann: Bankuptcy Court Decision Portends Problems for Manager-Managed LLCs." (Abstract ID: 894571)

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Boston College's Mauricio Soto, Alicia H. Munnel, Francesca Golub-Sass, and Francis Vitagliano: "Why are Healthy Employers Freezing Their Pensions?" (Abstract ID: 893214)

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Federal Reserve Board's Daniel M. Covitz, Song Han, and Beth Anne Wilson: "Are Longer Bankruptcies Really More Costly?" (Abstract ID: 891486)

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NYU's Kimberly J. Rodgers, Indiana Univ.'s Randall A. Heron, and Univ. of Iowa's Erik Lie: "Financial Restructuring in Fresh Start Chapter 11 Reorganizations." (Abstract ID: 890693)

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Michael Nwogugu: "Structural Changes in the US Retailing Industry and Legal, Economic and Strategy Implications for the US Real Estate Industry." (Abstract ID: 883568)

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University of Virginina's Samuel E. Bodily and Robert F. Bruner: "Enron: 1986-2001." (Abstract ID: 302155)

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Harvard Business School's Michael Jensen: "Active Investors, LBOS, and the Privatization of Bankruptcy." (Abstract ID: 244152)

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Abstracts for each of these papers follow:

Daniel Bogart, "Liability of Directors of Chapter 11 Debtors in Possession: 'Don't Look Back - Something May Be Gaining on You'." (Abstract ID: 918814):

This article addresses a series of important questions involving the fiduciary obligations and personal liability of bankruptcy trustees and directors of debtors in possession. The article begins by noting the uncertainty of lawyers representing directors of chapter 11 debtors. These lawyers must advise individual directors on their possible liability for decision making post petition. The article continues with a review of basic corporate governance of companies preceding and following the filing of a chapter 11 petition.

The article focuses on the content of the fiduciary obligations of care and loyalty of directors of the bankrupt companies. Supreme Court opinions indicate that the fiduciary obligations of the debtor in possession are to be mirrored on the obligations of the trustee in bankruptcy. As a result, the article argues that the business judgment rule, as it is commonly applied to non bankrupt companies, is not appropriately applied to directors of chapter 11 companies. Although directors should be given broad discretion, it is not equivalent to the discretion they may have had prior to filing the petition.

The article evaluates cases involving trustees in bankruptcy in the course of reaching conclusions regarding the obligations of directors of the debtor in possession. In addition, the article suggests that trustees in bankruptcy and directors of chapter 11 companies ought to be subjected to a duty of impartiality. This latter duty is necessary because chapter 11 creates a host of beneficiaries of the bankruptcy trust, creating a set of conflicting interests for trustees and directors. The article demonstrates how trustee-based fiduciary obligations would operate in the course of decision making by directors of the debtor in possession. In particular, the article hypothesizes a chapter 11 airline in which directors ponder significant changes to the debtor's business model.

Finally, the article parses through the chaotic set of federal opinions concerning the personal liability of bankruptcy trustees, and directors of chapter 11 debtors. The article argues that the distinction drawn by some courts between breaches of the duty of care (for which trustees are rarely liable) and breaches of the duty of loyalty (for which trustees are usually liable) is incorrect. A breach of a fiduciary obligation to a beneficiary of the bankruptcy trust (creditors, et. al) should result in liability. Directors of debtor in possession should be treated in the same manner as trustees.

The author continued his treatment of the duties and liability of trustees and directors of chapter 11 companies in two additional articles: Finding the Still Small Voice: The Liability of Bankruptcy Trustees and the Work of the National Bankruptcy Review Commission, 102 Dick. L. Rev. 703 (1998), and Unexpected Gifts of Chapter 11: The Breach of a Director's Duty of Loyalty Following Plan Confirmation and the Post Confirmation Jurisdiction of Bankruptcy Courts, 72 Am. Bankr. L. J. 303 (1998).

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Michael G. Hertzel, Zhi Li, Micah S. Officer, and Kimberly J. Rodgers, "Inter-firm LInkages and the Wealth Effects of Financial Distress along the Supply Chain." (Abstract ID: 912795):

Extant research examines the extent to which bankruptcy effects are contagious within industries. This study broadens the investigation by examining the wealth effects of distress on customers and suppliers. On average, important contagion effects occur prior to and at bankruptcy filings and extend beyond industry competitors along the supply chain. Specifically, distress related to bankruptcy filings is associated with negative and significant stock price effects for rivals, customers and suppliers. Consistent with expectations, customer and supplier effects are more negative when industry contagion is more severe. We provide evidence on the importance of industry structure, specialized product nature, and leverage on supply chain effects.

