The End of Reorganizations, Rise of Asset Sales? 2002 - 2003

An entertaining, easy-to-follow, and educational debate took place in 2002 - 2003 in the Stanford Law Review. Baird and Rasmussen started it, LoPucki fought back, and Baird and Rasmussen replied. This debate has continued, however, to this day. Its fundamental battle lines are drawn around the deceivingly simple question of which is better: 363 sales or reorganizations? This post will explore the thesis, the antithesis, and the reply, setting us up for future debate.

Let's turn to the first article on the chopping block: Douglas G. Baird & Robert K. Rasmussen, The End of Bankruptcy, 55 Stan. L. Rev. 751 (2002). This is a great place to start for a few reasons: first, the article says that reorganization was practically dead in 2002, and that there's no reason it shouldn't be--so, it's controversial; second, it introduces the arguments that have been and are still salient in 363 discussions; third, it is wrong in various continually-important ways while being right or provocative in other equally important ways.

The Thesis: Baird and Rasmussen (BR) claim that "corporate reorganizations have all but disappeared. . . . Rarely is Chapter 11 a forum where the various stakeholders in a publicly held firm negotiate among each other over the firm's destiny." This state of affairs, they say, is altogether appropriate because firms very rarely have going-concern value -- at least not going-concern value that would justify reorganization of the present firm instead of selling the assets to another entity. Where reorganization is not needed, capital markets are strong enough for even the largest firms' assets to be sold. Finally, even if a firm should be reorganized, its reorganization is all but predetermined by contracts with creditors.

The Antithesis (Lynn M. LoPucki, Response: The Nature of the Bankrupt Firm, 56 Stan. L. Rev. 645 (2003)): Data prove BR wrong. Reorganizations are very popular--much more popular than asset sales. Even under BR's extremely narrow conception of reorganizations and broad conception of sales, reorganizations are are more vibrant than they admit. Going-concern value is not, as BR say, simply the product of specialized assets needing to reside in a particular firm. Instead, going-concern value is based on relationships (either people to people, assets to assets, or people to assets). For existing firms, the number of relevant relationships number in the billions. In order for another firm to step into the shoes of the existing, reorganizing firm using the existing firm's assets, the new firm would have to spend time and money rebuilding the relationships. Consequently, the large firms of which BR speak generally have a good deal of going-concern value--not because another firm couldn't put the reorganizing firm's assets to use, but because the new firm can't rebuild the relationships without significant cost. When the assets are sold instead of reorganized, the sales price cannot reflect these relationship-building costs, because it is not a benefit conferred upon the buyer; it is deadweight loss that can only benefit the buyer if they bought the assets cheaply, thereby gouging creditors of the reorganizing firm.
The going-concern-value-as-relationships argument holds true for physical assets, intangible assets, and firm-wide (as opposed to elite) teams, contrary to BRs' assertions that elite teams are the only things with going-concern value. In short, the firm is much more than a mere collection of assets that can be plugged into another framework with ease.
As for creditor control by contract, it simply is not as pervasive as BR make it sound, and contract does not allocate control rights in a way that ensures coherent decision making. Contracts do not shift control to the residual owner as the firm passes through various phases of insolvency. Reorganization is better because it leaves the directors in place and gives them fiduciary duties to ALL parties in interest.
LoPucki then argues, without data, that firms are not pushed into 363 sales by creditors. Instead, they sell when the directors are convinced that the firm will not be able to survive even after reorganization. Indeed, the board, not the DIP lender or anyone else, controls the firm in reorganization, and the board doesn't always do the bidding of creditors.

The Reply (Douglas G. Baird & Robert K. Rasmussen, Reply: Chapter 11 at Twilight, 56 Stan. L. Rev. 673 (2003)): Traditional reorganizations, by the numbers, are all but dead. 84% of big corporations entering Chapter 11 either have prepackaged plans or sell their assets. Further, the board does creditors' bidding, and the creditors often have the right to replace the board with their own people.

The Problems: The residual owner(s) of a firm is not necessarily the person with control over the firm in bankruptcy. Take a senior secured creditor, such as a DIP lender, who has a senior security interest in all of the debtor's assets. As long as the value of the assets exceeds the amount owed to this lender, the lender is not the residual owner and thus does not care whether the firm is sold for a little more than its claim or a lot more than its claim. Both BR and LoPucki argue that creditors have some influence in the case, but neither of them show that the right creditors (that is, those with the incentive to maximize the firm's value) have control at any one point. Thus, I would continue to question whether the ease with which 363 sales are often approved (using such flimsy standards as those in Delaware and SDNY) is a good thing.

Introduction and Scope

I like bankruptcy law, and I especially like Section 363 of the Bankruptcy Code. Section 363 allows a firm to sell its assets free and clear of claims to them and without a voted-on plan. All that's required is notice and hearing. This blog, which I don't expect anybody but me to read, will chronicle the arguments surrounding the expanded use of 363 sales (particularly comprehensive 363 sales, which I define as a sale of at least 50% of a firm's assets), both my own and others'. The first line of posts will contain my evaluations of others' arguments. From there, I plan to move to my own normative discussion of how 363 sales should be administered by bankruptcy courts. In particular, what standards should judges employ when deciding to approve or reject a motion for sale? Along the way, I might post on particular cases.

I'm going to focus on roughly the last decade of scholarship. After all, major changes, such as the increase in and normalization of creditor control (including DIP-financer control and the recent surge in secured credit) have occurred in the last ten years in this area. Additionally, the last ten years' scholarship includes a good deal of what went on before the last ten years, so I'm sticking to this model. Two exceptions I'll make for books: Skeel's "Debt's Dominion," which was published in 2001, and Jackson's "The Logic and Limits of Bankruptcy Law," which was originally published in 1986. Of course, when it comes to the books, I'll focus on the portions related to Chapter 11 and, in Skeel's case, the history of reorganization generally.