THE UNEASY CASE FOR CORPORATE

REORGANIZATIONS
DOUGLAS G. BAIRD*

I
A BANKRUPTCY proceeding is a day of reckoning for all parties with
ownership interests in an insolvent firm. Ownershipinterests are valued,
the assets are sold, and the proceeds are divided among the owners.
Bankruptcyproceedings take one of two forms, dependingon whether
ownershiprightsto the assets are sold on the open marketto one or more
third parties or whether ownershiprights to the assets are transferredto
the old owners in returnfor the cancellationof their prebankruptcyenti-
tlements. The first kind of bankruptcyproceeding, a liquidation,is gov-
erned by Chapter7 of the BankruptcyCode; the second kind, a reorgani-
zation, is governed by Chapter 11. A bankruptcy proceeding always
involves a sale of assets followed by a division of the proceeds amongthe
existing owners. In a Chapter7 proceedingthe sale is real;in a Chapter11
proceedingthe sale is hypothetical.'
An analysis of the law of corporate reorganizationsshould properly
begin with a discussion of whether all those with rightsto the assets of a
firm (be they bondholders, stockholders, or workers) would bargainfor
one if they had the opportunityto negotiate at the time of their initial
investment.2Properlyunderstood,a bankruptcyproceedingitself can be

* Professor of Law,
University of Chicago. I thank Walter Blum, Frank Easterbrook,
Victor Goldberg, Thomas Jackson, William Mitchelson, and Richard Posner for their help.
In the absence of consent, a bankruptcy judge places a value on an investor's claim
against the firm, in exchange for which the investor is given a share of the reorganized
company. In effect a reorganization is a forced sale. An investor "sells" his claim and
receives in return a share of the reorganized company. This point is made in Robert C.
Clark, The Interdisciplinary Study of Legal Evolution, 90 Yale L. J. 1238, 1250-54 (1981).
2
In the rest of this paper, I shall refer to all these people collectively as "investors."

[Journal of Legal Studies, vol. XV (January 1986)]

? 1986 by The University of Chicago. All rights reserved. 0047-2530/86/1501-0005$01.50

127

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128 THE JOURNAL OF LEGAL STUDIES

seen as the back end of the "creditors' bargain."3 If they had the opportu-
nity, investors in a firm might bargain to accept a bankruptcy proceeding
in advance in order to avoid a destructive race to a firm's assets that could
arise when several investors exercise their right to withdraw their contri-
bution to the firm.
The existing rules governing liquidations and reorganizations may suf-
fer from a number of defects in the way they are conceived and imple-
mented. But one does not reach the question of how Chapter 7 or Chapter
11 should be reformed unless one can first explain why both are neces-
sary. In this paper I ask whether corporate reorganizations should exist at
all. Even if some kind of collective proceeding is needed to prevent a
destructive race to the firm's assets, corporate reorganizations could be
justified only if investors before the fact would (if they could) agree to a
hypothetical sale of assets instead of a real one. I argue that, as a general
matter, investors taken as a group would rarely prefer the hypothetical
sale to an actual one. An actual sale eliminates the potential distortions
from a fictive valuation of a firm. More important, the costs of an actual
sale are likely to be less than the cost of the procedures needed to prevent
manipulation and game playing by the participants in a hypothetical sale. I
argue that for this reason the entire law of corporate reorganizations is
hard to justify under any set of facts and virtually impossible when the
debtor is a publicly held corporation.
This paper begins by showing how bankruptcy law itself should grow
out of the bargain that all investors in a firm would agree to at the time the
ownership rights were first divided. It rejects the traditional view that
bankruptcy law in some sense should change substantive rights that in-
vestors enjoy outside bankruptcy law. It links explicitly the creditors'
bargain model of bankruptcy to corporation law generally. Next this pa-
per shows that the set of conditions that make a corporate reorganization
preferable to a corporate liquidation is exceedingly narrow. There are a
large number of cases for which a reorganization seems clearly inferior to
the alternatives. This paper ends by assessing the feasibility of making
substantive changes in the Bankruptcy Code that are implicit in my criti-
cisms of it. This paper is largely normative and gives little attention to the
details of the current law governing both corporate liquidations and cor-
porate reorganizations. But my argument is premised on the existing
norms of nonbankruptcy law, which I assume to be fixed. If basic princi-
ples of nonbankruptcy law (such as the principle that, as a first approxi-

3 The term "creditors' bargain" is Jackson's. See Thomas H. Jackson, Bankruptcy, Non-
Bankruptcy Entitlements, and the Creditors' Bargain, 91 Yale L. J. 857 (1982).

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 CORPORATE REORGANIZATION 129

mation, the owner of an asset may use or transferit as he pleases) were

changed, features of my analysis might also change.

II
Seventy-five years ago Wesley Hohfeld noted that a corporationis
simply a contract among investors who choose to pool their assets in a
commonenterprise.4Settingaside the troublesomequestionwhether(and
which) investors should be liablefor torts a firminflictson others, one can
view a corporationas a collection of assets ownedjointly by shareholders
and creditors. The traditionalview of corporationsis that the sharehold-
ers, because they are the residual claimants, are the "owners"of the
corporationand that their "equity"interest in the firmis differentin kind
from the interest of any creditor. It is sometimes convenientto talk about
residual claimants as "owners" because they receive by definitionany-
thing that someone else does not claim. But shareholdersare not other-
wise necessarily any differentfrom other contributorsof capitalto a firm,
and it may sometimes be properto view some other group(such as cred-
itors) as residual claimants.5
Most rules of corporate law, includingthe rule that generally entitles
creditorsonly to assets that shareholdershave alreadycontributedto the
firm, not to any of their other wealth, are simply implicit or explicit
contract terms of a comprehensivebargainamong all the participantsin
an enterprise. Nothing prevents shareholdersfrom entering into a con-
tract with creditorsin which shareholdersagree to contributetheir entire
net worthto the firmif it is necessary to ensure thatthe claimsof creditors
are satisfied. Indeed, in the case of closely held corporations,individual
guaranteesof key officers and shareholdersmake such contractsthe rule
ratherthan the exception.
The bargainthat investors in a firm in fact strike among themselves

4 Wesley Newcomb Hohfeld, Nature of Stockholders' Individual

Liability for Corpora-
tion Debts, 9 Colum. L. Rev. 285, 290-91 (1909). Like many others since, Hohfeld seemed
to have thought of a corporation as a contract among shareholders. It is conceptually clearer
and more accurate to think of a corporation as a contract among all who have contributed
assets to the firm, including shareholders and creditors of every stripe (from bond and
debenture holders to trade creditors to unpaid workers). This view of corporation law,
however, may come on an important limitation if involuntary debt (such as obligations to
victims of a mass tort) looms very large. See Mark J. Roe, Bankruptcy and Mass Tort, 84
Colum. L. Rev. 846 (1984); Note, Tort Creditor Priority in the Secured Credit System:
Asbestos Times, The Worst of Times, 36 Stan. L. Rev. 1045 (1984).
' Such is the case when
ownership interests are being readjusted and the firm's liabilities
exceed its assets. The Supreme Court recognized this point when it drew an analogy be-
tween the duties of the bankruptcy trustee and those of the managers of a solvent firm in
Commodities Future Trading Commission v. Weintraub, 105 S. Ct. 1986 (1985).

