Four Bankruptcy-Related Working Papers Available for Downloading from SSRN

The following four bankruptcy-related working papers can be downloaded from the Social Science Research Network:

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Columbia University Business School's Kenneth Ayotte and Independent Consultant Yair Jason Listokin, Optimal Trust Design in Mass Tort Bankruptcy

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University of Nebraska's Susan D. Franck, Christians v. Crystal Evangelical Free Church: Interpreting RFRA in the Battle Among God, the Government, and the Bankruptcy Code

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Georgetown Univ. Law School's Milton C. Regan, Jr., Teaching Enron

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Duke University Law School's Steven L. Schwarcz, The Inherent Rationality of Judgment Proofing

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Abstracts for each of these working papers follow:


Kenneth Ayotte and Yair Jason Listokin, Optimal Trust Design in Mass Tort Bankruptcy:

Many firms have filed for bankruptcy to manage liabilities stemming from mass tort claims, most notably asbestos producers. This paper develops a model of an optimal bankruptcy procedure that balances the need to provide liquidity to the present claimants already injured with the need to set aside funds for the uncertain number of future claimants who may develop injury or illness at a later date. We also consider the appropriate division of value and risk between tort claimants and pre-existing contractual creditors of the firm. Our model suggests several significant improvements to current practice. In particular, we find that future claimants should receive greater awards in expectation than present claimants, due to precautionary savings motives. Comparing claimants and creditors, we find that allocating a greater share of the firm's value to contractual creditors makes an earlier bankruptcy filing more likely, which may increase overall welfare. We also find that optimal risk-sharing implies that creditors should receive this value through an equity claim in the trust fund, with tort claimants receiving senior claims resembling debt.

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Susan D. Franck, Christians v. Crystal Evangelical Free Church: Interpreting RFRA in the Battle Among God, the Government, and the Bankruptcy Code:

In the past, religious debtors have used the Religious Freedom Restoration Act (RFRA) to tithe to their churches at a time when they were insolvent and questions have arisen whether these tithes are fraudulent transfers, which should be repatriated to the bankruptcy estate for the benefit of all creditors. This case comment analyzes the first circuit court opinion to evaluate the intersection of religious tithing, bankruptcy, fraudulent conveyance law and RFRA. In light of the doubts as to RFRA's constitutionality, this comment argues for a narrow interpretation of RFRA and, when determining the scope of free exercise protection, courts should use a functional balancing test to weigh the competing interests of religious liberty against the need for effective government administration in the context of personal bankruptcy.

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Georgetown Univ. Law School's Milton C. Regan, Jr., Teaching Enron:

The word "Enron" has become shorthand to refer to corporate wrongdoing in the first years of the twenty-first century. Aside from the dizzying heights from which it fell, Enron was notable for the intricacy of the misbehavior in which it engaged. The company created elaborate organizational structures, often with multiple layers of control, that were intended to use legal form to disguise economic substance.

Such manipulation of form obviously required the services of many lawyers. Transactional lawyers in particular have expertise in fashioning elaborate permutations of form that the law will honor, even if the result is not entirely congruent with underlying economic substance. It's reasonable therefore to assume that lawyers' fingerprints were on Enron's arrangements perhaps more than in any other recent corporate scandal.

Much of the commentary on Enron's attorneys has focused on whether these lawyers violated ethical rules or other legal provisions, and on how the law governing attorney conduct might be strengthened to prevent future transgressions. This commentary generally has been thoughtful and valuable as far as it goes. The application of legal rules, however, is triggered by the existence of certain facts - and the perception that these facts exist is the result of a complicated process. This suggests that we may gain particularly rich insights into the complexity of ethical judgment by trying to understand circumstances as lawyers themselves may have seen them. Proposed transactions don't come labeled as problematic and intricate legal structures rarely are obviously fraudulent. Those characterizations are conclusions that are the product of a complex process of perception that organizes information in particular ways based on factors such as situational cues and personal predilections. Behaving ethically requires cultivating powers of perception that are sensitive to and recognize events that carry ethical significance.

