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Kenneth Ayotte & Jared Ellias, Bankruptcy Lenders in Command, 40 Am. Bankr. Inst. J. 26 (2021).

Abstract: 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.