A Normative Theory of Bankruptcy Law: Bankruptcy As (Is) Civil Procedure
Mooney, Charles W Jr
This paper develops a normative theory of bankruptcy law called “procedure theory.” The core of procedure theory is that bankruptcy law exists in order to maximize the recoveries for holders of legal entitlements (“rightsholders”) in respect of a financially distressed debtor. Bankruptcy law in the United States is a branch of civil procedure and the jurisdiction of federal courts. Procedure theory holds that it generally is wrong in bankruptcy to redistribute a debtor ‘s wealth away from its rightsholders to benefit third-party interests, such as at-will employees and the general community. It also generally is wrong to rearrange priorities in bankruptcy as among a debtor ‘s rightsholders. Procedure theory explains what bankruptcy law is supposed to achieve, not how bankruptcy law is to achieve its proper ends.
Procedure theory draws support from three perspectives. First, it argues that it is incoherent to provide different substantive rules in bankruptcy when those substantive rules are equally applicable outside bankruptcy. This incoherence offends the interest of justice. Second, procedure theory is supported by the Erie doctrine in federal courts and considerations of federalism. Basic substantive law rules should not vary depending on the forum in which a proceeding is conducted-state court or bankruptcy court. Third, a public choice analysis reveals the enormous power of the bankruptcy bar. The Judiciary Committees in Congress and the bankruptcy courts are improper venues for the development of law that is not bankruptcy specific.
A justification for bankruptcy law must be that, as a collective proceeding, it can maximize or enhance recoveries and benefits for rightsholders when compared to nonbankruptcy law. This Article examines a number of important features of United States bankruptcy law that conflict with (or at least appear to conflict with) procedure theory. It generally rationalizes procedure theory with several of these features. In several other cases, procedure theory calls for a modification of current law.
During the past two decades, contemporary bankruptcy scholars have engaged in extensive academic debates that have played out in many law review articles and several books.1 This Article engages important aspects of those debates. It expands on a theme that I suggested almost a decade ago.2 It describes and defends a normative theory of bankruptcy law that views the core role of bankruptcy law as the maximization of recoveries for those with nonbankruptcy legal entitlements relating to financially distressed debtors.3 Stated otherwise, bankruptcy law should exist, essentially, in order to serve the interests of the holders of nonbankruptcy legal entitlements. I call these holders “rightsholders.”4 For reasons developed fully below, I refer to this normative theory as “procedure theory.”
This Article focuses primarily, but not exclusively, on business bankruptcy. It is in business bankruptcies, in particular in Chapter 11, that the greatest temptations may exist to favor extraneous social goals at the expense of a debtor’s rightsholders.5 It also focuses primarily on bankruptcy law in the United States, but the core insights of procedure theory should be robust in the consumer bankruptcy setting as well as under the laws of any jurisdiction.
Part II of this Article provides an overview of the principles embraced by procedure theory, including its ends and basic features. It also situates procedure theory in the ongoing normative debates about bankruptcy philosophy and policy and distinguishes procedure theory from much of the other bankruptcy scholarship that has been featured in these debates. In particular, it addresses academic critiques of the path-breaking scholarship of Douglas Baird and Thomas Jackson and identifies procedure theory’s similarities to, and differences from, Baird and Jackson’s theoretical work. Part III makes the normative case for procedure theory and identifies sources and bases of its normative content. It first addresses the application of procedure theory to the interests of a debtor’s rightsholders versus those of nonrightsholders and then as to the rights of a debtor’s rightsholders inter se. It then fashions a normative account of procedure theory based on jurisprudential and philosophical grounds, on theoretical underpinnings of civil procedure law and federal court jurisdiction, and on a public choice analysis. Part IV addresses bankruptcy law as a procedural system for maximizing recoveries and benefits for a debtor’s rightsholders. It considers justifications for bankruptcy law as a special branch of procedural law. It also identifies several aspects of bankruptcy law that alter or appear to alter nonbankruptcy entitlements. It explains how some of these alterations may be coherent under, and entirely consistent with, procedure theory. Part IV also tests procedure theory against various controversial elements of bankruptcy law and identifies some aspects of current bankruptcy doctrine that offend procedure theory. In this way it explores the explanatory and instructional powers of procedure theory to suggest doctrinal reforms. Part V then concludes the Article.
A complete account of procedure theory first would address all aspects of nonbankruptcy law as affected by all aspects of bankruptcy law. second, it would identify and call for retention of only those aspects of bankruptcy law that comport with procedure theory and the elimination of those that do not. Third, it would compare and contrast procedure theory with all of the theoretical academic literature on bankruptcy during (at least) the past two-plus decades. Fully realized, that project would be not only enormously ambitious but also quite lengthy. Instead, this Article will be satisfied to examine the intersection of some of the more important aspects of nonbankruptcy law with some of the more significant aspects of bankruptcy law, and it necessarily will be selective in the breadth and depth of its consideration of the literature. This initial project provides a platform for subsequent work that will target narrower, more discrete areas of nonbankruptcy law and bankruptcy law with correspondingly greater depth and detail.
II. Basic Elements of Procedure Theory
A. Normative Theory and Bankruptcy Policy
This Article should pose and answer several questions before outlining the content and significance of procedure theory. For example: What is a normative theory of bankruptcy law? What distinguishes a normative theory of bankruptcy law from other approaches-both normative and non-normative-to examining and providing content to bankruptcy policy? What is it that a normative theory of bankruptcy law does and does not do?
In his 1996 article, Professor Donald Korobkin explained how normative theory could contribute to the ongoing policy debates about bankruptcy law.6 For the most part, I subscribe to Korobkin’s taxonomy of bankruptcy scholarship, which may be non-theoretical or theoretical and non-normative or normative.7 A normative theory can provide a compelling story about what the means and ends of bankruptcy law should be.8 Although a normative theory also may provide explanatory insights concerning current bankruptcy law, it need not do so (at least not with perfect precision) to be successful. As Korobkin has observed, “[t]he very object of a normative theory is to establish a critical perspective on current law.”9 Obviously, normative theory is based on values. As a theory, moreover, normative theory may offer guidance for resolving competing values.10 To be successful, a normative theory of law must identify the nature and source of the values and principles on which it is based and also must offer some meaningful prescriptive force concerning how law should be altered or preserved. But it need not resolve every detail of a large and comprehensive statute such as the Bankruptcy Code.11 Put in context, procedure theory prescribes what bankruptcy law should achieve, but it does not dictate precisely how to accomplish its goals most effectively, except in a very general fashion.12 Indeed, there is no reason to suppose that a single means or structure can reach the ends of bankruptcy law.
The following subpart outlines the essential attributes of procedure theory. Procedure theory identifies the ends that bankruptcy law is supposed to achieve. Essential goals are the cornerstone of any normative theory of bankruptcy law. Procedure theory holds that the goal of bankruptcy law as a system is to maximize the recoveries or other benefits for the debtor’s rightsholders. A corollary of this principle recognizes the procedural character of procedure theory: Bankruptcy law should take substantive legal entitlements of rightsholders as it finds them, honoring both powers and limitations under nonbankruptcy law.