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Lynn M. LoPucki and Joseph W. Doherty, "Rise of the Financial Advisors: An Empirical Study of the Division of Professional Fees in Large Bankruptcies." (Abstract ID: 913841):

In a study of the division of professional fees in 74 large, public company bankruptcy cases concluded from 1998 through 2003, we find that 79% of court-awarded fees are awarded for services rendered directly to the debtor in possession. Only 20% are awarded for services rendered to creditors committees, only one half of one percent are awarded for services rendered to equity committees, and less than one percent are awarded for services rendered by court appointed professionals.

Fifty-three percent of the fees were awarded to attorneys, 42% to financial advisors, 5% to accountants, and a fraction of 1% to all other professions combined. Of the 53% that went to attorneys, more than two thirds went to bankruptcy attorneys and less than one third went to "special" or "ordinary course" counsel performing nonbankruptcy work.

We estimated regression models for the fees of each of five types of professionals: (1) attorneys, (2) DIP bankruptcy attorneys, (3) DIP special attorneys, (4) financial advisors, and (5) DIP financial advisors. Debtor size, case duration, and the number of attorney firms working were the principal determinants of attorneys fees. But those factors were only weak determinants of financial advisors' fees. The strongest determinants of financial advisors' fees were court (the Delaware and New York courts awarded more to financial advisors) and the trend over time. Over the period of our study, the fees of financial advisors increased at the rate of 25% per year. Courts did not award higher fees to financial advisors in cases where the debtor sold its business or a controlling interest in its business.

By comparing the results of our study with the results of LoPucki and Whitford's study of reorganizations in early 1980s, we find a sharp increase in the employment of financial advisors by creditors' committees and a sharp decline in the employment of professionals by equity committees.

We found that several factors thought to cause DIP bankruptcy attorneys fees to be higher in fact did not. They include whether the DIP lead attorneys were a New York firm, whether the DIP lead attorneys were from a city distant from the courts, and the hourly rates charged by the attorneys.

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Mathias Hild and Matthew R. McBrady, "A Managerial Primer on the US Bankruptcy Code."  (Abstract ID 912038):

This note offers an introduction to reorganization procedures within the US bankruptcy law from a business perspective. It can be used to explore the strategic dimensions of bankruptcy procedures and to set the stage for Darden Case QA-0634.

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Bennett Stewart, "The Real Reasons Enron Failed." (Abstract ID: 911690):

In desperate attempts to keep up with aggressive earnings targets, Enron's managers became so indiscriminate in committing the firm's capital that, in 1999, the international energy division presented Skilling with a plan that contemplated earning just $100 million in profit on a capital base of $7 billion. With that kind of performancewhich amounts to a loss of several hundred million in terms of economic profitsthe CFO faced considerable pressure to use deceptive tactics to put off the day of reckoning. The real Enron story may thus be more than the morality play told in press accounts. A major part of the blame must be assigned to the design of the company's performance measures and internal controls. This article argues that the popular accounts may confuse causes and consequences and suggests that the seeds of Enron's demise were sown years before criminal behavior took root. The more fundamental causes appear to have been matters of organizational designin particular, bonus plans that paid managers to increase reported earnings; the use of mark-to-market accounting, with the blessing of the SEC, in generating those earnings; and CEO Skilling's decision to permit CFO Fastow to make finance a profit center all of which happened five to ten years before Enron's bankruptcy filing.

Why did Enron fail? Was it the criminality of key corporate executives, and their resort to deceptive bookkeeping and off-balance sheet financing, as the popular accounts suggest? This article argues that the popular accounts may confuse causes and consequences and suggests that the seeds of Enron's demise were sown years before criminal behavior took root. The more fundamental causes appear to have been matters of organizational designin particular, bonus plans that paid managers to increase reported earnings; the use of mark-to-market accounting, with the blessing of the SEC, in generating those earnings; and CEO Skilling's decision to permit CFO Fastow to make finance a profit centerall of which happened five to ten years before Enron's bankruptcy filing. In desperate attempts to keep up with aggressive earnings targets, Enron's managers became so indiscriminate in committing the firm's capital that, in 1999, the international energy division presented Skilling with a plan that contemplated earning just $100 million in profit on a capital base of $7 billion. With that kind of performancewhich amounts to a loss of several hundred million in terms of economic profits the CFO faced considerable pressure to use deceptive tactics to put off the day of reckoning. The real Enron story may thus be more than the morality play told in press accounts. A major part of the blame must be assigned to the design of the company's performance measures and internal controls.