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 130 THE JOURNAL OF LEGAL STUDIES

contains only a few basic elements. The differencesin the rightsof inves-
tors chiefly concern: (1) the timing of payout, (2) the control over use of
the assets, (3) the conditionsthat triggera rightto withdrawthe contribu-
tion to the firm, and (4) the priorityof this withdrawalrightrelativeto the
withdrawalright of another if both are exercised at the same time. A
particularinvestor may be a general creditor who enjoys regularpay-
ments of interestand principal,a creditorholdinga zero-couponnote who
will be paid in a lump sum at some futuredate, or a stockholderwho will
receive dividendsonly if and when the firmshows substantialprofits.The
investor may exercise control over the debtor throughcovenants in an
indenture,the power to cut off a creditline, or the rightto elect a boardof
directors.6An investor may be a bondholderentitled on liquidationto be
paid before everyone else or a common stockholderwho receives what-
ever may be left over aftereveryone else is satisfied.The withdrawalright
may be specified in elaboratedetail in a bond indenture,or it may simply
be an event that allows a generalcreditorto bringa lawsuitand reducehis
claim to judgment.
This view of ownershipcould be expandedeven further.For example,
a contributorof laborto a firmmay in some sense be seen as an "owner."
Assume that a workerwho is owed no back wages and works underan at
will contract has developed a special skill runningdebtor's drill press.
One of the "assets" of the firm is the expertise of this worker, and the
"owner"of that asset in this case is the workerhimselfbecause he has the
sole power of keeping that asset in the firmor withdrawingit. The asset,
however, has no value to the workerwhen he withdrawsit if the skill of
the worker is firmspecific. There is a bilateralmonopoly:the "asset"has
value only if the firm and the worker bargainsuccessfully with one an-
other.
For the most part, investors who pool their assets may divide rightsof
payout, control, withdrawal,and priorityamong themselves as they see

6 There are, of course, other ways of identifying those with rights to a firm's assets. Black
and Scholes, for example, have suggested that the ownership structure of a firm can be
viewed as a complicated set of options. See Fischer Black & Myron Scholes, The Pricing of
Options and Corporate Liabilities, 81 J. Pol. Econ. 637 (1973). For discussions of the various
monitoring devices available to investors in a firm, see Frank H. Easterbrook & Daniel R.
Fischel, Corporate Control Transactions, 91 Yale L. J. 698 (1982); Eugene F. Fama &
Michael C. Jensen, Separation of Ownership and Control, 26 J. Law & Econ. 301 (1983);
Saul Levmore, Monitors and Freeriders in Commercial and Corporate Settings, 92 Yale L.
J. 49 (1982); Clifford W. Smith, Jr., & Jerold B. Warner, On Financial Contracting: An
Analysis of Bond Covenants, 7 J. Fin. Econ. 117 (1979). For some examples of typical
events of default in a loan agreement, see Douglas G. Baird & Thomas H. Jackson, Cases,
Problems and Materials on Security Interests in Personal Property 798-99 (1984); Reade H.
Ryan, Jr., Defaults and Remedies Under International Bank Loan Agreements with Foreign
Sovereign Borrowers-a New York Lawyer's Perspective, 1982 U. Ill. L. Rev. 89, 90-100.

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 CORPORATE REORGANIZATION 131

fit. This fact of corporatelaw reflectsthe generalprinciplethat individuals

can, for the most part, deploy their assets and enter into contractsas they
please. In such a world, bankruptcylaw has only a limited role to play.
Bankruptcylaw is or should be the set of proceduresthat can come into
play when multiple withdrawalrights are triggeredand the exercise of
these rights by individualinvestors is costly and interfereswith the de-
ployment of the firm's assets. Bankruptcylaw prevents a costly and de-
structive race to the firm's assets by offeringa collective proceedingthat
freezes the rights of all investors in a firm, values them, and then distrib-
utes these assets accordingto the priorityscheme that the partiesagreed
would be used in the event that such a day of reckoning should come
about.7Every investor in a firmbargainsexplicitly at the time he contrib-
utes assets to the firmfor the power to extract his assets from the firmif
events do not work out as planned.This power to withdrawassets arises
not simplybecause an investor wants to liquidatehis investment.This can
be done easily enough by transferringhis ownership rights to another
party (by selling his shares of stock or by assigningthe debt). The with-
drawalrightis exercised because of some changein conditionsthat makes
the existing distributionof ownership rights undesirable.
An occasion that may lead to a reallocationof ownershipinterests is a
turn in fortunes that renders a firm insolvent. A creditormay originally
allow shareholdersto be the residualclaimantsof the firmand controlthe
managementof the firm, but he would not want to allow shareholdersto
retain such control once the value of the residual claim becomes very
small. Once a firm is insolvent, shareholdersat best have little incentive
to monitorthe firmand at worst have an incentiveto encouragethe firmto
engage in risky projects. At the time of their initial bargain,individual
creditors bargainfor a right to opt out of the firm if such an imbalance
between the rights and the obligationsof the investors arises.
The interests of junior and senior investors are at odds with one an-
other. Juniorinvestors will not give senior investors an unlimitedrightto
withdrawtheir contributionto the firm. Comparingthe sole bwner of an
enterprise with one that has many owners illustrates this point. A sole
owner who is risk neutralhas no incentive to change a lottery ticket into
cash or cash into a lottery ticket. Butjoint owners with differentpriority
rightsview things differently. Posit a firmwith two owners. One is Cred-
itor, who is owed $10 in a month's time, and anotheris Shareholder,who
owns 100 percent of the firm's common stock. Both are risk neutral.

7
See Jackson, supra note 3; Douglas G. Baird & Thomas H. Jackson, Corporate Reor-
ganizations and the Treatment of Diverse Ownership Interests: A Comment on Adequate
Protection of Secured Creditors in Bankruptcy, 51 U. Chi. L. Rev. 97 (1984).

