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SECURED CLAIMS IN BANKRUPTCY: Can Disclosure by Borrowers Eliminate the Problem of Excessive Use 2

Moreover, notification is unlikely to be able to cost-effectively reduce nonadjustment (and, therefore, the absence of notification is not likely to indicate that the magnitude of nonadjustment is small) for creditors with small claims that could in principle adjust the size of their claims to take into account the existence of previously-issued secured debt in the borrower’s financial structure. The cost of effectively communicating one’s financial structure to these creditors may not be insignificant.

First, the debtor will have an incentive to mislead because the debtor would face liability only in the event it cannot pay its creditors, at which point the debtor has already failed, and the additional liability is of no consequence. Thus there must be a third party involved to provide verification.93 Second, accuracy would require that disclosure be continuous; otherwise, lenders would suspect that, since the previous disclosure, the borrower had significandy changed its financial structure to their detriment read only.

Third, and most importantly, even if the borrower could cheaply provide up-to-date accurate information about its financial structure, creditors with small claims would still bear the cost of assessing the information provided by the borrower and the cost of negotiating special rates. When the amount of the loan, and therefore the expected risk of loss, is relatively small, it will simply not be worthwhile for the creditor to incur these processing and negotiation costs. Moreover, even in the absence of those costs, many creditors with small claims—including the borrower’s employees and customers—are not sophisticated enough to adjust the (implicit) rate they charge a borrower to take into account the existence or non-existence of secured debt in the borrower’s financial structure.

In short, borrower disclosure is unlikely to convert creditors with small claims into adjusting creditors, and in any event could not cause the other three classes of nonadjusting creditors (tort creditors, the government, and creditors with prior claims) to become adjusting.

This post was written by , posted on August 14, 2014 Thursday at 3:51 pm