By Richard Hynes (University of Virginia School of Law)
The ancient right of redemption allows a party to repurchase assets lost through default at an earlier time. Recently, multiple prominent scholars and the American Bankruptcy Institute have independently proposed granting multi-year or even “perpetual” bankruptcy redemption options to holders of a firm’s junior claims or interests, such as shareholders or unsecured creditors. These options would allow juniors to repurchase or redeem the firm’s equity or assets from whomever received them in bankruptcy. If adopted, these reforms would fundamentally change corporate reorganizations as the current absolute priority rule requires that juniors lose all rights if more senior claims are not paid in full. The reforms would also fundamentally alter the corporate governance of firms emerging from bankruptcy as the investors enjoying the benefits of long-term success would not have voting control. This Article argues that the most plausible benefits of multi-year options could be achieved with shorter options measured in months or even with reforms that do not use options at all. Moreover, extending the options’ duration creates high costs because the former creditors placed in control of the firm will invest too little and take too little risk; if the firm enjoys a high-degree of long-term success, the holders will exercise their options and reap the gains.
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