INTRODUCTION 1676 I. THE CREDITORS' BARGAIN AND THE BANKRUPTCY ESTATE 1679 A. The Bankruptcy Partition and the Bankruptcy Estate 1680 B. The Bankruptcy Partition and the Bankruptcy Process 1684 C. The Anti- Commandeering Principle and Third-Party Releases 1686 D. Demarcating the Bankruptcy Partition 1690 II. POLICING THE BANKRUPTCY PARTITION 1692 A Rent-Seeking and the Bankruptcy Partition 1692 B. Guarding Against Creditors with Ulterior Motives 1693 C. Side Payments 1696 III. BARGAINING ACROSS THE PARTITION 1704 A. Deals with Nonstrategic Prepetition Actors 1705 B. Bargaining with Strategic Actors 1708 C. Judicial Restraint and Coasean Bargaining 1711 CONCLUSION 1714 INTRODUCTION
The central ambition of Chapter 11 is to vindicate the creditors' bargain. (1) By the common account, if those who contribute capital to a firm could bargain among themselves, they would agree on a set of rules that would maximize value. As a group, they prefer more to less. There is, however, an important qualification to this idea. When investors gather to invest in a common venture, their focus is on maximizing the value of that venture, rather than maximizing their total wealth as a group. The creditors' bargain is similarly focused on the bankruptcy estate, something that is partitioned from the other interests of the creditors. The ambition of bankruptcy law is to put in place a process that maximizes its value.
At first approximation, the assets inside the bankruptcy partition are easy to define. The assets available to the general creditors of a common debtor in bankruptcy are those available to them outside. (2) The bankruptcy judge has no power to bring other assets into the estate merely because appropriating such assets would make the creditors better off. Moreover, everyone's focus is supposed to be on maximizing the value of the assets in the estate and not on how decisions might improve the outside assets or fortunes of the stakeholders.
Also inside the bankruptcy partition is a forum--the bankruptcy court-that resolves the rights of stakeholders. This process can extend beyond disputes about assets of the bankruptcy estate proper. Secured creditors must, for example, sort out their rights to their collateral as part of the bankruptcy process. Although bankruptcy respects nonbankruptcy entitlements, the rights of secured creditors, as well as those of others, are assessed according to "chancery methods." (3) Secured creditors can be forced to give up their rights to their collateral and to take something else in its stead, provided they receive its "indubitable equivalent." (4) Similarly, the bankruptcy court routinely enforces subordination agreements that creditors strike between themselves and uses its own procedures in the process. (5)
Establishing exactly which rights are sorted out in the bankruptcy forum requires line-drawing. Claims a creditor has against the debtor are almost always resolved in bankruptcy. Rights two creditors have against each other that are unrelated to their stake in a common debtor are not. (6) Other matters are less clear. It is important, however, to ensure that sorting out rights among stakeholders in the bankruptcy forum does not bring benefits to general creditors that they would not receive outside of bankruptcy. They should not enjoy "a windfall merely by reason of the happenstance of bankruptcy." (7)
This paper shows how focusing squarely on the bankruptcy partition sheds light on many debates about modern bankruptcy practice. Part I of the paper looks more closely at the assets and processes that take place inside bankruptcy. By doing so, it suggests how courts should approach a number of important questions--in particular third-party releases, which provide the bankruptcy court with the ability to release one party from liability to another as part of a larger plan to resolve the debtor's affairs.
Part II explores how the bankruptcy judge must police the bankruptcy partition in a fashion that ensures that the value of the estate's assets is protected and that wasteful rent-seeking is minimized. In the process, it explicates bankruptcy's longstanding prohibition on "gifting," a practice in which senior stakeholders divert value from themselves to others during the course of the bankruptcy process. Focusing on the need to police the bankruptcy partition also sheds light on such doctrines as vote designation, rights offerings, and equitable subordination.
