Bankruptcy's Turn to Market Value
Chapter 11 was widely viewed as a failure in the first decade of the Bankruptcy Code’s operation, the 1980s. Large firms were mired in bankruptcy for years; the process was seen as expensive, inaccurate, and subject to abuse. While basic bankruptcy still has its critics 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, new techniques, fuller integration of the improved mechanisms that the 1978 Code added—and we do not challenge their relevance. 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 accept and use market value. 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 the firm can ride through bankruptcy without the bankruptcy process materially scarring the enterprise.
This switch to market values has multiple channels: more whole-firm sales, wider and deeper access to financing for bidders and bankrupts, growing judicial deference to market valuations, and a bigger and more sophisticated private equity and distressed debt industry that buys bankrupt companies and their securities. We argue that valuation improvements explain much of the increased speed and efficiency of Chapter 11 practice over the decades. We provide evidence that valuation conflicts narrowed and that the corporate reorganization process accelerated.
This market-based-valuation result has implications for bankruptcy law reform around the world. Several European and Asian nations have looked to Chapter 11 to model 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 developed such institutions only in recent decades; many nations have not developed them yet.
Chapter 11 went from being viewed by many as a deficient legal structure in the 1980s to a substantial success story by the twenty-first century. The switch to market thinking across the bankruptcy spectrum—in bankruptcy transactions, in judging, and in lawyering—goes far in explaining why.