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Contracting About Bankruptcy

Author

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  • Alan Schwartz

    () (Law School)

Abstract

Creditors and the insolvent firm are required to use the state supplied bankruptcy procedure if they cannot agree on a private resolution after financial distress has occurred. While these ex post workouts are legal, parties cannot agree in the lending contracts to use a bankruptcy procedure alternative to the one the state supplies. This paper considers this legal prohibition. The paper makes three principal claims: the prohibition on contracting for preferred bankruptcy procedures exacerbates underinvestment; the prohibition should be lifted for this reason and because parties could coordinate on "bankruptcy contracts" although firms tend to have numerous creditors, who lend at different times and may have different preferences over procedures; and methodologically, that regulators should take the ability of parties to contract about bankruptcy issues into account when devising legal rules.

Suggested Citation

  • Alan Schwartz, 1997. "Contracting About Bankruptcy," Yale School of Management Working Papers ysm71, Yale School of Management.
  • Handle: RePEc:ysm:somwrk:ysm71
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Dailami, Mansoor & Hauswald, Robert, 2000. "Risk shifting and long-term contracts : evidence from the Ras Gas Project," Policy Research Working Paper Series 2469, The World Bank.
    2. Bhattacharyya, Sugato & Singh, Rajdeep, 1999. "The resolution of bankruptcy by auction: allocating the residual right of design," Journal of Financial Economics, Elsevier, vol. 54(3), pages 269-294, December.
    3. Stanley D. Longhofer & Stephen R. Peters, 2000. "Protection for whom? creditor conflicts in bankruptcy," Working Paper 9909R, Federal Reserve Bank of Cleveland.
    4. Dailami, Mansoor & Hauswald, Robert, 2003. "The emerging project bond market - covenant provisions and credit spreads," Policy Research Working Paper Series 3095, The World Bank.
    5. Antje Brunner & Jan Pieter Krahnen, 2008. "Multiple Lenders and Corporate Distress: Evidence on Debt Restructuring," Review of Economic Studies, Oxford University Press, vol. 75(2), pages 415-442.
    6. Tarbalouti, Mr, 2010. "Défaut de paiement,Achat de consentement et efficience économique
      [Default, purchase of consent and economic effeciency]
      ," MPRA Paper 56220, University Library of Munich, Germany.
    7. Acharya, Viral V. & Amihud, Yakov & Litov, Lubomir, 2011. "Creditor rights and corporate risk-taking," Journal of Financial Economics, Elsevier, vol. 102(1), pages 150-166, October.
    8. Xavier Giné & Inessa Love, 2010. "Do Reorganization Costs Matter for Efficiency? Evidence from a Bankruptcy Reform in Colombia," Journal of Law and Economics, University of Chicago Press, vol. 53(4), pages 833-864.
    9. John Armour & Audrey Hsu & Adrian Walters, 2006. "The costs and benefits of secured creditor control in bankruptcy: Evidence from the UK," Working Papers wp332, Centre for Business Research, University of Cambridge.
    10. Bigus, Jochen, 2002. "Bankruptcy law, asset substitution problem, and creditor conflicts," International Review of Law and Economics, Elsevier, vol. 22(2), pages 109-132, August.
    11. Pindado, Julio & Rodrigues, Luis & de la Torre, Chabela, 2008. "How do insolvency codes affect a firm's investment?," International Review of Law and Economics, Elsevier, vol. 28(4), pages 227-238, December.
    12. Nicola Gennaioli & Stefano Rossi, 2010. "Judicial Discretion in Corporate Bankruptcy," Review of Financial Studies, Society for Financial Studies, vol. 23(11), pages 4078-4114, November.
    13. Fisher, Timothy C.G. & Martel, Jocelyn & Gavious, Ilanit, 2016. "Tax claims, government priority, absolute priority and the resolution of financial distress," International Review of Law and Economics, Elsevier, vol. 48(C), pages 50-58.
    14. Michelle J. White, 2005. "Economic Analysis of Corporate and Personal Bankruptcy Law," NBER Working Papers 11536, National Bureau of Economic Research, Inc.
    15. Gennaioli, Nicola & Rossi, Stefano, 2008. "Optimal Resolutions of Financial Distress by Contract," CEI Working Paper Series 2008-6, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University.
    16. Inderst, Roman, 2006. "Consumer Lending When Lenders are More Sophisticated Than Households," CEPR Discussion Papers 5410, C.E.P.R. Discussion Papers.
    17. Edward R. Morrison, 2007. "Bankruptcy Decision Making: An Empirical Study of Continuation Bias in Small-Business Bankruptcies," Journal of Law and Economics, University of Chicago Press, vol. 50, pages 381-419.

    More about this item

    JEL classification:

    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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