Part III examines transactions that cross the partition. When the trustee seeks to maximize the value of the estate, she necessarily must transact with parties who hold assets outside the bankruptcy partition, including parties who are also prepetition creditors. Transactions benefiting the estate that involve assets outside the bankruptcy partition will, like any other mutually beneficial transaction, leave the party with assets on the other side of the partition better off as well. That the other party happens to be a prepetition creditor is not, on its own, reason to forbid it. But when a prepetition creditor is also a postpetition actor, opportunities for strategic behavior arise, and rules need to be put in place to minimize them. This perspective gives purchase on current controversies about critical vendor orders, roll-ups, settlements, and other postpetition transactions between the debtor and prepetition creditors.
Focusing on the bankruptcy partition largely moots a question that has recently been hotly debated both in the courts and in the academy: whether the bankruptcy judge should enjoy the discretion to depart from bankruptcy's distributional rules. (8) Once the dynamics of establishing and policing the bankruptcy partition are taken into account, there is little room for departures from bankruptcy's distributional rules. (9) There might be some cases in which maximizing the value of the estate requires them, but these inhabit an exceedingly narrow domain so small and so hard to navigate that they are sensibly handled with a per se rule.
THE CREDITORS' BARGAIN AND THE BANKRUPTCY ESTATE
Thinking about bankruptcy policy sensibly begins with asking what creditors as a group would have agreed upon if they had been able to bargain with one another before the fact. Commentators often tacitly assume that bankruptcy law is built around the idea that creditors would agree to maximize their joint welfare, but this is too simple. The Bankruptcy Code focuses only on the assets of the estate itself and is designed to ensure that these assets bring the most value possible consistent with nonbankruptcy law. The trustee must try to maximize the value of what falls inside the bankruptcy partition, the line that separates the estate from the rest of the world. (10)
The Bankruptcy Partition and the Bankruptcy Estate
Asset-partitioning is central to the modern account of the firm. (11) Investors are better off when they can contribute capital to a discrete pool that is used for defined projects. The investor wants to limit her own liability if the project is unsuccessful, and, more importantly, wants to be able to monitor the fate of this project independent of all the other projects that fellow investors might have. The directors of a corporation are, thus, charged with maximizing the value of the firm itself. (12) Those directors are not to take into account how actions they take at the firm benefit themselves--indeed, to do so would violate their duty of loyalty to the firm--or other parties in some other way. Focusing narrowly on the firm itself creates a risk of losing some projects that might be in the collective interests of all the stakeholders, but these losses are more than offset by the way the partition reduces monitoring costs.
Bankruptcy law embraces this idea of asset partitioning. It works somewhat differently than asset-partitioning in the context of corporate law, however. Most significantly, the bankruptcy process sometimes resolves disputes among stakeholders even when the disputes do not involve assets that belong to the bankruptcy estate. There is a need to partition those disputes that are heard within the bankruptcy process from those that are not. There is no ready analogue in the context of an ordinary business entity, but the basic idea is the same. Directors of a corporation are charged with maximizing the value of the firm independent of the consequences for different investors with respect to other projects. The bankruptcy trustee (or, as is most often the case in Chapter 11, the debtor in possession) is charged with ensuring the most value is obtained from the assets of the estate without regard to how doing this affects the outside interests of the creditors. (13)
In the hypothetical creditors' bargain, creditors recognize that it is not possible to establish a relationship in which the benefits of every possible mutually beneficial deal among them is vindicated. Nor is it realistic for the bankruptcy process itself to account for all the possible effects that a reorganization might have for the welfare of the parties. To the extent creditors and other stakeholders want to realize other benefits or pursue other rights, they must do so outside the bankruptcy process or rely on their ability to strike entirely consensual bargains with each other during the course of the bankruptcy itself. (14)
The judicial inquiry becomes unmanageable if parties can justify transactions based on indirect benefits running to any stakeholder in any capacity. Imagine a debtor has to choose a new product line. It has two options. One choice indirectly benefits a creditor who happens to sell a product that is complementary to the first line, and the other choice benefits another creditor who happens to sell a different product that is complementary to the second line. The trustee is poorly equipped to trade off such benefits against each other. Things become even more complicated if we consider stakeholders...