Gaining an appreciation of the circumstances in which a given set of lawyers operated can be difficult, because it requires access to details about the texture of practice that often are unavailable. In the case of Enron, however, the Bankruptcy Court appointed an Examiner to review many of Enron's transactions. Of particular interest, the Examiner's final report contains an Appendix that discusses possible causes of action that Enron might have against its inside and outside legal counsel, along with potential defenses to these claims.

The Examiner's reports constitute one of the most detailed accounts available of the activities of transactional lawyers as they worked on matters that later were deemed fraudulent, in some cases criminally so. This article discusses several transactions that the Examiner scrutinized. These represent only a portion of the transactions that the Examiner analyzed, but constitute a large number of the transactions with respect to which he focused on the conduct of attorneys. My aim is not to evaluate these attorneys' possible liability. Rather, my goal is to try to imagine the world as these lawyers may have seen it at the time the events unfolded. What influences shaped their perception of what was occurring? To what situational cues were they sensitive or blind, and why? How might they have interpreted information that in retrospect seems incriminating? What precisely does it mean, in other words, to say that Enron's lawyers "blessed," "signed off" on, or "approved" the company's transactions? Are these conclusions consistent with how the flow of events unfolded?

Addressing these questions ideally will shed light on broader issues. When are circumstances likely to suggest that an ethical question has arisen? What kinds of factors enhance or obscure the ability to recognize this? What rationalizations tend to be available in what circumstances which provide reassurance that nothing is amiss?

The article suggests that transactional lawyers may face a distinctive ethical challenge because their stock in trade is the creative manipulation of legal form. Law's tolerance of some divergence between legal form and economic substance helps create a background assumption that such divergence is normal and not problematic. At some point the divergence becomes wide enough that the law will treat it as fraud. The working assumption that divergence is normal, however, means that it may take something striking for a transactional lawyer to conclude that this point has been reached. When we add the common tendency to engage in self-serving rationalization to the picture, the perceptual problem becomes even more challenging. My hope is that engaging in a close analysis of the work of Enron's lawyers on specific transactions will suggest how Enron might be used as a case study that makes lawyers and law students more sensitive to the process of exercising judgment in ambiguous situations in which wrongdoing is not apparent on its face.

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Steven L. Schwarcz, The Inherent Rationality of Judgment Proofing:

In recent articles in the Yale Law Journal and the Stanford Law Review, Professor Lynn M. LoPucki has sparked much academic discussion arguing that recent developments in corporate law have led to an erosion in the system of corporate liability, such that it might one day prove impotent. LoPucki has argued that transactions such as asset securitizations, sale-leasebacks, and corporate structures in which liabilities are placed in asset-poor subsidiaries are driving this change. One early critic to the LoPucki thesis, Professor James J. White, has argued that empirical data show no evidence of increasing use of judgement proofing techniques. In this Article, Professor Steven L. Schwarcz joins this debate, arguing that an economic analysis of these transactions suggests that widespread use of these judgement proofing techniques is unlikely. A key distinction in the analysis, Schwarcz argues, is between arm's length and non-arm's length transactions. Arm's length transactions are unlikely to lead to judgement proofing because corporations will receive value - often cash - for the assets they sell. It is only by paying out this value in dividends that a corporation begins to judgement-proof itself. The theoretical possibility to take value away from future involuntary creditors through such transactions will rarely be realized because of the costs - taxes, negative publicity, personal and criminal liability - of entering into such agreements. By contrast, in non-arm's length transactions, corporate owners do have the incentive to create judgement-proof structures. However, these structures are not innovative, and they will continue to be well-regulated ex post by existing legal doctrines in bankruptcy, corporate law, tort law, and criminal law. Following this article are a response from Professor Lynn LoPucki, a comment by Professor Charles Mooney, and a breif rejoinder from Professor Schwarcz.

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