B. The Ends and Principles of Procedure Theory of Bankruptcy Law
1. Bankruptcy as Civil Procedure
Procedure theory conceptualizes bankruptcy law as a subset of the law of civil procedure.13 Thus, before turning in earnest to what it is that bankruptcy law should do (and does), it is helpful to focus on what it is that civil procedure should do (and does). It is the relationship of procedural law to substantive doctrinal law that gives content to the nonbankruptcy legal entitlements of rightsholders. Books on civil procedure normally begin with an identification of the substance-procedure dichotomy.14 A standard conceptualization is that substantive law creates legal rights and duties and procedural law provides a means to enforce the substantive rights and duties.15 Procedural law serves substantive law, the latter having primacy in this sense.16 Although a significant role of procedural law is the actual resolution of disputes between and among parties, it also is a “social process.”17 Procedural law must provide assurances to all parties that the process is fair and that they will have an opportunity to present a case.18 Moreover, procedural law should provide courts that are available to parties at a reasonable cost and that act with reasonable swiftness. It should also result in final resolutions that provide repose and security.19
The social significance of civil procedure embraces much more than a means of judicial enforcement of private rights. It is inextricable from and essential to those rights.20 For example, the quality of a tort claim or contract claim necessarily, and obviously, is a function of the enforceability of the claim-whether a court would be legally obliged to give a remedy to the holder of the claim. But it also is a function of whether or not there exists a judicial system available to the claimant pursuant to which the claimant in fact can both obtain a legal remedy (such as a money judgment) and exercise effective judicial enforcement (such as execution and sheriffs sale or garnishment). To the extent that effective procedural remedies are not available, the substantive doctrine of tort and contract law provided by lawgivers-legislatures, judges, and administrators-is undermined.21
An understanding of the role of procedural law is informed by the comparative work of Kathryn Hendley. Among other things, Hendley addresses the relationship between substantive and procedural law in her insightful book on the role of law in the former Soviet society.22 Her study focuses on “law in action”-how “law was actually being implemented at the grassroots level.”23 Hendley argues that law can matter either reciprocally or coercively. Law matters in the reciprocal sense (Hendley’s preferred sense) when it serves “as a means of constraining official power, vindicating citizens’ grievances, and facilitating private transactions.”24 On the other hand, law matters in a coercive sense when its effect and design is to impose social order.25 Hendley identifies the “defining elements of law that matters reciprocally” as “legitimacy, accessibility, and efficacy.”26 These elements are affected by the nature of the enforcement system available to litigants. If the applicable enforcement system is adequate, the system enhances legitimacy, accessibility, and efficacy. A defective enforcement structure detracts from these elements.27
Hendley explains that only by understanding the specific characteristics of the gap between the written law and the law as implemented can one realistically evaluate the obstacles to the realization of a legal order in which law matters reciprocally, not coercively.28 Under the Soviet regime, the low level of trust in the basic fairness of law-both substantively and procedurally-resulted in a great reluctance of Soviet citizens to turn to the legal system for vindication of their rights.29 A widely held belief that the judicial system or judge is inherently biased or corrupt discourages resort to the courts.30 Substantive doctrine is meaningless in a system in which an aggrieved party cannot obtain effective relief in the courts. Significantly, the inadequacy of available remedies and judicial enforcement power also contributed to this reluctance, thereby rendering the Soviet courts ineffective.31
One can easily apply Hendley’s analysis of the Soviet legal regime to legal systems in developing third-world countries, many of which may possess similar attributes.32 It also offers to inform the study of bankruptcy law, improbable as that might seem at first glance. Viewed in this context, Chapter 11’s dilution of the benefits of some rightsholders arguably moves the aggregate system of civil procedure in the United States toward the third-world model.33 The infamous delay and expense imposed by Chapter 11 provides an obvious example.34 Another example is the failure to compensate secured creditors for the delay in obtaining and applying the value of their collateral.35 But the object of the present discussion is not a critique of current bankruptcy law through the lens of procedure theory.36 Instead, the central point here is to emphasize the connection between the aggregate system of civil procedure and the underlying rights provided by lawgivers under the substantive doctrine created for the benefit of rightsholders.37
Procedure theory’s conceptualization of bankruptcy law as civil procedure necessarily raises a more fundamental question. Why have bankruptcy law? In other words, what value does bankruptcy law add, if anything, to the generally applicable structure of civil procedure? Douglas Baird posed this challenge several years ago,38 and I confront this challenge below by examining the means employed by bankruptcy law to achieve its end.39 But first I consider in more detail procedure theory’s contemplation of the ends to which bankruptcy law should be directed.
2. Respecting Nonbankruptcy Entitlements of Rightsholders: Procedure Theory in Context
As explained above, procedure theory takes as its central principle that bankruptcy law should maximize the recoveries and benefits for a debtor’s rightsholders, but within constraints consistent with the rationale for having a bankruptcy law. Before examining the normative basis for procedure theory, it is worth considering bankruptcy policies reflected in the Bankruptcy Code itself. In our recent article, Professor Steven Harris and I undertook this positive account and noted the enormous respect that the Bankruptcy Code generally affords legal entitlements under nonbankruptcy law.40 In particular, we argued that Revised Article 9 of the Uniform Commercial Code is fully consistent with the policies underlying the Bankruptcy Code.41 As we acknowledged, our positive account could not answer the question whether and to what extent bankruptcy law should respect nonbankruptcy entitlements.42 Procedure theory addresses that question.
Procedure theory draws its authority and normative force from the moral foundations of the sources and substance of nonbankruptcy law. It assumes a legitimate basis for respecting the decisions of our lawgivers. And it assumes that bankruptcy law, as a part of the law of civil procedure, should not undermine these rules of law based on conflicting policy views. In short, nonbankruptcy law determines rightsholder status. Unless special treatment in bankruptcy can be justified on a basis or context peculiar to bankruptcy,43 nonbankruptcy policies announced by lawgivers necessarily are undermined if the interests of persons other than rightsholders are addressed in bankruptcy to the detriment of rightsholders. The same is true if the interests of rightsholders are diminished or enhanced at the expense or for the benefit of other rightsholders in a manner inconsistent with nonbankruptcy law. These caveats are crucial. Clearly, bankruptcy law could improve the lot of persons other than rightsholders while in no way deviating from procedure theory. But procedure theory holds that the interests of rightsholders should not be set aside or put at risk for the benefit of nonrightsholders or for the benefit of other rightsholders.
Procedure theory recognizes that bankruptcy law is not only about enforcing the rights of rightsholders against a debtor but it also addresses protection of the interests of the debtor. In the case of a corporate debtor the distinction in not significant, inasmuch as the interests of the corporate debtor can be identified by the interests of the shareholders, who are themselves rightsholders. Even in the case of an individual business debtor, the debtor is a rightsholder. Civil procedure is about a fair system of determining and dealing with legal entitlements of all concerned, and bankruptcy law fits this model.
