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SECURED CLAIMS IN BANKRUPTCY: ON THE COST AND AVAILABILITY OF FINANCING UNDER PARTIAL PRIORITY

Why Not Partial Priority Outside of Bankruptcy?

The rules we describe would apply in bankruptcy. However, it is important to emphasize that we are not advocating, as others have suggested, that partial priority apply only in bankruptcy. If partial priority is superior to full priority, we think that this distributional principle should apply to any liquidation or reorganization of an insolvent firm, either inside or outside of bankruptcy.
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As a practical matter, however, it makes sense to consider first rules that would apply only in bankruptcy. First, it would be simpler to make changes to bankruptcy laws than it would be to make uniform changes to the various state laws that govern priority in personal property and real property. Second, there is no need to apply partial priority to solvent firms (and there may well be costs). A bankruptcy-only rule ensures that the rule will apply only to firms in financial distress.
Of course, a bankruptcy-only rule will not be as effective as a more widely implemented rule. However, as we will explain below, we think that a bankruptcy-only partial priority rule could still be quite effective.

ON THE COST AND AVAILABILITY OF FINANCING UNDER PARTIAL PRIORITY

Various symposium participants and others have expressed concern that a partial priority rule would have an adverse effect on the financing of business activity. That is, partial priority might make it more difficult for businesses to finance desirable (value-increasing) projects.
Before we analyze this claim in more detail, three points are worth noting upfront. First, in a world where not all business projects are value-increasing, the desirability of a partial priority rule’s effect on firms’ ability to finance their projects will depend not only on whether partial priority prevents some desirable projects from going forward, but also on whether it prevents some undesirable projects from going forward. To be specific, a partial priority rule’s effect on firms’ ability to finance their projects would actually be desirable (relative to an alternative rule) if the economic cost avoided when bad projects do not go forward is greater than the economic benefit lost when desirable projects do not go forward.

This post was written by , posted on January 25, 2015 Sunday at 4:36 pm