Resolving transnational insolvencies through private ordering.

• Author: Rasmussen, Robert K.

There is no international bankruptcy law. No question, there are international insolvencies. Transnational firms, just like domestic ones, often cannot generate sufficient revenue to satisfy their debt obligations. Their financial distress creates a situation where assets and claimants are scattered across more than one country. But there is no international law that provides a set of rules for resolving the financial distress of these firms. The absence of any significant free-standing international bankruptcy treaty means that a domestic court confronted with the domestic part of a transnational enterprise has to decide which nation's domestic bankruptcy law will apply to which assets. To the extent that one wants to talk about an "international bankruptcy law," it is nothing more than the question of when, as a matter of domestic law, a court will resolve a dispute according to the law of another country rather than its own nation's bankruptcy law.

International bankruptcy law as it currently exists is thus, in reality, domestic bankruptcy law. The challenge for each nation's domestic law in this area is to mediate the tensions that arise because the firm and its creditors are spread across more than one jurisdiction. This question becomes difficult in large measure because each country's domestic bankruptcy laws diverge. Such divergence is not surprising. Bankruptcy laws address a myriad of discrete questions. At a minimum, the bankruptcy laws of each nation must specify who will decide the future deployment of the insolvent firm's assets, who will own these assets after the proceeding ends, and who will run the firm while all these matters are being sorted out. Scholars exploring the best way to address these questions have provided a number of conceptually coherent theories,(1) yet they have not come to a consensus on the "correct" bankruptcy law -- and, even if they had, there is little reason to think that the actual political process would embrace this consensus.(2)

Thus, bankruptcy laws differ across nations. We would expect such differences to exist even if all countries agreed that the sole purpose of such laws was to resolve the problems caused by financial distress in the most efficient manner. To be a bit more concrete, perhaps the fundamental question confronting a bankruptcy system concerned with efficiency is how to determine whether a firm in financial distress should be liquidated or reorganized. Some domestic bankruptcy laws guard against inefficient attempts to keep the firm going, while others protect against premature liquidation.(3) These countries agree that the goal is to promote efficiency by liquidating those firms in economic distress but reorganizing those that are suffering from only financial, as opposed to economic distress. The rub is they disagree on how to get there. Indeed, scholars who embrace efficiency as the sole goal of bankruptcy law have yet to reach consensus on the optimal bankruptcy system.(4)

These differences among the world's bankruptcy regimes are exacerbated by the fact that while any insolvency law reflects some concern with efficiency, other interests, such as redistribution to favored groups, shape the final legislative product.(5) These choices reflect different, often conflicting, policy judgments about which group or groups should be favored in the bankruptcy proceeding itself. Some countries provide extra protection to current employees, others to certain other creditors. Some nations treat tort victims on a par with consensual unsecured creditors, and others grant them even lower priority.

The problem that arises when a transnational firm becomes insolvent presents a basic choice-of-law problem: How should law reconcile these differing decisions? Some of these reflect differing judgments as to how to implement the same goal, others stem from a disagreement over the goals themselves. Commentators have proposed three general approaches to reconcile these conflicts: universalism, which comes in varying degrees;(6) territorialism;(7) and contractualism.(8)

Universalism posits that a single country's reorganization laws should govern the insolvency of a transnational firm. The system depends on countries agreeing to a set of choice of law rules that identify the "home" country of the transnational firm. The home country administers the insolvency proceeding. Territorialism, in contrast, allows each country to administer the assets that it finds within its borders according to its own domestic bankruptcy law. Finally, contractualism allows each independent corporate entity to specify in its corporate charter the jurisdiction that will handle any bankruptcy proceeding involving that entity.(9) The transnational firm under a bankruptcy selection regime could thus opt for a universalist approach -- by having all of its constituent entities select the same jurisdiction to govern bankruptcy proceedings -- or for a territorialist approach -- by having all of its entities select the jurisdiction in which they are incorporated. It could even adopt a mixed approach under which a subset of the firm's entities would be administered in one jurisdiction while the remainder would be handled where they were incorporated.

The main justification for universalism has been an economic one. Its proponents, the most effective of whom have been Professors Jay Westbrook and Andrew Guzman, suggest that it will lead to more efficient investments and, on average, promise a greater return to the creditors of the insolvent firm.(10) The main proponent of territorialism, Professor Lynn LoPucki, suggests that the economic justification offered for universalism falls suspect, particularly because it is impossible to design a system that can implement universalism in a coherent manner.(11) Professor LoPucki now endorses the holy grail of the universalists -- a single law administered by a single court -- but insists that territorialism should reign in the interregnum.(12)

One could also mount a noneconomic argument against universalism; namely, that it fails to respect the bankruptcy policies of the different countries involved. This argument relies on a principle of national self-determination and posits that each country ought to be free to pursue its own policies through its bankruptcy law. Any credible theory of how to handle transnational insolvencies must wrestle with the problem of comity between sovereign nations.

Allowing firms to specify the relevant bankruptcy forum through a provision in their corporate charter is, like universalism, premised on efficiency grounds.(13) The justification for the contractual approach begins with the assumption that some firms are better off with a territorial system, others with a universalist model, still others with a mixture of the two. Faced with this heterogeneity of types of firms, the main argument for the contractual approach is that firms ex ante, rather than courts ex post or legislatures ex ante, can best decide which regime is better for them. The one constraint on firm choice is that the ability to change a choice already made has to be constrained so as to guard against opportunistic change.(14) Like universalism, however, contractualism can be subject to the twin attacks that it cannot be implemented in a satisfactory manner(15) and that it fails to take account of comity concerns.

This essay addresses the points of contention among these theories, and endeavors to further the debate by explaining that bankruptcy selection clauses can perform better from an economic perspective than can either of its rivals, and by considering the noneconomic issues that some may offer as a reason to adhere to territorialism. The essay first examines the question, raised by Professor LoPucki, regarding which of the three systems promises the greatest efficiency. It then responds to Professor LoPucki's concern that enforcement of bankruptcy selection clauses would create "debtor havens" that design their laws so as to transfer wealth from small creditors to the debtor and large creditors. Finally, the essay closes by responding to the argument that both universalism and the bankruptcy selection clause system frustrate the fulfillment of national policy.(16)

1. EFFICIENCY AND TRANSNATIONAL INSOLVENCIES

   All the participants in the debate over transnational insolvencies claim that their approach is the most (economically) efficient. Indeed, to date, this is the primary claim of both the universalist and bankruptcy selection clause approaches, both of which have yet to even assert that they respect the noneconomic decisions reflected in domestic bankruptcy law.(17) The exploration of the force of these efficiency claims, as well as of the argument that neither system can be implemented in a way that would generate its purported benefits, requires the delineation of the theoretical arguments in favor of the universalist and bankruptcy selection clause approaches. Because territorialism has been the de facto approach to transnational insolvencies for years, each system starts with that baseline and attempts to demonstrate that a shift away from territorialism holds the promise of gains.

   It is easiest to start with universalism, which has long been the system of choice among academics. The advocates of universalism identify two ways that a universalist system would promote greater efficiency than a territorial system. First, universalism would discourage inefficient investment. As Professors Bebchuk and Guzman have pointed out, territoriality raises the possibility that a debtor will invest in a new country even when such an investment has a negative net present value.(18) This result relies crucially on the premise that the new country will give priority to that country's creditors, who may have extended credit more recently than have creditors in another country. This priority accorded to the new debt effectively places some of the...