More equal than others: defending property-contract parity in bankruptcy.

• Author: Rohrbacher, Blake

INTRODUCTION I. DEFINING RIGHTS IN PROPERTY AND CONTRACT A. Property or Contract: Distinguishing Features B. Property in Contract: Choses in Action C. Property and Contract: Intersections and Implications II. THE PROPERTY-CONTRACT DISTINCTION IN BANKRUPTCY A. Current Law B. Justifications for the Property-Contract Distinction III. PROPERTY, CONTRACT, AND BANKRUPTCY: WHAT SHOULD BE DONE? A. Property-Contract Parity in Bankruptcy B. The Current Approach: Problems and Solutions 1. Landlords Under [section] 502(b) 2. Automatic Stay 3. Executory Contracts CONCLUSION All animals are equal but some animals are more equal than others. (1)

[S]ome forms of property are worth more than others. (2)

INTRODUCTION

Imagine you own a successful donut shop, and an entrepreneur named Anthony Jenkins wants to franchise your idea and open a shop in a nearby city. You're worded that Anthony, who seems to have plenty of cash, might open some shops near you in the future. You request that a covenant not to compete be put in the franchise agreement. If Anthony refuses to sign a noncompete clause without a price reduction, how much less should you charge? If he does sign, how protected are you from Anthony's future encroachments?

Or, imagine you're Anthony's insurance company, and your contract explicitly says that you can cancel his fire policy if he doesn't maintain his shops' sprinkler systems. Have you charged enough in premiums to offset your risk? Are you really protected from Anthony's cavalier attitude toward sprinkler maintenance?

It all depends: How likely is it that Anthony will go bankrupt? Where could Anthony file for bankruptcy? Which bankruptcy judge will hear his case? These last three are questions you can't answer. Under current bankruptcy law, you can't, therefore, answer any of the previous questions.

While the common law has recognized property in contract for hundreds of years, bankruptcy law typically does not. Bankruptcy's distinction between property and contract is unjustifiable. It results in disparate treatment depending on what a given court terms a party's interest. This nominalist, form-over-substance reasoning can lead to inconsistent application of bankruptcy law, disregard for bankruptcy's fundamental principle of deference to nonbankruptcy entitlements, disruption of party expectations, and unequal treatment of interested parties in bankruptcy proceedings. Treating contractual property as regular property, I argue, would help rectify these problems and provide a normative policy justification that is lacking in much of bankruptcy law.

The property-contract approach detailed in this Note should improve the current system. Property-contract parity would lead to more efficient contracting ex ante (i.e., before the debtor files for bankruptcy) and more efficient behavior ex post. One example of the current system's flaws is explored in Subsection III.B.3: For executory contracts in bankruptcy, the debtor's right to performance is treated as property, but the debtor's obligation to perform is treated as contract. Furthermore, bankruptcy courts are inconsistent in their treatment of executory contracts--for example, some courts hold that covenants not to compete are rejected in bankruptcy, while some do not. Thus, a party to a contract, who cannot know when or if the other party will file for bankruptcy, cannot be certain of the effect or permanence of his contract.

Ex ante, the current system results in less efficient contracting. When the parties first make their contract, they cannot predict which way a future bankruptcy court will rule. This uncertainty regarding the outcome and effect of contractual relationships precludes contracting parties from correctly calculating their gains and losses from the relationship. Thus, a creditor, or any party contracting with a potential debtor (i.e., virtually any contracting party), will have to charge higher prices, raising the price of doing business for the potential debtor. The uncertainty inherent in the current system also manifests itself in other ways, as seen in Subsection III.B.2: Nondebtors may find themselves stayed from asserting title to their property if they misjudge the bankruptcy court's future holdings. In the insurance context, this means that insurance companies may be barred from canceling policies under bargained-for cancellation clauses. Though there is some possibility that contracting parties can mitigate these inefficiency-causing wrinkles in the bankruptcy law by changing their behavior, the courts' inconsistencies, exacerbated in the current system, leave little guidance for adaptation. When bankruptcy courts hold either that noncompete covenants are rejected or are not, for example, parties cannot efficiently adapt to prevailing law.

