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The Logic and Limits of Contract Bankruptcy

Corporate reorganization under chapter 11 of the Bankruptcy Code is the current focus of heated debates among bankruptcy scholars. Recent commentary is filled with calls from neo-libertarian bankruptcy scholars arguing for the privatization of business insolvency proceedings. These theorists argue that private-law bankruptcy alternatives are preferable to legislation on freedom-of-contract grounds. They emphasize the efficiency of contract-based bankruptcy rules and contend that the shift from public to private rules would substantially reduce enforcement costs. Based on an economic analysis, these commentators argue that federal bankruptcy law is unnecessary and costly and that private contracts, subject only to common-law rules of property and contract, are sufficient to resolve financial common pool problems. Finally, these theorists argue that bankruptcy law should seek to maximize distributions to creditors, but should not seek any redistributive purposes. They criticize current bankruptcy law for improperly incorporating redistributive goals more appropriately addressed through tax laws.Traditional bankruptcy scholars have criticized these theorists on numerous grounds. They argue that private bankruptcy contracts do not create the appropriate ex ante incentives for the affected parties and permit a redistribution of wealth from weak to strong creditors. Finally, these traditionalists question the claim that private contracts would reduce enforcement costs.In this article, Professor Block-Lieb argues that current commentary on both sides of the debate fail to address the issue of private action in a meaningful manner. She argues that the choice between mandatory bankruptcy legislation and contract bankruptcy must consider implementation costs and ex post effects as well as ex ante incentives and enforcement costs. The article analyzes the choices among bankruptcy rules in terms of the broad institutional choices they implicate and seeks to refute the neolibertarian contention that private action is preferable to legislation in the context of bankruptcy.*Professor of Law at Fordham Law School

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