By Professor Mark Roe (Harvard Law School) and Professor Michael Simkovic (USC Gould School of Law)
Many lawyers viewed Chapter 11, which came into effect in 1979, as unsuccessful in the 1980s. Large firms were mired in bankruptcy for years—three years on average; the process was seen as expensive, inaccurate, and subject to abuse. While bankruptcy today still has problems and few would say it works perfectly, the contrast with bankruptcy today is stark: bankruptcies that took years in the 1980s take months in the 2020s.
Multiple changes explain bankruptcy’s success—creditor learning, statutory reform, better judging and lawyering, newly-developed techniques, stronger implementation of the useful mechanisms that the 1978 Code contained but which were not immediately implemented well. We do not challenge the relevance of those that have been brought forward. But in our analysis, one major change is missing from the current understanding of bankruptcy’s success: bankruptcy courts and practice in the 1980s rejected market value; today bankruptcy courts and practice generally accept it and use it. This shift is a major explanation for bankruptcy’s success. It reduces opportunities for conflict in bankruptcy. It speeds up proceedings. It allows firms to be repositioned in market transactions. Deals among claimants and interests are more readily reached and firms can often ride through bankruptcy without the bankruptcy process materially scarring the enterprises.
This switch to market values is evidenced by four central developments: first, a change in bankruptcy judges’ thinking, from rejecting market value in the 1980s to presumptively accepting it decades later; second, the rise of market transactions such as 363 sales that were not used widely in the 1980s; third, the major deepening and broadening of distressed debt markets; and, fourth, the narrowing dispute range in contested valuations, which we document. On the latter, the severity of valuation disputes in plan confirmations declined sharply over four decades. The trend to using market value was accompanied both by parties moving closer in the disputes that arose and by an accelerated bankruptcy process. Bankruptcies are completed more quickly in the absence of a valuation dispute.
This market-oriented result has implications for bankruptcy law reform around the world. Several European and Asian nations have looked to chapter 11 as a potential model for their own restructuring laws. We urge caution. Chapter 11 works best in conjunction with institutions that facilitate market valuation and market transactions. The United States only developed such institutions in recent decades; many nations have not yet developed them.
The switch to market thinking across the bankruptcy spectrum—in bankruptcy transactions, in judging and in lawyering—goes a long way to explain Chapter 11’s success.
The embedded video below features one of the authors summarizing the article in a 15-minute PowerPoint presentation, followed by a group discussion of valuation issues in American and European bankruptcies hosted by Reorg.
The article, which is forthcoming in the University of Chicago Law Review, is available here.
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