Unwritten Law and the Odd Ones Out.

AuthorBuccola, Vincent S.J.

The Unwritten Law of Corporate Reorganizations




In the spring of 1916, Paul Cravath, namesake of the storied law firm and one of the nation's leading railroad lawyers, addressed the New York bar on the topic of corporate reorganization. A recent decision of the Supreme Court threatened to unsettle what had become a lucrative practice on Wall Street.' Many in the audience were no doubt eager to hear the great man's account of the state of play. Cravath began, however, with a striking caveat. He did not have much to say about reorganization in general, he warned. To treat the subject in a systematic fashion would be as hopeless as "for a poet to tell how to write poetry." (2) It was not that Cravath thought he lacked the necessary analytic or expressive powers of abstraction. He was not a modest man. Rather he thought the systematic approach ill-suited to the field. "One cannot formulate many rules or refer to many precedents which will serve as a guide to the reorganizer," he explained. (3) Circumstances were too various. The most a savvy audience could wish for was what Cravath called "a series of practical suggestions based upon experience." (4)

The folly of imagining reorganization law to be a set of articulable rules is no mere prefatory warning, but the organizing theme of Douglas G. Baird's new book, The Unwritten Law of Corporate Reorganizations. (5) To the uninitiated, it might seem a doubtful thesis. Cravath preceded the era of codification. In his day, the freewheeling courts of equity superintended reorganization. (6) Variability was to be expected. Now, though, a century later, title 11 of the United States Code runs more than 300 small-print, dual-column pages. The Federal Rules of Bankruptcy Procedure run another 150 pages, and the volumes of judicial guidance grow apace. One might have supposed that the excess verbiage available to the modern bar would have made reorganization more explicable. Hardly so.

As Baird tells it, much of what matters most in corporate reorganization still is not in print. An intelligent generalist who read only the orthodox legal materials, however assiduously, would find even standard practice baffling.' The book's unifying insight explains why: reorganizes have created a world in which ordinary assumptions about the relationship between text and custom are inverted. In the world of corporate reorganization, ostensibly binding statutes, rules, and judicial opinions embellish practical norms rather than the other way around. What is essential to reorganization law, then, is not the Bankruptcy Code, much less any distributional principles it frames, but rather the commitments of the lawyers and judges who specialize in distress. (8) Baird withholds judgment of the world he conjures, but it is fair to say that he emphasizes its virtues.

My principal aim in this Book Review is to draw out the dark side of Baird's account of "unwritten law." The nub of the problem is that it can be expected to subordinate the interests of so-called legacy creditors to the interests of incumbent managers and their allies. I argue that the values of what I will call "reorganization culture" are apt to yield a process of norm development biased against creditors who cannot offer new investment. What is more, such a bias in fact describes the history of innovation in Chapter 11, and I suggest that Baird's account goes a long way toward explaining a troubling and otherwise puzzling tendency. Exposing the dark side of unwritten law does not resolve any important normative questions. But I hope it will illuminate the law as it stands, as well as the stakes of meaningful reform.

The Book Review has two parts. Part I lays out the normative logic of the world Baird so vividly illustrates. Baird identifies a surprising variety of persistent, unwritten norms widely shared by reorganizers and indicates their importance to practice. (9) He likewise shows that many written rules have less bite than commentators often suppose. (10) But the relationship between written and unwritten law, as such, remains implicit. By making the schema explicit, I hope both to open the door to critical appraisal and to help the casual reader see how the book's elements hang together--to see why, for example, a conceptual analysis of absolute priority (11) belongs in the same work as a commentary on the plight of national merchandisers in the late nineteenth century. (12)

That logic of unwritten law begins and ends with an insular and self-propagating subculture comprising the investors, bankers, and especially lawyers (including judges) who specialize in corporate distress. On Baird's telling, the values of reorganization culture antedate modern bankruptcy legislation. Its values, like the values of any culture, are complex, multidimensional, and contested. They are therefore impossible to state definitively: they are not only unwritten, but unwriteable. (11)

