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Those who have expressed concern about full priority in the past have generally done so on fairness and distributional grounds. In contrast, our analysis in The Uneasy Case has focused on the efficiency costs of according full priority to secured claims. Our view is that, even assuming that efficiency is the sole criterion for assessing the desirability of full priority, full priority would still be problematic. This Part develops and defends our claim that, under full priority, security interests will be used excessively. What we mean by excessive use of security interests is as follows: in a loan transaction that will go forward whether or not a security interest is used, full priority may cause the parties to incorporate an inefficient security interest into the arrangement, a security interest whose use in the arrangement reduces the total value available to all parties affected.

The analysis of the problem of excessive use proceeds as follows. Under lull priority, the use of a security interest can effect a transfer of bankruptcy value from nonadjusting creditors—creditors that do not adjust the terms of their loan to reflect the effect on them of the creation of security interests which, under full priority, completely subordinate the nonadjusting creditors’ claims in bankruptcy. This transfer of value effectively acts as a “subsidy” for the use of a security interest, by reducing the apparent cost (or increasing the apparent benefit) to the borrower and the secured creditor of using a security interest. This “subsidy,” in turn, can lead to the use of inefficient security interests.

This post was written by , posted on July 15, 2014 Tuesday at 3:34 pm