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132 THE JOURNALOF LEGAL STUDIES

Firm's sole asset is a lottery ticket that gives the owner a one in ten
chance at a $100 prize. The drawingwill take place in twenty-ninedays.
As the senior investor, Creditor,other things being equal, will favor con-
verting the lottery ticket to $10 cash before the drawing. If Creditoris
owed $10, keepingthe ticket instead of selling it exposes Creditorto a 90
percent chance that he will not recover his investment.Yet in the cases in
which Creditordoes recoup his investment,his recovery is limitedby the
amount of his claim. A certain $10 is better than a 10 percent chance of
$10. Shareholdertakes exactly the opposite view. Once the ticket is con-
verted into cash, he is certainto receive nothing,while as long as the firm
owns the ticket, he has a 10percentchance of receiving$90. The firmas a
whole is worth the same whether it has the lottery ticket or the proceeds
from selling it, but in the first case the value of the Creditor'sinterest is
$1.00, and in the other case the value of Creditor's interest is $10. If
Creditorhad the power to force Firm to convert the ticket into cash, he
would exercise it.
A rightto withdrawone's contributionto a firmis similarto Creditor's
havingthe power to force Firmto convert its lottery ticket to cash. It is a
rightto freeze the value of assets at a particulartime and take away from
shareholdersthe possibilityof a futuregain. The withdrawalrightand the
priorityrighton withdrawal,the rightof one investor to be paid ahead of
another under defined conditions, are crucial in the bargainamong the
investors. Indeed, these are the rights that chiefly distinguish secured
creditorsand bondholdersfrom general creditorsand debentureholders
and all creditorsfrom shareholders.For the same reason,juniorinvestors
tend to resist any procedure (such as a bankruptcyproceeding) that
freezes the value of the assets, and when such a procedurestarts, they
seek to stretch it out and delay it as much as possible.
Bankruptcy, however, should not and, by and large, does not give
senior investors an opt-out right that they did not already have. Senior
investors invariablyinsist (or would insist in the absence of a legal rule
that gives it to them) when they originallycontributeassets to the firm
that they be allowed to withdrawthose assets when the firmhas failed to
meet its payout obligations. Senior creditors cannot begin a bankruptcy
proceeding unless the firm is generally failing to meet its obligations.8
Bankruptcylaw does not create a new opt-out rightbut ratheroffers an
alternativemechanismfor senior investors to convert a firm's assets to
cash. The virtue of bankruptcylaw is that it allows the assets to be
convertedinto cash cheaply withoutinterferingwith the optimumdeploy-

8 11 U.S.C. ? 303(h).

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 CORPORATE
REORGANIZATION 133

ment of the assets. It solves a common pool problem that would otherwise
exist.9
A creditor whose opt-out right has ripened may reduce the total value
of the assets of the firm if he acts alone. If he sues the firm and reduces his
claim to judgment, the sheriff may seize a $10 machine to satisfy a $10
debt. The sheriff may leave behind the custom-designed dies that with the
machine are worth $10 but that without it are worthless. When firm de-
faults to several investors and triggers opt-out rights, a race to assets may
begin that ultimately could leave the creditors as a group worse off than
they would have been if they had acted in concert. Bankruptcy law simply
provides a mechanism whereby they can act in concert. The bankruptcy
process is an off-the-rack term that each diverse owner would agree to in
conjunction with his bargain about his opt-out rights (if he could be cer-
tain all others would be bound as well). The investors as a group want to
ensure that the assets are deployed in a way that gives them the highest
possible return. Similarly, the investors as a group would want to ensure
that changes in the ownership of the assets would not interfere with their
deployment.
This view of bankruptcy law as a common pool problem treats corpo-
rate reorganizations as simply a different kind of collective proceeding in
which rights are frozen and ownership interests reallocated according to
nonbankruptcy entitlements. The more traditional view of corporate reor-
ganizations is strikingly different. Under this view, reorganizations pro-
vide breathing space for troubled enterprises. They do not exist to imple-
ment the investors' bargain (more specifically, the effective exercise of
their withdrawal rights). Rather, they exist to prevent the creditors' indi-
vidual (or collective) interests from destroying a firm as a going concern
by forcing it to liquidate piecemeal, destroying both jobs and assets in the
process.' Bankruptcy law, under this view, tries to ensure that a firm

9 For a discussion of bankruptcy as a common pool problem, see Douglas G. Baird &
Thomas H. Jackson, Cases, Problems and Materials on Bankruptcy 31-35 (1985). That
resolving conflicting interests of investors was at the heart of the bankruptcy process was
noted by James S. Ang & Jess H. Chua, Coalitions, The Me-First Rule, and the Liquidation
Decision, 11 Bell J. Econ. 355 (1980); Jeremy I. Bulow & John B. Shoven, The Bankruptcy
Decision, 9 Bell J. Econ. 437, 454 (1978); Michelle J. White, Public Policy toward Bank-
ruptcy: Me-First and Other Priority Rules, 11 Bell J. Econ. 550 (1980).
0oSee, for example, H. R. Rep. No. 595, 95th Cong., Ist Sess. 220, reprinted in 1978 U.S.
Code Cong. & Ad. News 5963, 6179: "Often, the return on assets that a business can
produce is inadequate to compensate those who have invested in the business. Cash flow
problems may develop, and require creditors of the business, both trade creditors and long-
term lenders, to wait for payment of their claims. If the business can extend or reduce its
debts, it often can be returned to a viable state. It is more economically efficient to reor-
ganize than to liquidate, because it preserves jobs and assets." This kind of justification
suffers from, among other things, the problem of assuming that the costs of a "cash-flow

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134 THE JOURNAL OF LEGAL STUDIES

survives, quite apart from whether the owners as a group want it to or not.
The filing of bankruptcy petition stays collection efforts of creditors to
give a debtor an opportunity to recover from a "temporary cash-flow
problem" or a cyclical downturn in the economy. I have criticized else-
where any justification of bankruptcy law that gives any investor (or
indeed anyone else) substantive rights in bankruptcy that they did not
have outside of bankruptcy." This approach to bankruptcy law frequently
seems to assume that we are always better off if a particular firm stays in
business. It does not squarely face the possibility that all interested
parties might be better off as a group if the firm's assets were put to a
different use.
The common fear that investors will exercise withdrawal rights when
the firm's fortunes take a turn for the worse is misplaced. Investors con-
tribute capital in the first instance because of the higher return the invest-
ment promises relative to the next best one available. An investor will not
ordinarily exercise a withdrawal right simply because the firm's fortunes
have dipped temporarily. Indeed, most investors in newly formed firms
are banking on future success rather than existing assets. Someone will
invest in a genetic engineering firm even though it does not even have a
marketable product. In the absence of a change in conditions, an investor
who wishes to end his participation is typically better off trading his rights
against the firm to someone else instead of trying to exercise a withdrawal
right.
Moreover, an investor will exercise his right to withdraw his contribu-
tion only if the firm is unable to find a new investor. If a firm with an
impatient investor is experiencing a reverse that is only temporary, it
should be able to find another investor who is willing to buy the impatient
one out. (The existing investors are obvious candidates.) A firm's inability
to replace a contribution may be good evidence that it has more than a
cash-flow problem.
One might argue that under existing law creditors in fact bargain for
withdrawal rights even when removal of capital from the firm is not
justified. But determining when withdrawal rights should be exercised is
difficult. It is possible that a senior investor would bargain for expansive
withdrawal rights to ensure that he would always have the power to
withdraw when he found it necessary. Bargaining for the power to do
something is quite different from exercising the power when one has it.