Although the culture is ultimately irreducible, it is oriented unmistakably toward a forward-looking commercial imperative. In a world rife with asymmetric information and holdup threats, the law on the ground must protect the ability of professionals to coalesce around deals that preserve enterprise value. (14) Fidelity to statute, rule, and appellate decision is secondary. Textual authorities that leave the bargaining environment intact are folded into practice, even when they modify substantially the terms of the deals likely to be struck. But an ostensible authority that gets in the way of value-conserving bargains altogether may be read implausibly narrowly (to neuter its charge) or ignored outright. The primacy of unwritten law does not, then, mean that the Bankruptcy Code is irrelevant. It means only that, as Baird has put it elsewhere, the way the Code operates in practice "cannot be easily reconciled with conventional understandings of how statutes are supposed to work." (15) Reorganization culture acts as a Procrustean bed, stretching or deforming written law as needed to make it fit with reorganizes' core commitments.

Part II links the culture's normative structure to a generic problem in reorganization practice: bankruptcy law encourages and validates practical innovations that tend to subordinate claims of right brought by legacy creditors. The odd ones out, so to speak, are not only well-known "marks" such as pensioners and tort and environmental claimants, whose interests are always "on the table" in reorganization talks, but all creditors poorly situated to provide new investment: landlords whose property is no longer useful to the business, vendors whose goods and services are easily replaced, financial creditors unable to provide new capital. Commentators have long debated the propriety of various techniques in Chapter n by which the interests of legacy creditors, seemingly safeguarded by Bankruptcy Code protections, can be undermined. (16) But the literature has not generally understood the problem as such, even less its connection to reorganization law's peculiar normative structure.

The problem comes down to motive and opportunity. Incumbent managers will always have reason to shortchange legacy creditors, whatever the legal system. From a forward-looking perspective, legacy creditors are mere rentiers. Their investments are sunk. They cannot contribute to prospective surplus. Consequently, it is in the interest of a debtor's managers to distribute as little value as possible to them and as much as possible to allies and investors whose new or continued support might help the business thrive. One of the functions of reorganization statutes is to police this motive, and the Bankruptcy Code in particular does so in a variety of ways. (17) Reorganization culture, by undermining relevant features of the written law, gives managers and their allies opportunity. Ironically, the blame lies with reorganizers' desire to achieve commercially sensible results in specific cases. This desire explains not only reorganization culture's insistence on contextual or case-specific norms, but also the poor treatment of legacy creditors, for incumbent managers will always be the masters of local context.

To notice a perverse tendency of unwritten law is not, of course, sufficient to condemn it. For that a better alternative is needed. The Unwritten Law is largely interested in the charm and stout good sense of reorganization culture. It is worth remembering as well, however, that there are drawbacks to a world in which the law consists of "a series of practical suggestions based upon experience."


    The Unwritten Law could be profitably read as a collection of independent essays. Each of the book's eight chapters covers an important moment, theme, or transition in the history of corporate reorganization. They feature everything from a busted land deal in post-Revolution New York to a critical discussion of single-asset real-estate bankruptcies in the 1970s, (18) from a eulogistic portrait of the great Victor Morawetz to gentle mockery of William O. Douglas. (19) Although notionally history--the events covered range from 1600 to the present and proceed roughly in chronological order--The Unwritten Law is more like a meditation on continuity and change. (20)

    Readers who have dipped a toe into the world of commercial-law scholarship in the last four decades will have no problem recognizing Baird's inimitable style--a unique combination of a historian's facility with concrete detail, an economist's eye for abstract analysis, and the storytelling instincts of an English major. One chapter forays into the early Republican system of merchant credit, showing how American courts wielded the old principles of fraudulent and preferential transfer to protect disfavored creditors and, by extension, the liquidity of budding secondary-debt markets. (21) Another keys into...

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