Ex post, the current system also results in inefficient behavior. According to Thomas Jackson, the role of bankruptcy law is to prevent the collective action problems that might result from a race by creditors to grab a bankrupt debtor's assets. (3) Thus, "bankruptcy law should not create rights.... [but] should act to ensure that the rights that exist are vindicated to the extent possible." (4) The inefficiency caused by the current system emerges when one party receives better treatment within bankruptcy than without. This differential treatment can distort incentives to file or not file for bankruptcy, with the possible result of destroying value through the process. (5) Property-contract parity should make bankruptcy outcomes more consistent with nonbankruptcy outcomes and minimize this inefficient distortional effect on behavior.

In Part I, I examine the relationship between property and contract. First, I look at what distinguishes the two. Then, I discuss the chose in action, a historical intersection of property and contract. Last, I create a definition for identifying and separating contract and property.

In Part II, I study the property-contract distinction as it currently exists under bankruptcy law. Then, I test the oft-proffered reasons for the distinction, showing why these reasons are unpersuasive.

In Part III, I propose an approach of property-contract parity in bankruptcy. Applying it to three areas of bankruptcy law, I show in Section III.B how property-contract parity could improve the treatment of landlords' remedies against bankrupt tenants, the automatic stay as applied to insurance contracts and government licenses, and executory contracts. In each of these areas, bankruptcy courts' different treatment of contract and property currently leads to inequitable and inconsistent results, while following property-contract parity would lead to more consistent decisions and a more optimal balance of rights for debtors and creditors.

1. DEFINING RIGHTS IN PROPERTY AND CONTRACT

   It is difficult to define the relationship between property and contract. Some commentators suggest that the two overlap. (6) Others consider them closely related parts of the common law triumvirate, along with tort. (7) Still others resist the notion that they occupy common ground, while recognizing that they do often work together. (8)

   Before examining bankruptcy through the lens of the property-contract intersection, we must consider how property and contract differ and how they intersect. The first Section briefly surveys the usual categorical definitions of property and contract. The next Section examines choses in action, which demonstrate the interrelationship between property and contract. The third Section builds on existing scholarship to advance a description of property and contract that serves as the foundation for Part III's bankruptcy analysis. Thus, I will examine how property and contract differ, how they overlap, and how these two principles can be reconciled.

   1. Property or Contract: Distinguishing Features

      While the exact relationship between property and contract is not often discussed, (9) scholars who do consider the two tend to view them as fundamentally different--if not opposite--in a number of ways. One oft-proposed difference between property and contract is that property is concerned with "creating and defining property rights," while contract is concerned with "facilitating the voluntary movement of property rights" from lower-valuing to higher-valuing users, (10) Contract is also defined as including "all promises that the law will enforce." (11) In this sense, the distinction between property and contract is that property is about a person's right to a thing, and contract is about promises to transfer those rights from one person to another.

      Some writers point to the "freedom to 'customize' legally enforceable interests" as a key difference between the two. (12) The law of contract is virtually unlimited in its ability to create legally binding contracts of varying lengths, natures, and subjects, while property rights can be held only in a limited number of fixed forms (13) (the familiar litany, including fee simple, life estate, reversion, and remainder).

      In 1917, Wesley Newcomb Hohfeld set out a framework for the fundamental differences between contract and property, analyzing the underlying rights of each. (14) Hohfeld denoted rights held by a person against one or a few definite persons as "paucital" rights, or rights in personam, and rights held by a person against a "very large and indefinite class of people" as "multital" rights, or rights in rem. (15) These multital rights are made up of a great number of similar but separate paucital rights. (16) Contract is exemplified by paucital rights, which bind only the parties to the contract, and property by multital rights, which bind the whole world. (17)

      J.E. Penner's definition of property turns on other elements: (18) Property is "the interest in exclusively determining the use of things," while contracts are "exchanges." (19) Just because contracts often deal with property does not mean, according to Penner, that...