Bankruptcy Law and Inefficient Entitlements

The question as to the justification of bankruptcy law remains unanswered. The literature tends to emphasize the conflict and inability to compromise between the different normative outlooks of the insolvency law system. A deeper reflection on the existing theories of bankruptcy law reveals, however, that all theories share the same starting point: All theories share the understanding that efficiency considerations justify the enforcement of contractual bankruptcy arrangements. When the social theories call for increased levels of coercion and redistribution, these theories rely on normative considerations of distributive justice and rehabilitation values. They by no means rely on efficiency grounds. This article presents a new theory of bankruptcy law that challenges this shared starting point. The article joins the economic analysis’ focus on efficiency considerations. It calls for bankruptcy law rules that would maximize the aggregate value of the debtor’s assets to his or her creditors and equity holders. Yet, the analysis shows that under particular circumstances, efficiency-based considerations can support the coercive avoidance of existing entitlements. Accordingly, I will argue that the role of bankruptcy law is to provide the procedural and substantive framework for severing the debtor’s economic resources from his or her inefficient liabilities. Finally, the analysis shows how the new theoretical framework explains many of the positive legal arrangements of bankruptcy law. First, it explains why courts prefer reorganization plans over liquidation proceedings. Second, it explains the special priority that is afforded by the law to post-petition creditors. Finally, it explains the arrangements regarding executory contracts