In recognizing that nonbankruptcy law creates, defines, and shapes the contours of the legal entitlements of a debtor’s rightsholders, procedure theory acknowledges the essential procedural nature of bankruptcy law. For example, nonbankruptcy law regulates competing claims to the debtor’s property and orders the priorities to be afforded to those claims. Procedure theory generally rejects a bankruptcy system that would create a special reordering of rightsholders’ interests in bankruptcy, whether inter se or vis-a-vis nonrightsholders. Procedural law, including bankruptcy law, should further, enhance, and vindicate, but not disrupt, policies that nonbankruptcy law creates and seeks to implement.
This overview of procedure theory must acknowledge its limitations as well. In two important respects, procedure theory presents a less sharp dichotomy than the foregoing might suggest. First, procedure theory’s respect for nonbankruptcy legal entitlements is not absolute. Bankruptcy law doesand should, even under procedure theory’s dictates-alter these entitlements in significant ways. Pro rata distribution among similarly situated claimants provides an example. As explained below, however, the concept of pro rata distributions conflicts with nonbankruptcy law only superficially and is fully consistent with procedure theory.44 Bankruptcy law materially alters nonbankruptcy entitlements in other respects as well. Some of these alterations are consistent with procedure theory, and some are not.45 As explained in Part IV, procedure theory recognizes that it sometimes is appropriate-and in fact feasible-to relax procedure theory’s strict respect for nonbankruptcy legal entitlements and to distinguish the procedures and remedies in bankruptcy (or any other collective system for dealing with financial distress) from those applicable under nonbankruptcy procedural law. But these special bankruptcy deviations are justified under procedure theory only when the bankruptcy context is distinctive and when they further procedure theory’s ends of generally respecting nonbankruptcy legal entitlements.46
Second, the dichotomy between procedural law and substantive law tends to blur at the margin. Moreover, the shape and effectiveness of procedural law necessarily have profound substantive effects. Bankruptcy law’s deviations from nonbankruptcy entitlements, such as pro rata sharing, undoubtedly are substantive in effect even if also characterized as a part of a generally procedural body of law.47 Furthermore, demonstrating that bankruptcy law essentially is procedural in nature does not of itself support a compelling normative theory. The procedural label may offer some illumination and a useful framework for analysis, but the label alone cannot carry the normative argument.48
Given these limitations, procedure theory faces three significant challenges. First, it must provide a convincing normative account of why bankruptcy law generally should respect, enforce, and give effect to nonbankruptcy legal entitlements. second, it must offer a coherent account for its acceptance of a relaxation of this general principle of respect in bankruptcy in certain limited but material respects, while not rendering the general principle superfluous. Third, it must take seriously and confront claims that bankruptcy law as we know it simply is not susceptible to any overarching normative theory.49
C. Situating Procedure Theory in the Normative Debates on Bankruptcy Philosophy and Policy
This subpart fits procedure theory into the ongoing normative debates about bankruptcy policy. Anyone joining these debates can draw enormous assistance, as have I, from Douglas Baird’s insightful article, Bankruptcy’s Unconlested Axioms.50 In his article, Professor Baird identifies and contrasts two separate “camps” of bankruptcy experts.51 The “traditionalists” inhabit one camp, and the “proceduralists” occupy the other.52 Traditionalists typically are bankruptcy lawyers and similarly inclined academics.53 They generally are skeptical of economic models and favor more general conceptions of equity and fairness.54 Traditionalists are open to redistributional goals of bankruptcy, and believe that “preservation of firms (and therefore jobs) is an important and independent goal of bankruptcy.”55 They seek to protect employment and general community interests, for example, as well as providing equity among creditors.56
Baird describes proceduralists as academics who focus (unsurprisingly) on procedure.57 Proceduralists resist redistributive goals for bankruptcy and interference with nonbankruptcy entitlements, except as may be necessary to maximize value for the holders of entitlements.58 In particular, proceduralists emphasize the instrumental role of law both outside and inside bankruptcy.59 They believe that efficient markets should permit the failure and liquidation of economically distressed firms-firms whose businesses cannot succeed because, for example, their products or services are inferior or otherwise are not desirable. In their view, bankruptcy’s goal is to preserve the value of financially distressed firms (firms with sound businesses but are unable to pay their obligations).60 They prefer market solutions to financial distress over judicial discretion.61 Offering essentially an economic account of bankruptcy, proceduralists insist that decision-making power in bankruptcy-whether to liquidate or attempt to reorganize-should be placed in the hands of those who stand to gain or lose.62 In the case of an insolvent debtor, that power should reside with the unsecured creditors, as shareholders and management have nothing to lose.63
Ted Janger has summed up Baird’s identification of the important frontiers of the traditionalist-proceduralist divide:
According to Douglas Baird, three litmus test questions, or axioms, determine a scholar’s affiliation. These questions are (1) whether the Bankruptcy Code should seek to rehabilitate firms; (2) whether bankruptcy judges should alter non-bankruptcy entitlements in order to rehabilitate firms; and (3) whether bankruptcy judges are capable of distinguishing ; likely candidates for reorganization from firms that are destined to fail. The paradigmatic proceduralist answers “no” to each question, while the paradigmatic traditionalist answers “yes” to all three.64
Janger dubs Baird’s proceduralist answers to the first two questions, that bankruptcy law “should not favor reorganization and . . . engage in post hoc reallocation of prebankruptcy entitlements,” as the “proceduralist ‘should not.'”65 He explains that Baird and some (but not all) other proceduralists, embrace a “weak version” of the “should not” principle, recognizing that some nonbankruptcy entitlements may need to be modified in order to, and only in order to, resolve the collective action problem that is created upon insolvency. What they oppose is redistribution for its own sake, not redistribution that increases the value of the bankruptcy estate.”66 Janger calls the proceduralist answer to the third question the “proceduralist ‘cannot.'”67 Even if judicial discretion might be justified by the weak version of the “should not,” proceduralists like Baird believe that judges are incapable of identifying which firms can successfully be reorganized and which cannot.68
No doubt, Thomas Jackson’s path-breaking article, Bankruptcy, NonBankruptcy Entitlements, and the Creditors’ Bargain,69 marks the inception of the proceduralist academic school. The creditors’ bargain theory, as further developed by both Jackson70 and Baird,71 featured a pseudo-Rawlsian contractarian core based on the idea that bankruptcy law generally reflects the hypothetical creditors’ bargain that creditors would reach if they were to bargain before their extensions of credit.72 But the theory generally embraced the principles that Baird has attributed to proceduralists, including respect for nonbankruptcy entitlements in bankruptcy except as necessary to solve the collective action problem facing creditors under the first-in-time state law collection system.73 While the creditors’ bargain itself never attracted widespread acceptance,74 the proceduralist principles that it embodied have been durable.75
Both the creditors’ bargain theory and the proceduralist variations have drawn considerable criticism from scholars in the traditionalist camp,76 scholars with an economics perspective,77 and scholars whose approaches are not easily classified.78 Procedure theory seeks to respond to and deflect much of this criticism. Procedure theory’s partial response is that it is less comprehensive than other proceduralist accounts. My personal policy intuitions favor most if not all of Baird’s proceduralist positions-embracing the weak “should not,” to use Janger’s characterization. But procedure theory as presented here stakes out a more modest scope. In his critique of Jackson’s creditors’ bargain theory, David Carlson challenged the very idea that anyone could discover a coherent “deep structure” in the Bankruptcy Code.79 Procedure theory proposes a much shallower structure but a normative structure nonetheless.
