Faculty Bibliography

Bankruptcy filings are thought to be traumatic events that demoralize workers and spark employee flight. Using social media data, I present evidence suggesting that this belief is both accurate and, to a large extent, overstated. Online employee reviews show that employees of distressed firms are much more likely to complain about corporate culture and the firm’s financial struggles after their employer files for Chapter 11. This may translate into real action, as I also observe a sharp increase in employee departures immediately following the bankruptcy filing. However, viewed in fuller context, these departures are best described as a continuation of a steady rise in employee attrition that began, on average, a year prior to bankruptcy, suggesting that workforce response to Chapter 11 filings is more a story of continued flight from a distressed employer than an abrupt shift following a federal bankruptcy filing.

In 1978, Congress created a new federal bankruptcy law that has since become a key part of the American capital markets. In this Article, I examine how large companies and their investors contract to make bankruptcy more or less likely, how distressed firms negotiate with creditors outside of bankruptcy and how companies plan for a Chapter 11 filing and navigate the bankruptcy system. I also survey the strategic moves, ranging from litigation to financing, that activist investors deploy to improve their bargaining power and to earn higher returns. The American bankruptcy system is constantly evolving and prevailing accounts of bankruptcy law quickly become stale, creating a constant need for new empirical research to establish a foundation for policy-making.

Judges perform very different analyses when investors ask for protection. When the petitioning party is a shareholder, the court will deploy broad equitable doctrines with an eye towards reaching a fair result. On the other hand, creditors typically find a much less sympathetic ear, as courts typically march through technical analyses such as examining whether the offending party violated a contract term, with far less concern for whether the outcome is fair. In an era where many firms are highly leveraged, the end result is that the role of the courts in regulating investor opportunism and creating boundaries for “market” conduct has been greatly diminished, with consequences for both real-world corporate behavior and the development of the law.

This Essay analyzes and assesses the approach of governmental entities to the bankruptcy filings of large, regulated companies. Regulated firms often enter Chapter 11 seeking to exploit bankruptcy law provisions that allow them to take actions that their regulators could block outside of bankruptcy, thereby undermining regulatory enforcement and oversight. As a result, governmental entities often react defensively to a bankruptcy filing, asserting that bankruptcy law does not displace their power over the regulated firm. This tactic is often unsuccessful, as we show by describing the doomed efforts of the Federal Energy Regulatory Commission (FERC) to maintain their statutory authority over Chapter 11 firms. We argue that governments would fare better - and the public interest would be better served - if they participated in, instead of resisting, the bankruptcy process, including by acquiring expertise in bankruptcy law and providing financial support to distressed companies. We illustrate this argument with a case study contrasting the approaches of the California State Attorney General's Office and the County of Santa Clara to the 2019 bankruptcy filing of a hospital system, Verity Health System of California. The County of Santa Clara succeeded in achieving its policy goals where the California Attorney General (like FERC) failed, because the County retained bankruptcy lawyers and took bankruptcy law on its own terms, acting in bankruptcy instead of against bankruptcy.

In this Article, we use hand-collected data to shed light on a troubling development in bankruptcy practice: distressed companies, especially those controlled by private equity sponsors, often now prepare for a Chapter 11 filing by appointing bankruptcy experts to their boards of directors and giving them the board’s power to make key bankruptcy decisions. These directors often seek to wrest control of self-dealing claims against shareholders from creditors. We call these directors “bankruptcy directors” and conduct the first empirical study of their rise as key players in corporate bankruptcies. While these directors claim to be neutral experts that act to maximize value for the benefit of creditors, we argue that they suffer from a structural bias because they often receive their appointment from a small community of repeat private equity sponsors and law firms. Securing future directorships may require pleasing this clientele at the expense of creditors. Indeed, we find that unsecured creditors recover on average 20% less when the company appoints a bankruptcy director. While other explanations are possible, this finding shifts the burden of proof to those claiming that bankruptcy directors improve the governance of distressed companies. Our policy recommendation, however, does not require a resolution of this controversy. Rather, we propose that courts regard bankruptcy directors as independent only if an overwhelming majority of creditors whose claims are at risk supports their appointment, making them accountable to all sides of the bankruptcy dispute.