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Adam Levitin, "Finding Nemo: Rediscovering the Virtues of Negotiability in the Wake of Enron." (Abstract ID: 910571):

Creditors have long understood that any claims they submit for repayment in a bankruptcy might be valid, but subject to subordination in the order of payment of the bankruptcy estate's limited funds if the creditor behaved inequitably as the debtor failed. A groundbreaking opinion in Enron's on-going bankruptcy has expanded the practice of equitable subordination far beyond its traditional reach. According to the court, buyers of bankruptcy claims are now subject to subordination, not just for their own conduct, but also for conduct of previous owners of the claims, regardless of whether the conduct related to the claims.

In a world of active bankruptcy claims trading, Enron raises powerful policy questions about the legal rules governing property transfers that affect the doctrinal development of bankruptcy law and the survival of a secondary market that provides important liquidity to other capital markets. This article shows how Enron was erroneous from both doctrinal and policy perspectives and examines the problems Enron has created for several distinct markets.

Enron is a reminder of the continuing value of negotiability in commercial contexts, for if the claims involved had been negotiable, they could not have been subordinated. Thus, this article considers what factors have traditionally determined when the law adopts a negotiability regime for property transfers and whether these factors make sense in today's financial markets. The article argues that in the bankruptcy claims context, the liquidity benefits of negotiability outweigh its costs. Accordingly, the article proposes a federal law of negotiability for bankruptcy claims to protect the liquidity of this vital market.

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Gerry Yemen, Marian Chapman Moore, and Geraldine R. Henderson, "Snibbie®: Spit Happens(B)." (Abstract ID: 910114):

Who hasnt had a great idea and believed they could make millions if they moved on it? Greg Heard actually took his idea and developed a bib for adult childcare workerscalling it the Snibbie Bib. His strategy is to follow the Diaper Genie model: develop the product, open enough doors in the baby-product market to grow the business to sufficient scale, and then sell it to a major player like Gerber or Procter & Gamble for buckets of money. The A case (UVA-M-0700) describes Heards learning experiences and progress in approaching institutional buyers, attending his first vendor fair, working with vendors, moving his operations out of his garage and into a warehouse, and becoming an international company. He also gets help from a mentor who steers him through the retailer-distribution process. The news that his biggest buyer has just filed for bankruptcy is unsettling and raises many questions about how this will affect his company. Also, what should he do about an offer from a large, national company to private label his products? The B case describes the direction he takes regarding private labeling, working with the bankrupt company, and further developing his brand by developing additional products.

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Yair Jason Listokin, "Is Secured Debt Used to Redistribute Value from Tort Claimants in Bankruptcy? An Empirical Analysis."  (Abstract ID: 909225):

Many scholars question the priority enjoyed by secured debt in bankruptcy. They fear that secured debt will be used to inefficiently redistribute value away from pre-existing unprotected creditors of a firm. These scholars advocate a host of legal innovations, such as ?superpriority? for tort claimants with respect to other creditors, to mitigate the redistributional problem. Other scholars minimize the redistributional problem, however, and argue that priority for secured credit is efficient. To help resolve this debate, this paper examines the redistributional theory from an empirical perspective. In particular, the paper focuses on secured debt usage by firms facing large tort liabilities (?high-tort? firms). In theory, secured debt should be attractive for high-tort firms because they have a large class of unsecured and uncovenanted creditors (tort claimants) exposed to redistribution in bankruptcy through the use of secured credit. The paper's empirical analysis contradicts the redistributional theory's prediction, however. High-tort firms have unusually low amounts of secured debt. While this result is very difficult to explain under the redistributional theory, it can readily be explained according to other theories of secured debt. Several important policy implications for bankruptcy priorities follow from these findings.