By proposing a baseline that generally respects nonbankruptcy legal entitlements in bankruptcy, procedure theory fully embraces the proceduralist “should not.” But this feature of procedure theory is not grounded normatively on contractarian theory, as Jackson claimed the creditors’ bargain to be, or on opposition to forum shopping. Indeed, its normative base is not primarily utilitarian at all, instead it draws normative support from the incoherence of any other baseline, insights drawn from bankruptcy law seen as a branch of civil procedure and federal court jurisdiction, and public choice perspectives on bankruptcy law. Procedure theory’s “should not” adopts neither the “weak” nor the “strong” versions. It can coexist with welfare-enhancing redistributive rules under the weak version80 or with adaptations of the strong version, such as permitting debtors to contract for bankruptcy terms or to provide for them in corporate charters.81 Procedure theory also does not dictate the shape of bankruptcy law except to acknowledge that bankruptcy law may be necessary to maximize the benefits for a debtor’s rightsholders.82 It identifies the beneficiaries, a debtor’s rightsholders under nonbankruptcy law, but does not specify the details of how value is to be preserved or grown for their benefit. Procedure theory is about who gets the pie, not about how to preserve or grow it. Consequently, it does not advocate for or against either market-based bankruptcy structures,83 generally favored by proceduralists, or those grounded in judicial discretion, favored by many traditionalists.84 This is not to say that neither approach is better than the other (one probably is)85 or that the preservation and growth of value are not important (they are, obviously), but procedure theory as advanced here does not offer an answer.86
In addition to rightsholders, bankruptcy law has other plausible beneficiaries. For example, no doubt a rehabilitated debtor firm could provide benefits to a variety of external constituencies, such as governments (more taxes), existing and future employees (continued or new employment and higher wages), and communities (wealth enhancements from increased economic activity). Procedure theory does not deny the existence or importance of these constituencies. They are without question direct social beneficiaries that a system of bankruptcy law can serve by preserving and growing value. But procedure theory holds that bankruptcy law should serve them only collaterally; it objects to serving these interests to the detriment of the interests of rightsholders.87
D. Why Bankruptcy?
1. Preserving, Increasing, and Fairly Distributing Value
This discussion meets, at least in part, Baird’s important challenge to explain why we need a bankruptcy law.88 In the context of procedure theory, if bankruptcy is civil procedure, why is civil procedure not bankruptcy? Why do we need a special body of procedural law for debtors in financial distress? Procedure theory’s justification for a bankruptcy law is that specialized bankruptcy procedure can serve to maximize the recoveries of and benefits for rightsholders. If the otherwise applicable procedural law were up to the task, however, much of bankruptcy law would be unnecessary.89 The same could be said in a perfect market world in which costless contracting could settle the matters that arise in financial distress and insolvency.90 Happily, there appears to be a general consensus that a bankruptcy law (in some form) is necessary for business debtors as well as individual consumers.
The need for a bankruptcy law is most obvious in the case of a debtor in financial distress, which typically involves multiple defaults on its obligations and the present or anticipated inability to satisfy its obligations.91 A debtor in financial distress may or may not be insolvent in the sense of its obligations exceeding the value of its assets.92 There is little disagreement that one important justification for a bankruptcy law is that it facilitates the preservation, and sometimes even the increase, of value for the collective benefit of rightsholders when compared to the nonbankruptcy law’s provisions for the enforcement of legal entitlements-most typically, the collection of debts.93 A single collective proceeding provides advantages over the independent efforts of rightsholders to secure their entitlements under nonbankruptcy law. For example, by calling off these uncoordinated efforts, the automatic stay imposed by Section 362 of the Bankruptcy Code allows the trustee-normally the debtor in possession in a Chapter 11 case-to identify and preserve the debtor’s assets.94 Although the automatic stay obviously and materially interferes with the enforcement of nonbankruptcy entitlements of rightsholders, it is a justifiable procedural device to the extent that the end result maximizes (or at least enhances) the benefits for rightsholders.95 Even outside bankruptcy, the civil judicial enforcement of legal entitlements takes time-it is not instantaneous. Viewed in this way, one can see bankruptcy as a class action enforcement proceeding for rightsholders; it provides a single proceeding in a single court in which the affairs of the debtor and its rightsholders are sorted out.96 Resulting cost savings and efficiency gains in bankruptcy are analogous to those for which the class action has been created.97
In addition to preserving value for the benefit of rightsholders, bankruptcy law also provides a necessary procedural means for determining who is entitled to the value-for identifying the debtor’s legitimate rightsholders under nonbankruptcy law. Moreover, it provides procedures for distributing the value to rightsholders, either in liquidation or under a plan of reorganization.98
To be sure, enormous disagreement exists on the answers to and the normative basis for answering questions such as why and for whose benefit is bankruptcy law positioned to preserve value.99 For example, Jackson sees bankruptcy essentially as a response to a “common pool” problem.100 Under the state law first-in-time “grab” rule, individual creditors’ actions would harm the creditors as a group.101 Bankruptcy law can ensure a larger pie, on average, for creditors by preserving a firm’s “going concern” value.102 As a corollary, in Jackson’s view bankruptcy law generally should respect nonbankruptcy entitlements except as necessary to benefit creditors as a group.103 Unwarranted deviations from this principle would provide incentives to file bankruptcy cases in circumstances in which bankruptcy is an inappropriate response.104 On the other hand, Korobkin’s Rawlsian-contractarian theory would extend the proper reach of bankruptcy to address goals of all affected interested persons, including nonrightsholders.105
Procedure theory resolves the Jackson-Korobkin disagreement by concluding that bankruptcy law should exist to vindicate and enhance benefits for a debtor’s rightsholders generally as their rights exist according to nonbankruptcy law. To this extent it lines up with Jackson and other proceduralists, but without embracing Jackson’s creditors’ bargain or common pool heuristics. Procedure theory embarks from the commonly accepted proposition that there is a need for a collective federal bankruptcy law designed to preserve value that justifies the existence of bankruptcy as a separate, distinct body of procedural law.106
Procedure theory does not reject the idea that the shape of bankruptcy law can, in turn, impact contents and effect of nonbankruptcy law. For example, the protections afforded an individual debtor under bankruptcy law, such as the discharge,107 may relieve nonbankruptcy law from concerns that bankruptcy law adequately addresses.108 The interactions, however, between bankruptcy law and nonbankruptcy law in no way undercut procedure theory’s normative ground. Procedure theory addresses the appropriate role of bankruptcy law but does not deny that bankruptcy law has a proper domain.
