Corporate bankruptcy law is built around the idea of replicating the hypothetical bargain that would occur among creditors of a firm if they could all negotiate ex ante. By the common account, the creditors in that bargain would agree on a set of rules that maximize value. In our working paper, “The Bankruptcy Partition,” we introduce an important qualification to this idea. When investors gather to invest in a common venture, their focus is on maximizing the value of that particular venture, rather than maximizing their total wealth as a group. The focus of the hypothetical creditors’ bargain, then, is similarly limited. The bankruptcy partition draws the line that defines the assets and procedural forum that fall within that focus.

This foundational point has been absent in many recent bankruptcy debates. Indeed, we suggest that concentrating on the partition and establishing a framework for what lies inside and outside the bankruptcy partition can largely moot a recurring debate in the courts and the academy: whether the bankruptcy judge should enjoy the discretion to depart from bankruptcy’s distributional rules. We suggest that once the dynamics of establishing and policing the bankruptcy partition are taken into account, there is little room for departures from bankruptcy’s distributional rules.

Using examples from recent high-profile debates in bankruptcy cases—from critical vendor orders to the Supreme Court’s decision last year in Jevic—we show that most analyses have mistakenly focused on distributional questions without first identifying which assets and procedural rights fall with the bankruptcy partition. What appear to be distributional disputes are more often debates about the demarcation of the bankruptcy partition and the best way to police it.

Read more at The CLS Blue Sky Blog