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This Part addresses the circumvention objection that has been raised against our partial priority rules—that borrowers and creditors could easily avoid the effect of partial priority in bankruptcy. Two circumvention strategies have been considered. The first is that, regardless of how we implement partial priority, creditors could structure their transactions in a way that would be economically equivalent or similar to a secured loan, but formally would not fall under the partial priority rule. The second is that secured creditors seizing their collateral outside of, or prior to, the debtor’s bankruptcy filing can circumvent a partial priority rule implemented only in bankruptcy. The analysis of this Part suggests that neither one of these circumvention strategies is likely to materially undermine the effectiveness of a partial priority rule in bankruptcy. Before elaborating however, it is worth pointing out that there is a tension between the argument that creditors can easily circumvent a rule of partial priority and the argument that a rule of partial priority would substantially reduce the financing of good projects.

The Tension Between the Circumvention and Credit Availability Arguments against Partial Priority
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If one believes that borrowers and creditors can easily circumvent a rule of partial priority, then one cannot simultaneously argue that adoption of such a rule would substantially reduce the availability of financing for good projects. (Of course, if one believes that a creditor could circumvent a formal partial priority rule, but only at some expense, one could object to such a rule on the grounds that such a rule might produce undesirable transaction costs.) Likewise, those who argue that a partial priority rule would reduce the financing available for good projects are implicitly assuming that creditors could not easily circumvent such a rule.

This post was written by , posted on March 24, 2015 Tuesday at 4:48 pm