In sum, procedure theory accepts the lowest common denominator of the accepted wisdom as to the need for a separate bankruptcy law. Its point of departure is the justification for a bankruptcy law on which almost everyone would agree. It then moves on to address whose interests bankruptcy law should serve and/or whose benefit bankruptcy law should preserve value.
2. Procedure Theory and the Effectiveness of Bankruptcy Law
Procedure theory addresses the ends of bankruptcy law, enhanced benefits for rightsholders, not the specific means. As already discussed, procedure theory addresses the question whether the goals of bankruptcy should extend beyond benefiting rightsholders.109 But procedure theory makes no specific claims about the overall effectiveness or ineffectiveness of the provisions of the Bankruptcy Code in preserving wealth.
The particular outlines of bankruptcy law are as important as they are controversial. To the extent that current law fails to serve optimally the interests of rightsholders, procedure theory welcomes, but generally does not propose, useful reforms. For example, procedure theory does not address all aspects of the ongoing critiques and defenses of Chapter 11 reorganization. The delay and cost of Chapter 11 reorganization is a recurrent theme.110 Some scholars have questioned the very need for a regime such as Chapter 11.111 Others have stepped up with a vigorous defense.112 Still others have argued for retention of a system for reorganization with more or less radical market-based adjustments.113 Some have argued for a firm-by-firm contractually based system for reorganization of financially distressed debtors.114 The Chapter 11 debates are important and ongoing and reflect analogous debates about corporate governance.115 Baird and Rasmussen, understanding bankruptcy reorganization as a problem of corporate governance, recently explained the overriding importance of “control rights” in Chapter 11.116 Ultimately, however, debates over bankruptcy law will be resolved, if at all, in Congress. But proceduralists and traditionalists are unlikely to develop consensus views on either the basics or the specifics.117
While procedure theory may have little to advise about the effectiveness of bankruptcy law generally in preserving wealth, it must weigh in on whether bankruptcy law is faithful to the theory’s tenets.118 To this end, Part IV addresses several of the principal attributes of bankruptcy law and tests them against procedure theory. Next, Part III sets up the normative case for procedure theory.
III. The Normative Case for Procedure Theory
This Part makes the normative case for procedure theory. The first two subparts address the two contexts in which bankruptcy law is most likely to offend procedure theory. Subpart A considers interests of rightsholders vis-a-vis the extraneous interests of nonrightsholders-in particular, employees and other direct and indirect beneficiaries of debtor rehabilitation, including the larger community. Subpart B takes up the interests of rightsholders inter se. Subparts C, D, and E then examine the normative bases for procedure theory, focusing on procedure theory from the perspectives of legal philosophy, civil procedure and federal court jurisdiction, and public choice analysis.
A. Interests of Rightsholders Versus Interests of Nonrightsholders: Employees, Rehabilitation, and Community
Three sets of related interests or goals have commonly been mentioned in the literature as deserving of consideration in bankruptcy, whether or not nonbankruptcy law would take account of these interests. First, proponents of a broad scope for bankruptcy law’s goals point to the interests of employees.119 Of course, to the extent that an employee has an employment contract with or is owed wages by the debtor, the employee is a rightsholder.120 Of interest here are employees who care about future employment, to which the employees presumably hold no legal entitlement. A second interest is that of the reorganization or rehabilitation of debtors. Rehabilitation, the argument goes, sometimes can be a beneficial alternative to liquidation.121 To the extent that rehabilitation would preserve, or increase, value for the benefit of rightsholders, this rehabilitation interest does not run afoul of procedure theory.122 But to the extent that the interests to be protected by the rehabilitation goal are those of nonrightsholders and liquidation-as opposed to attempting rehabilitation-would be in the interests of rightsholders, the rehabilitation goal squarely offends procedure theory. Competing interests of nonrightsholders might include those of future employment for the debtor’s existing or future employees, future business opportunities for persons that wish to engage in business with the debtor or with the debtor’s future employees, or governmental interests in future tax revenues from the debtor’s future operations. A third interest sometimes singled out as deserving of special consideration in bankruptcy is that of “the community.”123 The interests of the community are essentially the same as those served by the employee-protection and rehabilitation goals. Preserving the going business can benefit the community at large. But it is taking into account these interests at the expense of rightsholders (because, for example, rightsholders would benefit from liquidation) that contravenes procedure theory.124
Consider an example. A Chapter 11 debtor in possession wishes to close one of its three plants, sell the related assets,125 and discharge many of the employees who work at the plant. The unsecured creditors’ committee supports the closure and sale. However, some unsecured creditors, whose businesses are located near the plant, a representative of the plant’s employees, and the city in which the plant is located all strongly oppose this step. Not surprisingly, the employees’ objections are based not on concerns about their legal entitlements such as payment of wages but on concerns about losing their jobs were the plant to close. The objecting creditors, likewise, are objecting not out of concern for satisfaction of their prebankruptcy claims, but concern for the loss of future business with the debtor were the plant closed as proposed. And the city lodges its objection based on the potential loss of future tax revenues and the negative impact on the local economy that would arise out of the proposed closure and termination of employees.126 Assume further that applicable federal and state nonbankruptcy law either (1) places no restrictions on the debtor’s closing of the plant127 and termination of the “at will” employees128 or (2) that the debtor complies with any applicable restrictions. Should the court consider these consequences of closure and sale, even though they have no bearing on the objectors’ legal entitlements? Clearly the answer is no, subject to one caveat. Procedure theory instructs that taking into account the interests of nonrightsholders generally is not within the proper domain of bankruptcy law.129
The caveat: If maintaining the operation of the plant would be in the interests of the debtor’s rightsholders generally and not to their detriment, then the judge’s taking into account the extraneous interests (future employment, future business, or community) might not contravene procedure theory.130 At worst, the court’s consideration of those factors would be harmless error. But this caveat is probably insignificant in practice. For example, if the debtor in possession and creditors’ committee supported the continued operations at a plant, why would the judge need to consider the extraneous interests beyond those of rightsholders?131
A closer examination of the basis for rejecting consideration of these extraneous interests that are not embodied in legal entitlements reveals a strong intuition as to the moral source of procedure theory. Consider the debtor in possession’s right to close the plant and terminate the employees under applicable nonbankruptcy law.132 Properly seen, the lawgivers have not only failed to restrict the debtor’s actions but have, implicitly but clearly, determined that society is improved when enterprises such as the debtor in possession retain this flexibility. If nonbankruptcy law has determined that restricting an employer’s right to close a plant and discharge its employees is a bad idea for a presumably solvent firm outside bankruptcy, it must be an equally bad (or worse) idea for a presumably insolvent firm in bankruptcy. That is to say, the harm that imposing or not imposing such a restrictive policy would address is wholly agnostic concerning the financial resources and viability of employers.133 Nonbankruptcy law reflects the considered social policy as whether and to what extent firms in a market economy should or should not be forced, or induced by threat of sanctions, to do business in a particular location when they deem it undesirable.134