problem" should be borne equally by all investors rather than by the residual claimants. The
question, of course, is not which is "fairer" but rather which is more consistent with the
bargain the investors would have reached among themselves initially.
" See Baird & Jackson,
supra note 9.

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 CORPORATE
REORGANIZATION 135

Senior investors may want not merely the power to withdraw when it is
necessary but also the right to determine when it is in fact necessary. One
should not, however, draw too many inferences from existing practices of
creditors, given the impediments under both bankruptcy and nonbank-
ruptcy law to exercising a withdrawal right once it has been triggered. If
courts and others were more willing to enforce the right, firms would
behave differently in granting such rights in the first instance.
The view that the goal of bankruptcy law governing corporate debtors
is to solve a common pool problem explains the general shape it should
have, but it does not explain many of its details. As with any off-the-rack
term, it is difficult to tell whether bankruptcy law, even understood in as
general terms as I have suggested here, would in fact be part of an inves-
tors' bargain. There is always the danger that the bankruptcy apparatus
may do more harm than good. This danger is much greater here than with
off-the-rack terms implied in a garden-variety two-party contract. If the
law implies a term counter to their interests in a two-party contract, the
parties simply have to replace it with one that is more to their liking.
The cost of a bad off-the-rack term is the cost of drafting a substitute. By
contrast, investors cannot easily substitute their own procedures in the
place of bankruptcy rules. Many different parties are involved, and they
come on the scene at different times. They cannot readily reach an actual
agreement among themselves.12
The purpose of a bankruptcy proceeding is to enable the owners of the
firm's assets to act collectively, but collective action may not always be in
the interests of the creditors as a group. If the value of the assets is
unlikely to be impaired by the actions of individual creditors, there is no
need to incur the costs of a collective proceeding. Costs include not
merely those of the procedure itself (such as attorneys' fees)13 but also
those that may result when the owners can no longer exercise their rights
to monitor and control the firm. A collective proceeding, for example,
prevents a secured creditor from seizing his collateral in the event of
default. A secured creditor's ability to seize collateral controls misbe-
havior, and this check redounds to the benefit of all parties. Even if the
secured creditor's priority right is adequately protected, the replacement
of this check with others (such as those provided by the trustee's supervi-
sion of assets of the estate) may make everyone worse off.

12
Waiving the bankruptcy process, even if all creditors could reach an agreement, is
probably not even possible under current law. See United States v. Royal Business Funds
Corp., 724 F.2d 12 (2d Cir. 1983). Thus it is hard to determine how much pressure there is for
opting out of the current system.
13
The cost of a straightforward Chapter 11 reorganization in which a creditors' commit-
tee is appointed runs in the neighborhood of $100,000.

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 136 THE JOURNALOF LEGAL STUDIES

III

The simplest collective proceeding is a sale of the firm for cash and the
distribution of the proceeds to all the investors. The common objection to
such sales is that they cannot preserve the value of a firm as a going
concern. Under this view, finding a third party who is willing to buy the
firm as a single unit is so time-consuming and so difficult that, without a
mechanism to stay the rights of all creditors and force them to become
owners of the firm, the firm would be broken into small pieces that are
worth less than the firm as a single unit. Only a reorganization provides
the necessary "breathing space" that gives all involved a chance to sort
out their affairs.
Finding buyers for firms that in fact are worth preserving as going
concerns may not be more difficult, more expensive, or more error prone
than the alternatives. Valuing a firm's assets is a tricky business. One
must project how much income can be derived from the assets in their
current use and alternative uses and discount all these to present value.
The value of assets may depend on much that is uncertain. It may also
depend on information that is hard to obtain. As a result, third parties may
underestimate a firm's chances for success. On the other hand, they may
overestimate them. The question is not how likely third parties are to
offer too much or too little for a collection of assets but whether they are
so apt to undervalue a firm's value or so apt to find the valuation process
itself costly that they are likely to be unwilling to pay an amount that is at
least equal to the value of the firm in the hands of the existing investors.
Third-party buyers may not value firms accurately, but before rejecting
a sale of assets to a third party (or third parties) as the best means of
ending a particular ownership arrangement, one must explain why anyone
else would appraise them more accurately or more cheaply. If assembling
information on the firm's value is hard for third parties, why would it be
easier for anyone else? Third-party buyers have an advantage over all
others in that they bear all the consequences of guessing right or wrong. If
they overvalue a firm (if they, for example, erroneously think the firm has
value as a going concern), they will not enjoy the same return on their
investment as other buyers. If they undervalue assets, they will lose in the
bidding to other, more astute buyers. Perhaps third-party purchasers are
not willing to pay as much for these firms as the old shareholders and
bankruptcy judges think they are worth, but how likely is it as a general
matter that shareholders and bankruptcy judges rather than buyers will
value the firm correctly? Unlike competing third-party buyers, the share-
holders have nothing to gain (and something to lose) from undervaluing
the firm. Unlike the competing third-party buyers, a bankruptcy judge