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Patricia H. Werhane and Julie Stocker, "Dow Corning Corporation(A): Breast Implant Design."
(Abstract ID: 908143):

This case presents background on the Dow Corning Corporation (DCC), its implant history, and information from two chemists in charge of developing a new design for DCC`s implant. The case raises several issues. In developing a new design, how much testing is enough? How does one balance the desire and pressure to market a product with the professional responsibility to test the product adequately? Whose decision is it: the designer`s, the manager`s, or the marketing team`s? The case challenges students to deal with these issues from the perspectives of design engineers and the managers who determine the marketability of these products. See also the B (E-0148) and C (E-0149) cases.

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Patricia H. Werhane,  "Dow Corning Corporation(B): Making A Decision." (Abstract ID: 908725):

These cases deal with the mid-1990s aftermath of the Dow Corning breast implant controversy, in which thousands of women claimed their silicone implants were responsible for a number of autoimmune diseases. Richard A. Hazleton, CEO of Dow Corning, must decide how publicly to defend his company. His first decision is whether to appear on a 1995 Oprah Winfrey show about breast implants (Case A). Subsequently, Hazleton and Dow Corning had to decide whether filing for Chapter 11 bankruptcy was financially and ethically sound (Case B). DCC did declare bankruptcy and, in 1997, Dow Corning representatives and attorneys for the plaintiffs were still trying to work out a Plan of Reorganization and settlement (Case C). When a settlement was finally reached in 2000, the Justice Department filed objections to the company`s court-approved reorganization plan and Dow Corning, as of September 2000, waited for the decision.

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Patricia H. Werhane, "Dow Corning Corporation(C): Closure?"
(Abstract ID: 908726):

These cases deal with the mid-1990s aftermath of the Dow Corning breast implant controversy, in which thousands of women claimed their silicone implants were responsible for a number of autoimmune diseases. Richard A. Hazleton, CEO of Dow Corning, must decide how publicly to defend his company. His first decision is whether to appear on a 1995 Oprah Winfrey show about breast implants (Case A). Subsequently, Hazleton and Dow Corning had to decide whether filing for Chapter 11 bankruptcy was financially and ethically sound (Case B). DCC did declare bankruptcy and, in 1997, Dow Corning representatives and attorneys for the plaintiffs were still trying to work out a Plan of Reorganization and settlement (Case C). When a settlement was finally reached in 2000, the Justice Department filed objections to the company`s court-approved reorganization plan and Dow Corning, as of September 2000, waited for the decision.

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UCLA School of Law's Lynn M. LoPucki and Joseph W. Doherty, "The Determinants of Professional Fees in Large Bankruptcy Reorganization Cases Revisted." (Abstract ID: 906184):

In an empirical study of professional fees and expenses in 74 large public company bankruptcies concluded 1998-2003, we found that (1) company size, case duration, and professional firm numbers account for nearly 85% of the variation, (2) fees and expenses increased about 7% per year, (3) the scale effect is so severe that reporting fees as a simple percentage of assets is misleading, (4) fees measured from SEC filing data are 59% higher than fees measured from court file data, and (5) certain factors thought to have a significant effect on the amount of fees and expenses do not. The factors include (a) the appointment of fee examiners and fee committees, (b) whether the company is liquidated or reorganized, (c) whether the case is in New York, (d) the hourly rates charged, (e) the use of paralegals, (f) the debtor's industry, and (g) whether the case is prepackaged or prenegotiated.

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Seton Hall University School of Law's Stephen Lubben, "The Other Liquidation Decision."  (Abstract ID: 903399):

A firm's liquidation decision actually involves two decisions: the initial decision to shut down the firm and the second question of how?. In the federal bankruptcy system this second question involves a choice between chapter 11 and chapter 7. Conventional wisdom instructs that the debtor's management will always favor chapter 11 because the Bankruptcy Code mandates a trustee in every chapter 7 case, while in chapter 11 the norm is that the debtor and its management remain in possession, with the powers and obligations of a trustee. What has been little examined is how creditors fare in the choice between chapters.

To further examine the second part of the liquidation decision, I present the results of a new empirical examination of 449 firms that liquidated under chapters 7 or 11. This study is unique in that it is the first multi-district study to examine business liquidation in all its forms since the enactment of the current Bankruptcy Code in 1978.

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Rutherford B. Campbell Jr. and Christopher W. Frost, "Managers' Fiduciary Duties in Financially Distressed Corporations: Chaos in Delaware (and Elsewhere)." (Abstract ID: 900904):

In this article, the authors consider the nature of corporate managers? fiduciary duties in periods when the company is in financial distress. This matter is important not only to corporate managers, who need clear rules regarding their duties, but also to equity and debt investors, who must understand the nature of corporate fiduciary duties in order to price the capital that they contribute to the enterprise and allocate the financial risks of loss to the most efficient risk bearer from among the investors.