Quite plausibly neither Congress nor the bankruptcy court135 even has the constitutional power to take into account these employee and community interests to the detriment of the debtor or the debtor’s rightsholders. Thomas Plank has developed a coherent and comprehensive doctrinal theory of the limited powers of Congress and the courts under the Bankruptcy Clause of the Constitution.136 He advances four principles that seek to identify and explain the dimensions of the “subject of Bankruptcies” as used in the Bankruptcy Clause. Under one of the four principles comprising Plank’s Bankruptcy Clause construct, the “Non-Expropriation Principle,” it is impermissible for Congress or a bankruptcy court to expropriate the rights of a debtor or its creditors for the benefit of a “Third Party.”137 Rights other than those held as a debtor or a creditor are rights held by a “Third Party” under Plank’s taxonomy.138 Heeding the wishes of Third Parties such as nonrightsholder employees and the city over the objections of the debtor or creditors appears to fit squarely within the proscriptions of Plank’s Non-Expropriation Principle because the Third Parties in the examples seek to enhance their wealth at the expense of the debtor and the creditors.139
It does not follow from the foregoing that procedure theory is hostile to the interests of employees or any other constituency of a debtor. Vary the example to assume that nonbankruptcy law provides substantial restrictions and consequences on a firm that wishes to close a plant.140 Now, assume that the debtor in possession and the unsecured creditors’ committee argue that closure should be permitted without compliance with the nonbankruptcy restrictions and without suffering any other interference or liability under nonbankruptcy law. They argue that the compliance and consequences would hinder the prospects for reorganization and the ultimate recoveries for the debtor’s rightsholders. Procedure theory dictates nonetheless that the debtor in possession is obliged to observe and suffer these restrictions and consequences. For example, the employees now are rightsholders not only to the extent of earned and unpaid wages but also as direct or indirect beneficiaries of the closure restrictions and consequences-even if not as creditors.141 Of course, the judge should take into account the interests of the debtor in possession and all rightsholders in determining whether to permit the plant to be closed, the assets to be sold, and the employees to be terminated. But the debtor should be required to observe the closure restrictions under nonbankruptcy law.142
Once again, it is plausible that neither Congress nor the bankruptcy court is constitutionally empowered to excuse the debtor from compliance with these restrictions to the detriment of the affected employees or other contemplated beneficiaries. Under this application of Plank’s “Non-Expropriation Principle,” bankruptcy law must not impair the rights of a “Third Party.”143 Depriving the direct and indirect beneficiaries of the value of the legal restrictions on plant closure clearly would violate this principle.
Assume next that the WARN Act provides its direct and indirect beneficiaries with rights that they do not enjoy under any other law. Does delivering these benefits in any way offend procedure theory? Of course not. The WARN Act is fully consistent with procedure theory because it is generally applicable within its scope; it is not a bankruptcy-specific law. One might argue that there are bankruptcy-specific considerations that warrant excusing a firm in bankruptcy from compliance with the WARN Act. The existence of a bankruptcy-related justification for special treatment could square that treatment with procedure theory.144 For example, if the debtor is liquidating and is no longer operating a business, relief from the WARN Act might be appropriate.145 But firms liquidate outside bankruptcy as well as inside bankruptcy. Bankruptcy is not a plausible, much less appropriate, proxy for liquidation. One also might argue that firms that genuinely cannot afford to comply with the WARN Act should be excused. Perhaps bankruptcy is a somewhat better proxy for the inability to pay. But the inability to pay is not the exclusive property of firms in bankruptcy. Indeed, the WARN Act itself recognizes as much in providing for exceptions based on various types of hardship.146 For present purposes, it is sufficient to note that procedure theory recognizes circumstances in which bankruptcy-only rules are appropriate, but plant closings and mass layoffs do not appear to qualify.
Consider another example-a lawsuit on a contract in a court of general jurisdiction. Assume that the court has concluded that an enforceable contract exists, that the defendant is in breach, and that the plaintiff is entitled to a money judgment. The defendant, however, argues that enforcement of the judgment will severely damage the defendant’s business prospects and force it to terminate many employees-all with disastrous effects on the local economy and the community generally. Should the court take these arguments into account in exercising its discretion under equitable principles? Of course not, and the arguments are no less morally offensive when made in a bankruptcy court.
Advocates of expansive goals for bankruptcy law generally have not articulated in detail how bankruptcy law could and should take into account extraneous (nonrightsholders’) interests that they favor.147 Presumably, these extraneous interests could be served by featuring into the exercise of judicial discretion, as in the plant closing example.148 They also might figure in a judge’s construction and application of provisions of the Bankruptcy Code,149 or the Bankruptcy Code itself could be revised to address explicitly the role of these extraneous interests in a bankruptcy proceeding.150 But however the approach may be disguised in noble rhetoric,151 service to these extraneous interests at the expense of or risk to rightsholders is prima facie theft.152 A judicial proceeding that transfers wealth from those who are legally entitled to benefit from that value to those who hold no legal entitlement is wrong. Sympathetic as an extraneous cause-“employment,” “rehabilitation,” or “community”-may appear, redistribution of wealth in bankruptcy away from those who hold legal entitlements to those who do not, whether to further a political agenda or a communitarian philosophy or otherwise, is a corruption of civil justice.153 Robin Hood was, after all, a crook.154
To be sure, advocates of expansive redistributive goals do not openly claim to be Robin Hood supporters. More typically, they argue that bankruptcy law should provide some redress for those whose interests are adversely affected by financial distress-with employees, rehabilitation, and community being the usual proxies-even if those affected interests do not amount to legal entitlements.155 For example, consider the normative arguments advanced by Korobkin. Korobkin’s move is to apply Rawlsian contractarianism to bankruptcy law in an attempt to discover its “deep structure.”156 Unlike Jackson but faithful to Rawls, however, Korobkin places the thick “Rawlsian veil” over the hypothetical bargainers imagined to be devising the principal patterns of a bankruptcy law, and he includes in the group of hypothetical bargainers representatives of all interests that might be affected by a debtor’s financial distress.157 The bargainers all know they may be affected by insolvency, but no one knows if he or she will be a debtor, an unsecured creditor (contractual or involuntary), a secured creditor, an at-will employee, a member of the community otherwise unconnected to a debtor, or the occupant of any other particular relationship.158 Having consecrated and (dis)armed his inclusive hypothetical group, Korobkin argues that they would come up with something like the major features of current bankruptcy law and would seek to protect those with something to lose and who occupy the “most vulnerable position” in connection with a bankruptcy.159 But Korobkin’s move seems little more than an argument that thoughtful, interested, objective, and neutral lawmakers would come to his conclusions about bankruptcy, which he claims fit “our strongly held considered judgments.”160 His “theory” turns out to be vacuous. Moreover, his conclusions generally match those of some other traditionalist scholars, consisting generally of populist ideals.161
A possible partial rescue of Korobkin’s thesis might be to construe it as consistent with procedure theory as advanced here. For example, one might understand him to argue that bankruptcy law should take into account the interests of nonrightsholders only if it can do so without risk or imposition on rightsholders.162 This understanding would invoke the caveat explained earlier.163 Alternatively, perhaps Korobkin’s conception of those in the “most vulnerable position” could conform his theory to procedure theory.164 Rescue attempts notwithstanding, Korobkin’s theory most likely lies in the tradition of Robin Hood, which procedure theory rejects.165 Otherwise, it would scrupulously and consistently favor those with legal entitlements over those without, and his critique of the exclusion of these extraneous interests in bankruptcy would be rendered meaningless.