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 CORPORATEREORGANIZATION 137

enjoys no benefits and suffers no costs if he under- or overvalues a firm. A

bankruptcy judge may be less able to cast a cold eye on an enterprise and
make tough decisions than someone who has put his own money on the
line. He may have no effective constraint analogous to the discipline a
market imposes on competing buyers who make systematic errors. Like
any other individual outside such constraints, he may tend to underesti-
mate risks.14
None of this, however, is to suggest that going concern sales of a firm
are without costs. In addition to the difficulties I have mentioned, one
must recognize that a sale of the firm's assets may be difficult to orches-
trate. The sale should be conducted by the residual claimants to the firm's
assets because they have an incentive to obtain the best price. If the firm
can be sold for about $10,000 (for more than $5,000 but less than $15,000),
and if secured creditors are owed $5,000, general creditors $10,000, and
subordinated debenture holders $10,000, the general creditors should con-
duct the sale. They stand to gain or lose when they decide whether to sell
the firm in pieces or as a unit. They also suffer the consequences if they
devote insufficient resources to finding a buyer or buyers, or if they waste
time and money trying to sell the assets for more than anyone is willing
to pay.
Ensuring that residual claimants conduct the sale (or, more precisely,
ensuring that those who conduct the sale are entitled to keep the excess)
is not easy. For example, the identity of the residual claimants may be
uncertain. If it is not clear whether the assets are worth more than is
necessary to satisfy the claims of general creditors and those senior to
them, a choice must be made between allowing the general creditors (or
the trustee, as their representative) to conduct the sale alone and allowing
those junior to them to participate. Either decision brings difficulties. If
the general creditors act alone, they may not take account of the interests
of those junior to them. On the other hand, if junior owners participate,
they will tend to favor any tactic that might bring a higher price-such as
costly searching or endless delay-that a sole owner would reject as
unjustified. These junior claimants would have the correct set of incen-

14 Jackson suggests that the inability of individuals to assess risks

accurately in the
absence of any market constraint may justify bankruptcy's fresh start policy for individuals.
See Thomas H. Jackson, The Fresh Start Policy in Bankruptcy Law, 98 Harv. L. Rev.
(1985). It is commonly assumed (although empirical data is scant) that bankruptcy judges
have tended to overvalue firms in bankruptcy. See Walter J. Blum, The Law and Language
of Corporate Reorganization, 17 U. Chi. L. Rev. 565, 577-78 & n.18 (1950); see also Paul F.
Festersen, Equitable Powers in Bankruptcy Rehabilitation: Protection of the Debtor and the
Doomsday Principle, 46 Am. Bankr. L. J. 311, 329 (1972); J. Ronald Trost, Corporate
Bankruptcy Reorganizations: For the Benefit of Creditors or Stockholders? 21 UCLA L.
Rev. 540, 548-49 (1973).

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138 THE JOURNAL OF LEGAL STUDIES

tives only if they bore the additional costs of searching for a buyer who
would pay more than the total amount of claims senior to their own.'5 One
might require the general creditors to buy out all those junior to them
before they conducted the sale, but conducting such a forced sale in-
troduces hoidout problems of its own.
In addition, there may be more than one residual claimant. A firm, for
example, may have dozens or thousands of general creditors. Even if they
can be identified easily, it may be difficult to fashion a set of rules that
enables them to work together or to appoint someone to act on their
behalf. Under current law, the bankruptcy trustee is charged with acting
on behalf of the general creditors, but in practice it is hard for general
creditors to monitor the trustee and ensure that he heeds his obligations to
them. Problems of monitoring arise whenever one person acts as the
agent of others. The problem is exacerbated in bankruptcy. Unlike the
directors of a corporation, a trustee's reputation is not closely tied to
the fortunes of any particular firm. His concern for his reputation may be
insufficient to check the temptation to place his own interests above those
of the creditors he represents. Perhaps for this reason, the costs of as-
sembling a debtor's assets and conducting the bankruptcy proceeding
(many of which are incurred by the trustee) consume, in practice, a large
part of the proceeds of many sales of assets. These costs need to be borne
in mind in evaluating whether there should be any bankruptcy process at
all (that is, whether these costs are not themselves greater than the costs
of a race to the firm's assets).
One should not, however, exaggerate the difficulties inherent in decid-
ing who among the investors should conduct the sale. In the case of a
large firm, the residual claimants would likely hire someone with the
appropriate expertise (such as an investment banker) to run the sale. It
may not much matter whether the decision to hire Goldman Sachs rather
than Shearman Lehman Brothers rests in one investor rather than an-
other.

IV
In a reorganization, prepetition creditors give up their claims against
the debtor in exchange for claims against and interests (such as stock) in a
reorganized firm that has been stripped of all prepetition liabilities. A set
of rules must ensure that the assets are effectively used while ownership
interests are readjusted. In addition, steps must be taken so that no one
creditor or group of creditors has the ability to exploit the reorganization
"5 See Baird & Jackson, supra note 7.

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 CORPORATEREORGANIZATION 139

process and receive more than his substantive nonbankruptcy rights en-
title him to. In a liquidation, what various claimants are entitled to receive
is relatively fixed. If a firm is sold outright, substantive nonbankruptcy
entitlements largely determine who gets what in what order. There is
often little to argue over because rights are fixed and payments are made
in cash. In a reorganization, on the other hand, many more issues are
open. One must value shares in the reorganized company and allocate
them to the old owners. Complicated procedures are necessary to tell us
who can propose a restructuring of the firm and under what conditions
others have the right to approve or reject such a proposal.
A threshold question is whether the complications of reorganizations
and the opportunities they provide for undercompensation and strategic
game playing by creditors, shareholders, and managers are worth the
benefits they bring. The justification for reorganizations usually begins
with the observation that many firms are worth more if kept intact (or
largely intact) than if sold piecemeal. The rationale for a reorganization,
however, must not be simply that some firms are worth more as "going
concerns" than if liquidated. Although not common under present law, a
liquidation is consistent with keeping a firm intact as a going concern. The
difference between a liquidation and a reorganization is that the first
involves an actual sale of all the assets of a business to a third-party buyer
and the second involves a hypothetical one. Under existing law, petitions
filed under Chapter 7 usually lead to a piecemeal sale of the assets, and
those under Chapter 11 involve attempts (many of which fail) to keep the
firm intact as a going concern. Nothing in current law, however, prevents
a sale of the firm as a going concern in Chapter 7, and Chapter 11 pres-
ently allows for a piecemeal sale of the assets of the firm. The justification
for a reorganization must focus on showing the higher costs of selling the
firm to a third party.
A common justification for corporate reorganization of closely held
corporations is that the firm's survival as a going concern depends cru-
cially on continued participation of the existing managers, who are also
present shareholders. A sale of the firm to a third party, however, should
not prevent the firm from surviving intact. Because the creditors have no
claim to the managers' expertise, they are entitled only to the value of the
firm without it. Even if the managers are under contract to the firm, the
remedy for a breach of such a contract is only damages, not specific
performance. The third party acquiring the assets can bargain with the
managers and obtain their services by striking separate deals with each of
them. If the managers will work only if given an equity interest in the firm,
the new owners can offer it to them. In this respect, new owners are in the