The lenders that fund Chapter 11 reorganizations exert significant influence over the bankruptcy process through the contract associated with the debtor-in-possession (DIP) loan. In this Article, we study a large sample of DIP loan contracts and document a trend: over the past three decades, DIP lenders have steadily increased their contractual control of Chapter 11. In fact, today’s DIP loan agreements routinely go so far as to dictate the very outcome of the restructuring process. When managers sell control over the bankruptcy case to a subset of the creditors in exchange for compensation, we call this transaction a “bankruptcy process sale.” We model two situations where process sales raise bankruptcy policy concerns: (1) when a senior creditor leverages the debtor’s need for financing to lock in a preferred outcome at the outset of the case (“plan protection”); and (2) when a senior creditor steers the case to protect its claim against litigation (“entitlement protection”). We show that both scenarios can lead to bankruptcy outcomes that fail to maximize the value of the firm for creditors as a whole. We study a new dataset that uses the text of 1.5 million court documents to identify creditor conflict over process sales, and our analysis offers evidence consistent with the predictions of the model.

While bankruptcy law appoints a federal judge to monitor management's use of bankruptcy powers, the judge's review of management's actions is a deferential one in which the judge balances supervision of management and protection for creditors with respect for management's business judgment. On the one hand, bankruptcy law has long urged managers to negotiate workouts with creditors to limit bankruptcy costs, and this new practice is consistent with that long-standing policy goal. The DIP loan contracts have been sorted into three buckets that capture the level of discretion that management would have after the bankruptcy judge approved the borrowing: (1) "management control DIP loans" that came with few strings attached that restricted management's ability to use the bankruptcy process; (2) "limited discretion DIP loans," which generally came with strict milestones for management to leave chapter 11, but did not otherwise restrict management's ability to use that time to implement whatever restructuring transaction was found to be best; and (3) "bankruptcy process sale loans," in which management agrees in the DIP loan contract to implement a specific transaction negotiated with senior creditors, such as a quick auction process. Why is this happening, and should we be concerned? A Theory of Problematic Process Sales Let's examine the drivers of process sales by analyzing the incentives that senior creditors have to seek control of the bankruptcy process, and when those incentives might lead to a bankruptcy transaction that fails to maximize the value of the firm, which is a key goal of bankruptcy law.

In this Chapter, we survey the common law’s adventures with creditor protection over the course of American history with a special focus on Delaware. We examine the evolution of the equitable doctrines that judges have used to answer a question that arises time and again: What help, if any, should the common law be to creditors that suffer losses due to the purported carelessness or disloyalty of corporate directors and officers? Judges have struggled to answer that question, first deploying Judge Story’s “trust fund doctrine” and then molding fiduciary duty law to fashion a remedy for creditors. This reached a high point in the early 2000s as judges flirted with recognizing a “deepening insolvency.” Delaware’s judges effectively abandoned this project in a series of important decisions around the time of the financial crisis. In this “third generation,” judges told creditors to look to other areas of law to protect themselves from opportunistic misconduct, such as bankruptcy law, fraudulent transfer law, and their loan contracts. The question has arisen time and again and today’s “settled” law is unlikely to represent the end of history in creditor protection.

It is widely recognized that bankruptcy law can stymie regulatory enforcement and present challenges for governments when regulated businesses file for Chapter 11. It is less-widely understood that bankruptcy law can present governments with opportunities to advance policy goals if they are willing to adopt tactics traditionally associated with activist investors, a strategy we call “government bankruptcy activism.” The bankruptcy filings by Chrysler and General Motors in 2009 are a famous example: the government of the United States used the bankruptcy process to help both auto manufacturers resolve their financial distress while promoting the policy objectives of protecting union workers and addressing climate change. A decade later, the government of California applied its bargaining power in the Pacific Gas & Electric Company’s Chapter 11 case to protect climate policies and the victims of wildfires. These examples illustrate that, by tapping into the bankruptcy system, governments gain access to the exceptional powers that a debtor enjoys under bankruptcy law, which can complement the traditional tools of appropriations and regulation to facilitate and accelerate policy outcomes. This strategy is especially useful in times of urgency and policy paralysis, when government bankruptcy activism can provide a pathway past veto players in the political system. However, making policy through the bankruptcy system presents potential downsides as well, as it may also allow governments to evade democratic accountability and obscure the financial losses that stakeholders are forced to absorb to help fund those policy outcomes.

