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A longstanding and basic principle of U.S. bankruptcy law is that a secured creditor is entitled to receive the entire amount of its secured claim—the portion of its bankruptcy claim that is backed by collateral—before any unsecured claims are paid. This principle of full priority is generally reflected in the provisions of the U.S. Bankruptcy Code, although, as is widely recognized, there are number of rules, doctrines, and practices that have the effect of eroding the priority of secured claims in bankruptcy. Until relatively recently, there has been a general consensus among economists and legal scholars that secured claims should be given full priority in bankruptcy because full priority promotes desirable contracting between borrowers and their creditors. As a result, the rules, doctrines, and practices that cause deviations

In a paper published last year in the Yale Law Journal entitled The Uneasy Case for the Priority of Secured Claims in Bankruptcy [hereinafter The Uneasy Case], we presented a detailed analysis of the economic costs that arise from according full priority to secured claims in bankruptcy. One of the main contributions of the paper was to show that full priority could give rise to inefficient contracting between a borrower and its creditors, and to several types of efficiency costs even in a world where all of the borrower’s creditors are voluntary and sophisticated. We also presented two partial priority rules that could reduce the inefficiencies we identified (one of which could, in principle, eliminate them). We suggested that the two rules of partial priority be considered as possible alternatives to the principle of full priority and the ad hoc system of partial-priority that currendy governs the treatment of secured claims in bankruptcy.

This post was written by , posted on June 21, 2014 Saturday at 3:17 pm