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140 THE JOURNAL OF LEGAL STUDIES

same position as investors who continue to own the firm after a reor-
ganization.
While a sale to a third party is being negotiated, it may be necessary to
persuade the old managers to continue temporarily. The shareholder-
managers of a closely held firm who might well be replaced if a third-party
buyer acquired the firm may not be willing to continue to manage the firm
during the search for a new buyer. Without their help during the interreg-
num, the firm might shut down, and its value as a going concern might be
lost. The difficulties the residual owners might have in acting collectively,
as in all bilateral monopoly situations, might be such that a going concern
sale to a third-party buyer was not possible, even though the assets were
most valuable in their present configuration.
Yet obtaining the cooperation of the existing managers during the bank-
ruptcy process should not depend on whether the firm is sold to third
parties. When the process is over, the investors who have the power to
hire and fire the managers will probably no longer be the managers them-
selves. Regardless of whether there is a liquidation or a reorganization,
these other investors will have the power to replace the existing man-
agers. There is no reason to think that either the existing owners or a
third-party buyer will choose to retain existing managers when others can
do the job better. The willingness of managers to keep working temporar-
ily should not turn on who ends up with the corporation. The same fate
should await them when the bankruptcy proceeding is over regardless of
who owns the assets. The perception that presently exists that managers
will only cooperate in reorganizations, not in liquidations, may be due to
the imperfections in existing law that may make continuation of the busi-
ness and retention of managers in liquidations difficult.'6 In both liquida-
tions and reorganizations, the owners must bargain with the existing man-
agers, and in both cases the owners must strike a deal or do without them.
In principle, there is no reason why the bargaining should be easier in one
place rather than another.
The owners of a firm might prefer a forced sale of assets to themselves
(which a reorganization is, in effect) to an actual sale to one or more third
parties if it were cheaper. In that event, the owners would spare them-

16 The difficulties of continuing to run the firm in a Chapter 7 liquidation stem largely from
the presumptions built into current law. Thus a trustee is appointed in liquidation cases
under Chapter 7, while in Chapter 11 reorganizations the managers of the firm continue to
operate as the debtor in position unless replaced. (A trustee is appointed only for cause,
such as fraud, dishonesty, incompetence, or gross mismanagement, or when such an ap-
pointment is in the interests of creditors and equity holders. ? 1104(a).) Under existing law,
the trustee in a liquidation may continue to run the business and continue to employ the old
managers "if the operation is in the best interest of the estate and consistent with the orderly
liquidation of the estate." ? 721.

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 CORPORATEREORGANIZATION 141

selves the expenseof searchingfor an actualbuyer.But these savings

may not be substantial.The abilityinvestmentbankershave shownto
takelargefirmspublic(suchas the FordMotorCo. or AppleComputer)
and the willingnessof othersto acquirefirmsfor huge sums (such as
GeneralMotors'multibillion dollarpurchaseof HughesAircraft)suggest
that it is possibleto sell the assets of even giantcorporationsto third-
partybuyers.In a worldin whichinformation can be gatheredandcom-
municatedquicklyandin whichmanyentrepreneurs specializein acquir-
ing firmsin distress,the practicalobstacles(as opposedto the ones that
are purelylegal)seem quite surmountable. Moreover,the savingsfrom
eliminatingan actualsale may be morethanoffset by the costs of con-
ductinga hypotheticalsale in whichthe assets mustbe appraisedand
proceduresmust be createdto preventone set of ownersfromtaking
advantageof the absenceof the disciplineof an actualsale.
Ownersmightprefera forcedsale to themselvesfor one otherreason.
The assets mightin fact be worthmorein theirhandsthanin anyone
else's. In sucha case, it wouldbe in theirinterestto havea hypothetical
sale even if it cost as muchas an actualone. Onecan imaginecases in
whichone of the presentownerswouldputa highervalueon the assets
thanan outsider.The founderof a firm,for example,mighthavea large
interestin the firm,andhis energyandexpertisemaybe hardto replace.
Similarly,a largefirm(such as IBM)mightbuy a minorityinterestin
anotherfirm(suchas MCI).In neithercase is the investorpassive.Each
exercisescontrolover the directionandmanagement of the firm.Never-
theless,it is rareto findmanysuchinvestorsin a publiclyheldfirm.The
largemajorityof stock-,bond-,anddebentureholdersprobablyhaveno
specialexpertiseor knowledgewith respectto the firmthatwouldgive
them an advantageover others.They are typicallyindifferentwhether
they hold an interestin one firmor in anotherofferingsimilarrisksand
returns.
The managersof a publiclyheld firmmightnot be perfectlyfungible.
Nevertheless,few managersare irreplaceable. Rareis the publiclyheld
firmwhosefutureheavilyturnson the presenceof a singlemanageror
groupof managers.Moreimportant, themanagers' expertiseandtheneed
to compensatethemfor it exists regardlessof whetheror not managers
have ownershipinterestsin the firm.Givingstockholderssharesin the
reorganizedcompanycannotbe justifiedon the groundthat it ensures
continuedparticipation of the managers.If theownersas a groupwantthe
to
managers stay with the firm,theycanpaythemin cash,stock,or some
otherway. Compensating them,however,shouldhavenothingto do with
dividingrightsto the firmamongthe existingowners.In short,few own-
ers of publicly held firms place a special value on the assets, and those

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142 THE JOURNALOF LEGAL STUDIES

that do can easily bid at a sale that is open to third parties as well.
Alternatively, they can reacquire a fresh interest from the successful
third-party purchaser.
Special expertise, however, may be spread among the owners of
closely held corporations. There is often a close correspondence between
the managers and the shareholders. Other owners may also have special
knowledge and expertise. Just as the managers might bargain successfully
for an equity interest in the reorganized firm, a finance company that has
monitored the firm for years and knows its operations might be best able
to buy the reorganized firm's accounts and take a floating lien on its
inventory. The bank that lent the firm money initially might be more
confident that the firm's business would improve than a lender who had
not dealt with the firm before. The bank, therefore, might also come to
terms with the purchaser so that it could participate in the credit extended
to the new enterprise.
Bargaining between several diverse former owners and the purchaser is
likely to be difficult and costly. The more diverse owners there are, the
less likely it is that bargains can be reached with all of them. If enough of
the owners of an insolvent enterprise have expertise or other advantages
that potential third-party purchasers do not possess, the assets of the firm
may in fact have their highest value in the hands of the existing owners,
albeit with a different configuration of ownership interests. If these di-
verse owners cannot cooperate, however, a sale of the firm may separate
the assets from the existing owners, making them worse off because the
assets will not be put to their best use. A reorganization may be justified in
these cases involving closely held corporations where there is special
expertise spread among several owners if the reorganization provides a
better forum for readjusting ownership interests than exists elsewhere. In
other words, reorganizations may be desirable if they enable those who
value the assets the most to acquire them and if the alternatives (liquida-
tions or nonbankruptcy workouts) do not.
Reorganizations may not be a good place to rearrange ownership inter-
ests. They take time. Parties need to bargain and dicker with one another;
there must be proposals and counterproposals. If a party holds out, a
court proceeding may be necessary to determine whether that party is
trying to take advantage of the problems large groups face in reaching
agreement or simply insisting on the priority and procedural rights he
bargained for or would have bargained for when he became an owner. In
addition, a reorganization requires a valuation of everyone's rights. Valu-
ing assets without the discipline of a firm offer from a third party is
inherently difficult. While it might be easy enough to determine that the
market value of the firm's used drill press is $10,000 and that of its real