Claims trading has become a significant and controversial feature of American bankruptcy practice over the past thirty years. This Report chronicles the rise of claims trading in the second decade of the Bankruptcy Reform Act of 1978 and analyzes the various policy concerns it raises. Most importantly, claims trading has led to, and been accelerated by, the development of an industry of specialized distressed investors who raise billions of dollars of capital to buy and sell the claims of Chapter 11 debtors. Despite attracting periodic concerns from policy-makers, the legal institutions of Chapter 11 appear to have mostly proven capable of handling the concerns raised by claims trading. In sum, the best interpretation of the available empirical evidence is that claims trading and activist investing has, at the very least, not harmed Chapter 11 or distressed corporations and may have actually improved the capacity of the American bankruptcy system to reorganize distressed assets.

On the eve of the financial crisis, a series of Delaware court decisions resulted in a radical change in law: creditors would no longer have the kind of common law protections from opportunism that helped protect their bargains for the better part of two centuries. In this Article, we argue that Delaware’s shift materially altered the way large firms approach financial distress, which is now characterized by a level of chaos and rent-seeking unchecked by norms that formerly restrained managerial opportunism. We refer to the new status quo as “bankruptcy hardball.” It is now routine for distressed firms to engage in tactics that harm some creditors for the benefit of other stakeholders, often in violation of contractual promises and basic principles of corporate finance. The fundamental problem is that Delaware’s change in law was predicated on the faulty assumption that creditors are fully capable of protecting their bargains during periods of distress with contracts and bankruptcy law. Through a series of case studies, we show how the creditor’s bargain is often, contrary to that undergirding assumption, an easy target for opportunistic repudiation and, in turn, dashed expectations once distress sets in. We further argue that the Delaware courts paved the way for scorched earth corporate governance. Fortunately, judges can help fix the problem with more rigorous application of existing legal doctrines.

This Essay (the “Essay”) estimates the U.S. bankruptcy system’s ability to absorb an anticipated surge of financial distress among American consumers, businesses, and municipalities as a result of COVID-19. An increase in the unemployment rate has historically been a leading indicator of the volume of bankruptcy filings that occur months later. If prior trends repeat this time, the May 2020 unemployment rate of 13.3 percent will lead to a substantial increase in all types of bankruptcy filings. Mitigation, governmental assistance, the unique features of the COVID-19 pandemic, and judicial triage should reduce the potential volume of bankruptcies to some extent, or make it less difficult to handle, and it is plausible that the predictive power of the recent unemployment spike will be smaller than history would otherwise predict. We hope this will be so. Yet, even assuming that the worst-case scenario could be averted, our analysis suggests substantial, temporary investments in the bankruptcy system may be needed. Our model assumes that Congress would like to have enough bankruptcy judges to maintain the average bankruptcy judge’s caseload at no more than it was during the last bankruptcy peak in 2010, when the bankruptcy system was pressured and the public caseload figures indicate that judges worked 50 hour weeks on average. To keep the judiciary’s workload at 2010 levels, we project that, in the worst-case scenario, the bankruptcy system could need as many as 246 temporary judges—a very large number. But even in our most optimistic model, the bankruptcy system will still need 50 additional temporary bankruptcy judgeships, as well as the continuation of all current temporary judgeships. The optimistic model begins with the observation that an unusually large number of the unemployed believe that they are only temporarily furloughed and will be back at work soon. Accordingly, we (optimistically) removed the excess-from-baseline number of unemployed who believe they will be back at work shortly—as if they will be back at work shortly with no adverse impact on the economy’s channel to bankruptcies. That reduction yielded a projected need of between 50 and 69 fewer judges to maintain a judicial workload no greater than the one bankruptcy courts faced in the 2009 financial crisis. In other circumstances, the enormous uncertainty of what the bankruptcy caseload will be would warrant waiting to see what develops. And strong action probably will not occur until we see a major across-the-board rise in filings. (Large business filings are rising sharply now, but consumer filings are not rising.) The downside of a wait-and-see strategy is that full-scale bankruptcy court appointments need about a year to complete. The dilemma in what action to take now is that if bankruptcies do in fact rise by several-fold---a plausible but uncertain prospect, then waiting for the rise will lead to a large gap that will put the system one year behind where it ought to be if the filings had been anticipated as certain and acted upon. Hence, we recommend that the relevant players act on the optimistic estimation and re-assess bankruptcy needs as the economy evolves and more information develops. Judicial appointments need not be for the full term of a bankruptcy judge. Capacity can be added via temporary judges (of which there already are some in the bankruptcy court system) and by recalling recent retirees who are willing to serve.