B. Interests of Rightsholders Inter Se, Including Priorities
Procedure theory generally insists that nonbankruptcy priorities be honored and respected in bankruptcy.166 Consistent with the foregoing discussion of allocating to nonrightsholders value that otherwise would benefit a debtor’s rightsholders, procedure theory also teaches that it is wrong for Congress to allocate assets first to rightsholders who have no legal entitlements under nonbankruptcy law, to be satisfied first from a particular item of a debtor’s property, or to allocate assets first to those with junior interests in the assets to the detriment of those who have senior interests.167
Secured claims against a debtor’s assets are ubiquitous and their treatment in bankruptcy has provided fodder for a substantial volume of commentary.168 Subject to relatively narrow avoidance powers and costs of delay,169 however, security interests in a debtor’s personal and real property that are effective under nonbankruptcy law generally are respected as well under the Bankruptcy Code.170 This treatment corresponds to procedure theory’s tenets.
Respect for nonbankruptcy priorities in bankruptcy is particularly significant in cases in which nonbankruptcy lawmakers selected priority rules because of the primarily instrumental roles of the rules, particularly in facilitating extensions of credit.171 As discussed above,172 traditionalist bankruptcy scholars, more than proceduralists, tend to “assume a bankruptcy” and then to consider what happens, or should happen, to the assets and the players involved. This approach offers the freedom to allocate value to the interests that one deems most deserving (however that might be determined). But this approach obviously ignores the instrumental role of law in shaping behavior. Presumably, the treatment that bankruptcy law affords legal entitlements in bankruptcy affects behavior of many more market participants outside bankruptcy.173
Procedure theory instructs that it is not for bankruptcy law to dull the effects of nonbankruptcy law, instrumental or otherwise. When bankruptcy law gives effect to nonbankruptcy entitlements, it enhances the instrumental effects that nonbankruptcy law may afford.174 But procedure theory is not grounded on the principle that nonbankruptcy priority rules necessarily are socially optimal. Consider another example. Assume that a nonbankruptcy law priority rule awards priority to a statutory lien in favor of an artisan over a security interest created and perfected under Article 9 of the UCC.175 Assume further a proposal to amend the Bankruptcy Code to provide that a secured claim created under Article 9 would have priority over a statutory artisan’s lien, reversing the nonbankruptcy priority rule. The proposal is supported by a credible, even convincing, argument that the proposed bankruptcy priority rule would be preferable as a matter of policy to the nonbankruptcy rule. Procedure theory holds nonetheless that Congress should reject the proposed amendment.
As explained and defended in the following subpart, procedure theory generally demands respect in bankruptcy for nonbankruptcy priorities even when the nonbankruptcy rule does not reflect an optimal social policy. Whether or not bankruptcy law should adjust nonbankruptcy priorities is a question distinct from the question whether bankruptcy law should confer bankruptcy-only rightsholder status to those who do not possess nonbankruptcy legal entitlements. The case for generally not adjusting priorities in bankruptcy may be harder than the case for not allocating rightsholders’ wealth to nonrightsholders inasmuch as the latter case seems more intuitive. But on close examination procedure theory generally disapproves of both forms of bankruptcy-specific adjustments.
The previous subpart noted the general consistency with procedure theory of Plank’s constitutional principles on the “subject of Bankruptcies” in respect of Third Party constituencies such as at-will employees and community interests. In the present context, however, of adjusting priorities in bankruptcy among rightsholders Plank’s constitutional structure fails to observe procedure theory’s admonitions. Under his “Debtor-Creditor Adjustment Principle,” bankruptcy law generally has carte blanche to adjust the rights between a debtor and creditor, and among creditors.176 Indeed, Plank’s construction of the Bankruptcy Clause would “empower Congress to abolish security interests granted by the debtor to secure the creditor’s debts.”177 If Plank’s construction is correct as a matter of existing doctrine-if the existence of the additional constraints procedure theory would impose cannot be supported based on the history and application of the Bankruptcy Clause-this theory provides an important illustration of the value of normative theory. A powerful normative claim contrary to accepted doctrine can serve as an instrument for reforming that doctrine.178
C. The Philosophical and Jurisprudential Account of Procedure Theory
The foregoing discussion explained that procedure theory calls on bankruptcy law to respect, observe, and enforce legal entitlements arising in nonbankruptcy law.179 The first two subparts of this Part identified the settings in which prima facie and intuitive wrongs would arise from a bankruptcy regime that would redistribute the wealth of rightsholders to nonrightsholders or reorder nonbankruptcy priorities.180 But procedure theory does not insist or assume that nonbankruptcy law necessarily is in all respects just and optimal, however those attributes might be measured or evaluated. So why is drawing an overarching normative baseline to respect nonbankruptcy legal entitlements a morally superior move? Why should the makers of bankruptcy law not correct and override perceived deficiencies in nonbankruptcy law? Procedure theory must confront these questions directly. This subpart and the following two subparts address these questions.
A conventional Jurisprudential approach might first confront the source of law’s validity, its relationship to accepted social customs and morals, and the basis for recognizing legal obligations. A plethora of theories have addressed these questions, including interpretive theories181 and theories such as positivism,182 natural law,183 and legal realism.184 Procedure theory generally is agnostic as to the application of these theories to nonbankruptcy law. However, procedure theory does assume the legitimacy of the body of nonbankruptcy law for which it dictates respect.185 Stated otherwise, if legitimate nonbankruptcy law should be observed and enforced outside bankruptcy, procedure theory insists that it should be observed and enforced inside bankruptcy, absent some bankruptcy-specific justification.186 It follows that procedure theory accepts that nonbankruptcy law reflects a wide range of normative justifications as well as inconsistencies and flaws. While procedure theory does not shy from beneficial reforms of nonbankruptcy law, it denies the coherence and rationality of implementing these reforms through bankruptcy law alone.
Consider again the example of a nonbankruptcy legal rule that awards priority to a statutory or common-law possessory lien over an Article 9 security interest, discussed in Part III.B. Assume that this nonbankruptcy law priority rule is demonstrably suboptimal because a different rule would increase economic efficiency, would further distributive justice, or would increase social welfare based on any other rationale.187 Under this assumption it follows that altering (reforming) the priority rule in bankruptcy would provide a net benefit in social welfare, albeit to a lesser extent than an across-the-board reform of the priority rule, a reform applicable both inside and outside bankruptcy. Yet procedure theory’s normative position would not condone this admittedly welfare-enhancing utilitarian move through changes in the bankruptcy laws.
