Corporate Restructuring under Relative and Absolute Priority Default Rules

A Comparative Assessment

The European Union recently adopted a Restructuring Directive intended to facilitate the reorganization of insolvent and other financially troubled firms. Although the central goal of the Directive parallels that of chapter 11 of U.S. bankruptcy law—to protect and maximize the value of financially distressed but economically viable enterprises by consensually reorganizing their capital structure—the Directive introduces an innovative but controversial option: that EU Member States can decree that reorganization negotiations should be subject to a relative priority default rule, in contrast to the type of absolute priority default rule used by chapter 11. EU officials argue that relative priority is not only fair but also provides the flexibility that is needed pragmatically to restructure a troubled firm. This Article explains why relative priority can inadvertently undermine the incentives needed to achieve a successful restructuring, and why absolute priority provides a more effective default rule for reaching a negotiated consensus. Additionally, the Article illustrates why the Directive’s standard not only may be unfair to creditors but also might discourage debt investments in the European Union.

a Visiting Assistant Professor, Duke University School of Law.

b Stanley A. Star Distinguished Professor of Law & Business, Duke University School of Law; Senior Fellow, the Centre for International Governance Innovation (CIGI); Founding Member, the International Insolvency Institute (III). We thank Rolef de Weijs, Horst Eidenmueller, Aart Jonkers, Maryam Malakotipour, and Kristin van Zwieten for excellent comments and Doo Hyun Nam for valuable research assistance.

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