After the amendment became effective, bankruptcy judges could only authorize bonuses for senior managers if they were linked to specific performance goals, such as increasing revenue or moving the firm through the bankruptcy process. [...]key employee incentive plans (KEIPs) became an important part of the chapter 11 landscape, displacing the earlier era of KERPs. [...]the institutions of bankruptcy law have struggled to administer the law. For each of these cases, the author, along with a team of research assistants, examined all of the significant pleadings filed in the case, with special attention to the pleadings discussing bonus plans, as well as the firm's financial statements and subsequent filings in the bankruptcy case and with the Securities and Exchange Commission to determine whether the bonus goals were achieved. In a regression analysis in the Ellias article, the author controls for some observable aspects of each chapter 11 debtor - firm size, firm industry and the law firm advising the debtor - and still finds a negative association between the reform and the likelihood that a chapter 11 debtor would seek court permission to pay bonuses to senior managers during their time in bankruptcy. [...]when bonus plans were proposed, they were nearly always "incentive" plans tied to performance goals.

In 2005, the perception that wealthy executives were being rewarded for failure led Congress to ban Chapter 11 firms from paying retention bonuses to senior managers. Under the new law, debtors could still pay bonuses to executives – but only “incentive” bonuses triggered by accomplishing challenging performance goals that go beyond merely remaining employed. In this Article, I use newly collected data to examine how the reform changed bankruptcy practice. While relatively fewer firms use court-approved bonus plans after the reform, the overall level of executive compensation appears to be similar, perhaps because the new regime left large gaps that make it easy for firms to by-pass the 2005 law and pay managers without the judge’s permission. I argue the new law was undermined by institutional weaknesses in Chapter 11, as bankruptcy judges are poorly situated to analyze bonus plans and creditors have limited incentives to police executive compensation themselves.

A robust secondary market has emerged over the past 20 years in the debt of Chapter 11 firms. Critics worry that the trading associated with this market has undermined bankruptcy governance by forcing managers to negotiate with shifting groups of activist investors in the Chapter 11 bargaining process. This article investigates whether this is a common problem and concludes that it is not. Although trading of bond debt is pervasive, the activist groups that tend to participate in negotiations usually enter cases early and rarely change significantly. Trading in general, therefore, does not appear to have the impact on governance that many claims trading critics fear, at least insofar as the average case is concerned.

Over the past 30 years, the majority of large firms that filed for bankruptcy did so in the US bankruptcy courts of the Southern District of New York and Delaware. Some believe these experienced courts dominate because their expertise makes bankruptcy more predictable. Critics dispute this explanation, arguing instead that “predictability” is a cloak for the true, self-interested motivation of the debtor’s managers, lawyers, and senior creditors who influence the debtor’s choice of venue. In this paper, I look for evidence supporting the views of the proponents and detractors of bankruptcy forum shopping in a large sample of market data. My results suggest that the market is better at predicting the outcomes of bankruptcy cases in New York and Delaware, consistent with the hypothesis that the law there is more predictable. I do not find evidence supporting the view that those courts are biased in favor of senior creditors.

This article examines the hedge fund investment strategy of buying junior claims of Chapter 11 debtors and playing an activist role in the bankruptcy process. These hedge funds are often accused of rent-seeking by managers. I use a new methodology to conduct the first empirical study of this investment strategy. I find little evidence that junior activists abuse the bankruptcy process to extract hold-up value. Instead, the results suggest that they constrain managerial self-dealing and promote the bankruptcy policy goals of maximizing creditor recoveries and distributing the firm’s value in accordance with the absolute priority rule.

Response to: Douglas G. Baird & Anthony J. Casey, No Exit? Withdrawal Rights and the Law of Corporate Reorganizations, 113 Colum. L. Rev. 1 (2013). Baird and Casey recently argued in favor of contractual innovations that allow lenders to contract around bankruptcy law. These innovations, which they call withdrawal rights, are said to increase the efficiency of financing in many cases, and Baird and Casey urge judges to enforce them. This brief Essay uses a case study of a Chapter 11 bankruptcy where withdrawal rights were enforced by operation of foreign law to challenge Baird and Casey's assumptions. The case study suggests that managers may lack a full understanding of how their actions ex ante effect bankruptcy outcomes. Substantial changes for managerial behavior and corporate regulation may be needed to allow managers and investors to utilize withdrawal rights when doing so would enhance the efficiency of financing.