Section 365, Mandatory Bankruptcy Rules and Inefficient Continuance
AbstractSection 365 of the Bankruptcy Code prohibits enforcement of the once common "ipso facto" clause." The clause excuses the solvent party from performance of the contract when the other party becomes insolvent. We show that the ability of insolvent firms to continue bad projects is enhanced by the absence of ipso facto clauses. Without such a clause, the firm can exploit the inability of courts always to assess expectation damages accurately to compel a solvent party to stay in a bad deal. An ipso facto clause would preclude this outcome because the clause permits the solvent party to exit costlessly. Further, an ipso facto clause improves the managers' incentive to exert effort to avoid financial distress. These results have two broader implications. First, that the important mandatory rule regulating the ability of solvent parties to exit is inefficient suggests that the justifications for the Bankruptcy Code's other mandatory rules should be rethought. Second, under free contracting, the inefficient continuance of insolvent firms would be less of a problem than it now is because the ability of contract partners to withhold future performances sometimes would stop bad projects
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Yale School of Management in its series Yale School of Management Working Papers with number ysm94.
Date of creation: 24 Jun 1998
Date of revision:
Other versions of this item:
- Che, Yeon-Koo & Schwartz, Alan, 1999. "Section 365, Mandatory Bankruptcy Rules and Inefficient Continuance," Journal of Law, Economics and Organization, Oxford University Press, vol. 15(2), pages 441-67, July.
- G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
- K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
- G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Andreoni,J. & Miller,J.H., 1998.
"Analyzing choice with revealed preference : is altruism rational?,"
14, Wisconsin Madison - Social Systems.
- Andreoni, James & Miller, John H., 2008. "Analyzing Choice with Revealed Preference: Is Altruism Rational?," Handbook of Experimental Economics Results, Elsevier.
- James Andreoni & John H Miller, 2001. "Analyzing Choice with Revealed Preference: Is Altruism Rational," Levine's Working Paper Archive 563824000000000096, David K. Levine.
- Alan Schwartz & Joel Watson, .
"The Law and Economics of Costly Contracting,"
Yale Law School John M. Olin Center for Studies in Law, Economics, and Public Policy Working Paper Series
yale_lepp-1004, Yale Law School John M. Olin Center for Studies in Law, Economics, and Public Policy.
- Schwartz, Alan & Watson, Joel, 2001. "The Law and Economics of Costly Contracting," University of California at San Diego, Economics Working Paper Series qt2wh8m7bv, Department of Economics, UC San Diego.
- Alan Schwartz, . "A Normative Theory of Business Bankruptcy," American Law & Economics Association Annual Meetings 1037, American Law & Economics Association.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.