Unfortunately, courts - especially the important Delaware courts - have made a mess of all of this.

The positive portion of the article describes and offers some clarification of corporate managers? shifting fiduciary duties, as the corporation?s financial distress deepens. The conclusion of the article is that corporate managers are obligated in periods when the corporation is solvent to act in the best interests of shareholders. When, however, the corporation moves into the ?vicinity of insolvency?, corporate managers are obliged to act in the best interests of some undefined conglomerate of corporate stakeholders. In actual insolvency, managers? duties shift to a duty to act in the best interests of creditors. Finally, in bankruptcy, corporate managers must act in the best interests of shareholders and creditors as a whole.

The authors find these poorly articulated and constantly shifting standards to be pernicious, both with regard to the ability of corporate managers to make legally proper decisions and with regard to investors? ability to price their investments and predictably and efficiently allocate their risks of loss.

In the normative portion of the article, the authors argue for an abandonment of this confusing and inefficient regime of corporate fiduciary duties. Their view is that in all periods prior to bankruptcy, the fiduciary duties of corporate managers should be consistently defined by reference to the best interests of shareholders. Once a company is in bankruptcy, they believe that the obligation of managers should shift to an obligation to act in the best interests of shareholders and creditors as a whole. This approach will, in their view, lead in most (but not necessarily all) cases to pleasing and efficient outcomes. It will provide intelligible criteria to guide the actions of managers and will enable investors to price their capital and allocate risks of loss in efficient manners.

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Adam Levitin, "Rough Justice? The Nature and Limits of Equitable Subordination."
(Abstract ID: 900444)

Courts have repeatedly state that equitable subordination is a compensatory remedy. This view is demonstrably mistaken. If equitable subordination is compensatory, only injured creditors, and not trustees or debtors in possession, would have Constitutional standing to bring equitable subordination actions.

Rather, equitable subordination is an unusual quasi-punitive remedy that looks to the actions of the inequitable party, not the harm caused. The proper remedy for parties injured by an inequitable creditor is a direct tort action. Equitable subordination should be granted only when an injured creditor cannot bring a direct action against the inequitable creditor or when a creditor has engaged in inequitable bheavior in the bankruptcy process itself.

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Susan Kalinka, "In Re Ehmann: Bankuptcy Court Decision Portends Problems for Manager-Managed LLCs." (Abstract ID: 894571):

The LLC has been touted for its many advantages, one of which is the ability of an LLC to protect the assets from claims of creditors of persons that are members in the LLC. In the case of In re Ehmann,[1] however, the Bankruptcy Court for the District of Arizona held that a trustee in bankruptcy had the power to exercise all of the management rights held by a debtor who was a member of an LLC. The court indicated that the trustee's rights might include such broad powers as the right to redeem the LLC interest, seek appointment of a receiver to operate the LLC in accordance with the LLC's purposes and the members' rights or to seek the dissolution, winding up, and liquidation of the LLC. The result in Ehmann raises concerns that bankruptcy courts may be willing to allow trustees in bankruptcy to interfere with the management of an LLC for the benefit of a debtor's creditors and to the detriment of the nondebtor members of the LLC. This column discusses the Ehmann case and its relevance to persons who own interests in an LLC.

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Mauricio Soto, Alicia H. Munnel, Francesca Golub-Sass, and Francis Vitagliano, "Why are Healthy Employers Freezing Their Pensions?" (Abstract ID: 893214):

The shift in pension coverage from defined benefit plans to 401(k)s has been underway since 1981. This shift is the result of three developments: 1) the addition of 401(k) provisions to existing thrift and profit sharing plans; 2) a surge of new 401(k) plan formation in the 1980s; and 3) the virtual halt in the formation of new defined benefit plans. A conversion from a defined benefit plan to a 401(k) plan was an extremely rare event, particularly among large plans. Historically, the only companies closing their defined benefit pension plans were facing bankruptcy or struggling to stay alive. Now the pension landscape has changed. Today, large healthy companies are either closing their defined benefit plan to new entrants or ending pension accruals for current as well as future employees. Why are healthy employers taking this action? And why now?

