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SECURED CLAIMS IN BANKRUPTCY: Some Preliminary Points 2

File-for-Bankruptcy
Suppose that the reason that certain lenders will not lend without a security interest is that security interests afford the lender priority in bankruptcy over the claims of unsecured creditors. Currently, secured claims do not get full priority in bankruptcy. Thus, these lenders clearly do not require full priority, and are satisfied with partial priority. The question, then, is how much priority is necessary to induce these lenders to lend? 90%? 80%? And how much priority would a secured lender require if it also obtained a guarantee from the borrower’s owners?
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Now suppose that the reason why certain lenders will not lend without a security interest is that the security interest gives lenders many other rights which are connected not to the priority accorded to secured claims in bankruptcy, but rather to something else. For example, it is possible that many lenders will not lend without a security interest because they have no other means of preventing the borrower, should it be on the verge of failing, from liquidating its assets and distributing the proceeds to related parties. To the extent certain lenders insist on a security interest for this reason, a partial priority rule in bankruptcy will not cause these lenders to lend any less. In short, we are skeptical of the claim that if priority is further reduced, the supply of secured credit will materially decrease (while, according to the same claim, the supply of unsecured credit would remain the same).
We just explained that the adoption of a formal partial priority rule need not reduce the aggregate supply of secured credit in the economy. Let us now consider how a partial priority rule would affect the aggregate cost of credit, assuming, for purposes of the analysis, that the availability of credit remains the same. As we will see, a partial priority rule could either increase or decrease the aggregate cost of credit in the economy.

This post was written by , posted on January 28, 2015 Wednesday at 4:41 pm