Journal Article

Creditor Control and Conflict in Chapter 11

Kenneth M. Ayotte and Edward R. Morrison

in Journal of Legal Analysis

Published on behalf of The John M. Olin Center for Law, Economics and Business at Harvard Law School with the support of the Considine Family Foundation

Volume 1, issue 2, pages 511-551
Published in print January 2009 | ISSN: 2161-7201
Published online January 2009 | e-ISSN: 1946-5319 | DOI: http://dx.doi.org/10.1093/jla/1.2.511
Creditor Control and Conflict in Chapter 11

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We analyze a sample of large privately and publicly held businesses that filed Chapter 11 bankruptcy petitions during 2001. We find pervasive creditor control. In contrast to traditional views of Chapter 11, equity holders and managers exercise little or no leverage during the reorganization process. 70 percent of CEOs are replaced in the two years before a bankruptcy filing, and few reorganization plans (at most 12 percent) deviate from the absolute priority rule to distribute value to equity holders. Senior lenders exercise significant control through stringent covenants, such as line-item budgets, in loans extended to firms in bankruptcy. Unsecured creditors gain leverage through objections and other court motions. We also find that bargaining between secured and unsecured creditors can distort the reorganization process. A Chapter 11 case is significantly more likely to result in a sale if secured lenders are oversecured, consistent with a secured creditor-driven fire-sale bias. A sale is much less likely when these lenders are undersecured or when the firm has no secured debt at all. Our results suggest that the advent of creditor control has not eliminated the fundamental inefficiency of the bankruptcy process: resource allocation questions (whether to sell or reorganize a firm) are ultimately confounded with distributional questions (how much each creditor will receive) due to conflict among creditor classes.

Journal Article.  0 words. 

Subjects: Jurisprudence and Philosophy of Law

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