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 CORPORATE REORGANIZATION 143

estate is $100,000, it is not easy to project the value of the firm as a whole,
which might well be greater or smaller than that of the assets piece by
piece. If the firm is using the assets to market a new product, the assets
may be worth considerably more if the new product becomes a huge
success. But predicting the fate of a particular product is a formidable
job. 17
There is another-and more intractable--valuation problem. If the cor-
porate reorganization is justified because many of the owners bring
significant expertise to the enterprise, part of the valuation process
should, if possible, put a value on that expertise. But allocating gains from
keeping the same group of owners in the picture will not be easy. By
hypothesis, all (or at least many) of the parties are adding value. Thus
simply knowing how much more the firm is worth in the hands of its
present owners (which is itself virtually impossible to determine) than it is
in the hands of third parties is not nearly enough. Ideally, we need to
know how much each of the participants is adding. The question is not
simply a distributional one. If parties who have expertise are not compen-
sated for it in a corporate reorganization, they will, at the margin, have
less incentive to invest resources in becoming experts in the first instance,
and it will be harder to use their expertise after the reorganization.
The law of corporate reorganizations has been based on the principle
that inquiring into the expertise of different owners is so difficult that the
game is not worth the candle. As a matter of substantive right, the rights
of individual owners are fixed by the absolute priority rule: senior owners
are entitled to be paid in full before junior claimants receive anything.
Justice Douglas justified the rule in Case v. Los Angeles Lumber Products
Co.:
[Findings below suggesting stockholder participation]will be beneficial to the
bondholdersbecause those stockholdershave "financialstandingand influencein
the community"and can provide "continuityof management"constituteno legal
justificationfor issuance of new stock to them. Such items are illustrativeof a host
of intangibleswhich, if recognizedas adequateconsiderationfor issuanceof stock
to the valueless junior interests, would serve as easy evasions of the principleof
full or absolute priority.... Such items, in fact present here, are not adequate
considerationfor issuance of the stock in question. On the facts of this case they
cannot possibly be translatedinto money's worth reasonablyequivalentto the
participationaccorded the old stockholders. They have no place in the asset

17 See Mark J. Roe, Bankruptcy and Debt: A New Model for

Corporate Reorganization,
83 Colum. L. Rev. 527 (1983) (noting the problem and suggesting a "float" of 10 percent of
common stock on the market, to set value, followed by an all common stock distribution to
claimants, as one method of reducing these valuation problems and concomitant
negotiations).

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144 THEJOURNALOF LEGALSTUDIES

columnof the balancesheet of the new company.They reflectmerelyvaguehopes

or possibilities.'8
A bankruptcy reorganization proceeding often does not entail an actual
appraisal of the value of the firm's rights and the rights of each individual
(according to the absolute priority rule). Investors and groups of investors
can waive their procedural rights. Despite their ability to waive their
procedural rights, investors as a group are worse off if there are too many
procedural rights. If they could have bargained together before investing
in the firm, each investor would have been willing to pay for additional
procedures to protect its interests only until the cost of the uncertainty
eliminated by additional procedure was less than the cost of the proce-
dures designed to eliminate it. Procedures can be too extensive or too
limited. Determining either the kind or the amount of procedure is
difficult. If the shareholders have the right to insist on a valuation that
would consume $10,000 of the firm's assets, it is in the interests of the
other owners as a group to offer the shareholders something less than
$10,000 to waive this right. But bargaining over the waiver of procedural
rights is itself costly and brings with it holdout and free-rider problems. If
one knew what procedural rights each of the owners would have bar-
gained for (and been willing to pay for) before becoming an owner, one
would want to provide each such owner with these rights and no more.
Offering more procedural rights would create either valuation procedures
that were not cost-effective or costly bargaining over the waiver of those
procedures. In theory and in practice a reorganization induces bargaining
among all those with rights to the firm's assets. Few firms go through the
entire route in which a bankruptcy judge actually does a full-scale valua-
tion. Reorganizations are (and were intended to be) a forum in which
parties would be able to reach some kind of deal without invoking all the
procedures. The whole structure of the present rules governing reorgani-
zations is designed to ensure that parties bargain with one another and
that there is not a full-blown valuation.
A major premise of the law of corporate reorganizations is that despite
its costs the bargain owners can reach in a reorganization is closer to the
bargain they would reach in the absence of transaction costs than the
bargain they could reach outside of bankruptcy (where creditors can in-
voke individual debt collection procedures) or in a liquidation (where the
new owner must bargain separately for the participation of the old own-
ers). Bargaining in a reorganization has to be compared with the bargain-
ing that might take place elsewhere. Bargaining is always going to take

18 Case v. Los Angeles Lumber Products Co., 308 U.S. 106 (1939).

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 CORPORATE
REORGANIZATION 145

place among creditors and shareholders inside of bankruptcy and out.

Legal rules play a large role in determining the terms of that bargain.
When ownership interests in a firm need to be readjusted, creditors will
meet, regardless of whether Chapter 11 exists or not. The greatest weak-
ness of a corporate reorganization may be what is often advanced as its
greatest strength-that it promotes bargaining among creditors and other
owners of an insolvent firm. We cannot say bargaining is good until we
know what the bargaining is all about. We may want the existing owners
to bargain over the unique contribution they make to the firm. But this
happens in a going-concern liquidation or a nonbankruptcy workout as
well as in a reorganization. In a reorganization, the bargaining is not only
over substantive nonbankruptcy entitlements but also over special bank-
ruptcy procedural rights the participants can either waive or invoke. To
the extent a reorganization promotes bargaining over rights that do not
exist elsewhere, it may promote bargaining about the wrong thing. Noth-
ing is gained from having, without more, bargaining about anything other
than substantive rights, yet much of the bargaining in a reorganization is
over procedural rights that exist nowhere else. Such bargaining is a cost
of a reorganization, not a justification for it. One must identify benefits
that offset this cost. Even if present owners value the assets the most, it
does not follow that a reorganization is the best forum or even a good
forum for them to rearrange ownership interests.