This brief reviews the major pension freezes during the last two years and explores the impact on employees at different stages in their careers. It then offers four possible explanations why employers are shutting down their plans. The first is that some U.S. companies are cutting pensions to reduce workers' total compensation in the face of intense global competition. The second explanation is that employers have been forced to cut back on pensions in the face of growing health benefits to maintain existing compensation levels. The third explanation, by contrast, points to the finances of the plans themselves - specifically, their market risk, longevity risk, and regulatory risk that make defined benefit pensions unattractive to employers. The final explanation is that with the enormous growth in CEO compensation, traditional qualified pensions have become irrelevant to upper management who now receive virtually all their retirement benefits through non-qualified plans. Each of these explanations contains a kernel of truth, and they all help explain the current trends.

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Daniel M. Covitz, Song Han, and Beth Anne Wilson, "Are Longer Bankruptcies Really More Costly?" (Abstract ID: 891486):

It is widely believed that financially distressed firms should be restructured as quickly as possible. Theoretically, however, it is not clear that speed is always better. The conventional wisdom is supported by the fact that both direct and indirect costs of restructuring increase with time. However, academics have argued that bankruptcy may allow firms to refocus in a more profitable direction. Such restructurings may take time, creating a marginal benefit to spending more time in default. When these marginal benefits exceed the marginal costs of restructuring, net restructuring costs may actually decrease with time in default.

Empirically, existing studies evaluating the net costs of bankruptcy duration find mixed results. More importantly, the extant research in this area fails to address the possibility that time spent in default is endogenous. Since claimholders? strategies are endogenously affected by firm values, time spent in restructuring is endogenously affected by restructuring costs.

We study the impact of time in default on firms? net restructuring costs, using an instrumental variable approach to explicitly address the issue of endogenous time in default. We utilize a dataset of about 1000 U.S. firms that defaulted on their public bonds and filed for bankruptcy between 1983 and 2002. Bond recovery rates, measured at the resolution of the bankruptcy cases, and the likelihood of a firm reentering bankruptcy are used to capture firm-level variation in net restructuring costs.

We construct two IVs. Our first IV is the real per-page fee of obtaining court documents such as bankruptcy dockets, which serves as a proxy for the marginal productivity of the court processing technology. The second IV is the percentage of days during a firm?s default period in which there were severe weather events such as blizzards or floods affecting the court where the firm filed for bankruptcy.

We find that creditor recovery rates increase with duration for roughly 1? years following default, but decrease thereafter. These results, which are similar when restructuring costs are measured by the likelihood of reentering bankruptcies, suggest that there may be an optimal amount of time spent in default. Moreover, the default duration of almost half of our sample is well outside that optimal default duration implied by our estimates. We also find that creditors benefit from more experienced judges and from oversight by only one judge. The results have implications for the reform and design of bankruptcy systems.

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NYU's Kimberly J. Rodgers, Indiana Univ.'s Randall A. Heron, and Univ. of Iowa's Erik Lie: "Financial Restructuring in Fresh Start Chapter 11 Reorganizations." (Abstract ID: 890693):

We find that firms substantially reduce their debt burden in fresh start Chapter 11 reorganizations, yet they emerge with higher debt ratios than what is typical in their respective industries. Cross-sectional regressions reveal that post-reorganization debt ratios are more in-line with the predictions of the static-tradeoff theory. However, in contrast to published evidence from much smaller samples, our large sample of emerging firms also reveals that pre-reorganization debt ratios affect post-reorganization debt ratios. Collectively, our results suggest that while fresh start reorganizations allow firms to improve their capital structures, impediments in Chapter 11 prevent them from completely resetting according to financial theory. Our results are also consistent with a clientele effect among the remaining claimants (pre-bankruptcy debtholders continuing their preference for debt claims) and with a dynamic theory of liquidation whereby debt covenants allow creditors to periodically revisit their choice between liquidation value and the value as a going concern. Despite the evidence of persistent debt, we also find that firms with higher pre-filing debt levels, higher short-term debt ratios in particular, are the ones that emerge the fastest. This suggests that it is quicker to remedy strictly financial distress (through capital restructuring) than economic distress (through operational restructuring). Finally, while our analysis of venue does suggest that Delaware Court supervised Chapter 11 filings are faster than those filed elsewhere, our data do not support the notion that the high rate of Delaware Court supervised Chapter 22 filings results from a willingness of that court to hastily approve reorganization plans with excessive levels of debt.