V
The thrust of the argument presented in this paper is that the owners of
a firm, especially a publicly held firm, would likely prefer a sale of the firm
outright to whomever was willing to pay the most for it. A going-concern
sale of assets is possible under the existing structure of Chapter 7 of the
Bankruptcy Code. Such sales, however, run counter to the thinking of
most bankruptcy judges and practitioners. To be effective, a bankruptcy
system that relied primarily (or virtually exclusively) on liquidations
(sales of the firm piecemeal or as a going concern to third parties) needs a
clear set of rules to handle any number of problems that are likely to arise.
A sale of assets to a third party must be free of all claims against it.
Those who have claims against the firm must satisfy themselves out of the
proceeds of the sale. If they are able to pursue the assets at a later time,
the price that can be realized from the sale will be depressed. Assume, for
example, that the firm is liable to thousands of individuals who have been
exposed to toxic substances that the firm once sold. The rights that these
victims have or will have against the firm exceed its net worth. Unless the
firm can be sold to a third party free of liability to the victims (who, of

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146 THE JOURNAL OF LEGAL STUDIES

course, share in the proceeds from the sale), the third party would never
pay what the firm was worth as a going concern, only what it was worth if
it were liquidated in a way that liability would not follow any of the
assets.19 Any second-guessing of the sale or the sale price would depress
the sale price. A third party must be able to enjoy the possibility that the
firm will do unusually well, or he will not accept the risk that the firm will
do unexpectedly badly.20 Similarly, there needs to be a mechanism for
resolving disputes about the firm's assets. To the extent that creditors (or
others) can assert that the firm does not own specific property (because it
is only leased, not sold), they can depress the sale and hold up the firm for
more than the value of their nonbankruptcy entitlements. The more vari-
ous parties are allowed to tie up the disposition of the firm's assets, the
less likely it is that the sale will bring the best possible price.
In addition, one must evaluate trade-offs between creating additional
uncertainty and gaining the most for the assets. For example, a require-
ment that a firm be sold for cash or a cash-equivalent imposes a cost that
may not be outweighed by the certainty it provides. In the case of small
corporations, those most anxious to buy the firm (and hence willing to pay
the most for it) may prefer, because of the different tax consequences, to
pay for the firm with shares of stock rather than with cash. If a market for
the stock exists, the shares may be sufficiently liquid that it makes little
difference. The trustee, on being given the stock, can sell it and convert it
into cash or transfer it to creditors and allow them to convert it to cash.
But such a market may not exist. A difficult choice must be made: one
must weigh the uncertainty of accepting stock that is difficult to value
against the possibility of receiving less for the assets of the firm by insist-
ing on cash.
Even though Chapter 7 permits going-concern liquidations, it was not
drafted with such sales in mind. The powers of the trustee have been
conceived over the years as the powers of someone who would oversee
the dismantling of a firm. Were the use of Chapter 7 to change, the powers
of the trustee (and the ways in which his behavior would be monitored)
would also change. Existing laws that give investors different rights if a
firm is liquidating rather than reorganizing should be eliminated. The
trustee should be able to transfer to a third-party buyer not merely all the

19 Mark Roe has made this point in Roe, supra note 4.

20 The fallacy of the "second-look" doctrine has been well understood. See, for example,
supra note 14; Spitzer v. Stichman (In re Hudson & Manhattan R. R. Co.), 278 F.2d 402, 410
(2d Circ. 1960); Victor Brudney, The Bankruptcy Commission's Proposed "Modifications"
of the Absolute Priority Rule, 48 Am. Bankr. L. J. 305, 331-35 (1974). It does surface now
and again, however. See, for example, William J. Rochelle, Jr., & Jack H. Balzerson,
Recommendations for Amendments to Chapter X, 46 Am. Bankr. L. J. 93, 99-102 (1972).

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 CORPORATE REORGANIZATION 147

tangible assets of the firm but also the intangible ones, including such
things as the lawsuits the firm has against others, such as its creditors and
managers. Some tax rules provide additional examples. Under existing
law, a tax-loss carryforward disappears when there is a sale of the firm for
cash, but it survives a sale of the firm for securities (even if they can be
readily converted into cash), and it survives when a firm is reorganized
under Chapter 11.21 The rule governing tax-loss carryforwards should be
independent of what kind of bankruptcy proceeding is involved and, in-
deed, whether there is any bankruptcy proceeding at all. To the extent
possible, bankruptcy law should not interfere with substantive nonbank-
ruptcy rights. Its ambition should be modest; it should give investors of a
firm an ability to readjust ownership interests in a firm that they would
bargain for if they had the opportunity.
This paper has suggested that the premise underlying Chapter 11 of the
Bankruptcy Code may be unsound. But in making this observation, one
should not overlook the virtues of the existing law. Existing rules of
corporate reorganizations are a vast improvement over what preceded
them. The number of cases in which the bankruptcy process has done
what it is supposed to do (readjust ownership interests while at the same
time respecting substantive nonbankruptcy rights without interfering with
the optimum deployment of the assets) is much greater now than it was
before the Bankruptcy Reform Act was passed in 1978, and courts are
more sensitive to the basic principles of bankruptcy law. A good example
is the Ninth Circuit's decision in American Mariner.22 There the court
held that a bankruptcy judge must take into account the time value of
money in deciding whether a secured creditor's interests were "ade-
quately protected." A failure to take time value into account would have
improved the position of junior creditors at the expense of the secured
relative to what it would have been outside of bankruptcy. Despite weak-
nesses of the Bankruptcy Code and the blind spots of some of its prac-
titioners (such as the failure to recognize when it is not in the interests of
the owners as a group for the firm to continue as a going concern), the
need to reform it may not be as pressing as the need to interpret it sensi-
bly.23 The Supreme Court's opinion last term in Commodities Futures
Trading Commission v. Weintraub24and its emphasis on the need to look
to nonbankruptcy law to determine both substantive and procedural
rights in bankruptcy seem healthy steps in the right direction.
21
See I.R.C. ? 368.
22
In re American Mariner Industries, 734 F.2d 426 (9th Cir. 1984). This problem is
discussed in Baird & Jackson, supra note 9.
23
If the past is any predictor of the future, the next reform should come in thirty years or
so. Major bankruptcy legislation was passed in 1800, 1841, 1867, 1898, 1938, and 1978.
24
105 S. Ct. 1986 (1985).

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