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 Michael Nwogugu, "Structural Changes in the US Retailing Industry and Legal, Economic and Strategy Implications for the US Real Estate Industry." (Abstract ID: 883568):

Between 1995-2003, the US retailing industry experienced substantial decline. This was manifested in layoffs, changes in management, inventory write-downs, discontinuation and streamlining of online marketing efforts, bankruptcy, reduced capital expenditures, store closings and cost cutting. In many companies in this industry, real estate accounted for a substantial portion of total assets (land, buildings/fixtures and lease interests), capital expenditures and operating costs. This paper analyses the economic, legal and strategic impact of the Internet and structural changes and industry restructuring in the US retailing on the US real estate sectors. The article's contributions to management theory, law and economics are in: a) improving the understanding of the analysis of structural changes in large industries, b) showing the relationships and dependencies among strategy, change management and regulation, c) critiquing the standard models/theories of industry growth and competition, d) showing why the standard method of analysis of antitrust and competition for regulatory purposes (industry concentration) may not be accurate in certain circumstances, e) introducing new models/theories of competition, and change, f) analyzing economic issues in real estate, g) analyzing real estate as a major component of retailers' supply chain.

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Samuel E. Bodily and Robert F. Bruner, "Enron: 1986-2001." (Abstract ID: 302155):

Enron Corporation's collapse in December 2001 triggered intense debate about drivers of the failure. Prominent among these were the firm's transformation and the culture it spawned.

Through the 1990s the firm had reinvented itself: reorganized, challenged standard business practices, redefined products and markets, and achieved Fortune magazine's sobriquet of "the most innovative firm in America" for six successive years. Students of transformation pointed to Enron as a noteworthy example for other firms. Then in 2001 what Enron exemplified changed sharply. Unsavory disclosures and a cascade of adversities drove the firm to file for bankruptcy in December, the largest to date in corporate history. The large question posed by the story of Enron is, for what should the brief history of this firm be remembered?

This case was developed to stimulate student discussion of the sources of Enron's early success, and its ultimate failure. The initial tasks for the student are to profile the transformation strategy of Enron, identify how it changed business practice in its industries, and derive lessons in strategy, innovation, and transformation. And then it is to understand the strands contributing to its spectacular fall, including the company culture, financing, governance, accounting, ethics, and strategy. Because of the large ideas and themes the case raises, it would be suitable for use in fields as diverse as strategy, finance, financial reporting, innovation, organization, and leadership.

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Michael Jensen, "Active Investors, LBOS, and the Privatization of Bankruptcy." (Abstract ID: 244152):

From the 1960s to the 1980s the corporate control market generated considerable controversy, first with the merger and acquisition movement of the 1960s, then with the hostile tender offers of the 1970s and most recently, with the leveraged buyouts and leveraged restructurings of the 1980s.

These control transactions are the manifestation of powerful underlying economic forces that, on the whole, are productive for the economy. Thorough understanding is made difficult by the fact that change, as always, is threatening - and in this case the threats disturb many powerful interests.

One popular hypothesis offered for the current activity is that Wall Street is engineering transactions to buy and sell fine old firms out of pure greed. The notion is that these transactions reduce productivity, but generate high fees for investment bankers and lawyers. The facts do not support this hypothesis even though mergers and acquisitions professionals undoubtedly prefer more deals to less, and thus sometimes encourage deals (like diversifying acquisitions) that are not productive.

There has been much study of corporate control activity, and although the results are not uniform, the evidence indicates control transactions generate value for shareholders. The evidence also suggests that this value comes from real increases in productivity rather than from simple wealth transfers to shareholders from other parties such as creditors, labor, government, customers or suppliers.

My purpose here is to outline an explanation of the fundamental underlying cause of this activity that has to date received no attention. In this paper I define active investors, explain their fundamentally important role in generating corporate efficiency, show how current corporate control activity is part of a larger set of economic changes sweeping the world, provide perspective on how LBOs, restructurings, and increased leverage in the corporate sector fit into the overall picture, and discuss some reasons why high debt ratios and insolvency are less costly now than in the past. Because of its topical relevance, I pay particular attention to LBOs and their role in the restoration of competitiveness in the American corporation.

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Special thanks also to Northwestern Univ.'s DeJohn Allen, our summer clerk, for helping me assemble this lengthy post.

© Steve Jakubowski 2006