Procedure theory rejects the bankruptcy-grounded utilitarian reform as incoherent, even if welfare-enhancing in the specific case. Consider, for example, Ronald Dworkin’s framework. The bankruptcy-only priority reform would offend Dworkin’s independent virtue of law’s “integrity.”188 In particular, the reform would succumb to Dworkin’s integrity-based condemnation of “checkerboard” laws.189 Dworkin posits an example of a society sharply divided on the morality of abortion. This division gives rise to a “Solomonic” law that would criminalize abortion “for pregnant women who were born in even years but not for those born in odd ones.”190 As a compromise, this statutory technique would please opponents of abortion rights more than no ban at all while pleasing proponents of reproductive freedom more than a complete ban. Arguing that neither concerns for justice nor fairness would condemn this checkerboard law, Dworkin nonetheless concludes that a state would violate the principle of integrity by enacting this “unprincipled” rule of law.191
Denise Reaume has advanced a trenchant critique of Dworkin’s integrity theory and analysis.192 She argues convincingly that integrity is not a standalone, independent value.193 She agreed, however, that Dworkin’s checkerboard examples should be condemned, but on grounds of fairness and justice instead of integrity, noting that “Dworkin has deliberately chosen examples involving irrational criteria.”194 Whether based on Dworkin’s integrity heuristic or Reaume’s fairness-justice critique, irrational and unprincipled checkerboard laws should be eschewed.
The bankruptcy-only priority rule posited in the example would be just such an irrational, unprincipled checkerboard statute. The example posits that nonbankruptcy law has awarded priority to certain possessory liens over those of Article 9 security interests in the context of competing claims to a debtor’s property. The factors that rationally might be considered for the posited rule are the same whether applied in a priority contest that takes place inside or outside of bankruptcy. The debtor’s assets are scarce.195 Whether the priority rule is applied inside or outside bankruptcy, there is no coherent basis for different outcomes. If Congress wishes to implement the desirable, welfare-enhancing reform embodied in a revised priority rule, it should do so generally without regard for whether bankruptcy is involved.196 To apply the revised rule only in bankruptcy is no more rational than applying it only in odd years. A bankruptcy-only fix would be incoherent.197
Procedure theory’s call for respecting nonbankruptcy entitlements in bankruptcy and its corresponding recognition of the incoherence of entitlement adjustments in bankruptcy (but not outside bankruptcy) is not new. For example, these principles are a central feature of the Baird and Jackson creditors’ bargain theory.198 But unlike the creditors’ bargain thesis, procedure theory makes no utilitarian claim that its respect for nonbankruptcy entitlements in bankruptcy necessarily enhances social welfare.199 It is not subject to Carlson’s critique of Baird and Jackson’s “bankruptcy neutrality” forum-shopping thesis.200 Unlike the creditors’ bargain analysis, procedure theory is not grounded on the reduction of inefficient forum shopping through eliminating perverse incentives created by inconsistencies in bankruptcy and nonbankruptcy law.201 Procedure theory does not claim that “bad” results necessarily result from its violation or that nonbankruptcy law is optimal.202
Could the posited bankruptcy-only priority rule be rationalized if it were instead an “insolvency-only” rule-one that would apply both outside and inside bankruptcy but only when the debtor is insolvent?203 I believe not, because there is no rational basis for a priority rule that applies only in the case of insolvency. In some situations nonbankruptcy law does take account of a debtor’s insolvency. For example, certain transfers can be set aside under state fraudulent transfer law when made by an insolvent transferor.204 But that is because the other creditors would be disadvantaged for the benefit of the transferee should the transfer stand.205 There is no analogous basis for applying the posited priority rule only in the case of insolvent debtors. Priority rules can have meaning and add value whether or not a debtor is insolvent.206 For example, the claimant that is advantaged by a priority rule applicable to particular property of a debtor need not look to the debtor’s other assets that would be reachable only through judicial process, even if the debtor is solvent.
Another possible justification of a bankruptcy-only priority rule would recognize that, under the appropriate circumstances, Congress might achieve a de facto generally applicable priority rule by enacting a bankruptcy-only rule. For example, a priority rule that materially weakened secured claims in bankruptcy would have an instrumental effect on the availability and price of secured credit generally, inasmuch as extenders of credit would take into account the effect of the rule at the time credit is extended or refused.207 Could such a bankruptcy-specific priority rule be defended from procedure theory’s condemnation? Clearly not, for several reasons. First, even the adoption of such a secured-claim-weakening bankruptcy rule would not mean priority contests outside bankruptcy would no longer occur. Consequently, the rule actually would not work the same as a generally applicable rule, even though some effects would be similar. Second, in general most bankruptcy-only priority rules are not likely to have such an enormous impact outside bankruptcy. Consider the proposed bankruptcy-only priority rule posited in the example-awarding priority to perfected consensual security interests over statutory artisan’s liens. Reported decisions relating to priority contests between statutory or common-law liens and consensual security interests strongly support both the first and second points. These priority contests have occurred (at least, according to the reported decisions) overwhelmingly outside bankruptcy.208
Third, if legislating a generally applicable priority rule were the goal of Congress, why would it codify the rule as part of the Bankruptcy Code? One obvious reason is that Congress might not have the power to enact a generally applicable rule, leaving the Bankruptcy Clause as its avenue of last resort. But justifying a (purported) de facto generally applicable rule in this way would pervert the Bankruptcy Clause.209 Finally, enacting a bankruptcy-only rule also probably would reflect a second-best strategy supported by those who might favor a generally applicable rule but whose influence and power is limited to the field of bankruptcy law.210
Consider further the posited priority rule, assumed to be a desirable reform that rationally should be made across-the-board. If Congress otherwise lacks the constitutional power to enact across-the-board reform,211 the Bankruptcy Clause should not be interpreted to confer that power on Congress. Inasmuch as the reform is assumed not to be rationally limited to bankruptcy cases, it would be incoherent to empower its enactment under the Bankruptcy Clause.212
The incoherence of bankruptcy-only rules in neutral settings also reflects the incoherence of some traditionalist accounts of bankruptcy policy. If nonbankruptcy legal entitlements do not provide the baseline in bankruptcy (subject to coherent relaxation, as contemplated by procedure theory),213 what baseline would be preferable? Presumably, bankruptcy-only distributional rules could be justified on any conceivable normative grounds ranging from economic efficiency to communitarian values to any other theory of welfare or justice. Limited only by the stricture of legislating for bankruptcy cases alone, bankruptcy policy would amount to no more than “do good” as Congress might view “good” from time to time in a given context. That unbounded approach does not offer any theory of bankruptcy whatsoever.
Plank’s theory of the Bankruptcy Clause and its proper limits rejects such an open-ended approach to the-treatment of Third Parties under the Non-Expropriation Principle (as moderated by the Non-interference Principle).214 But Plank’s Debtor-Creditor Adjustment Principle in large part would embrace this unbounded scope of the Bankruptcy Clause. That principle would allow Congress and bankruptcy courts a free rein, constitutionally, to adjust the relationships between and among a debtor and its creditors.215 As a constitutional matter, it would easily welcome the proposed priority rule discussed in the example. Presumably, bankruptcy law could adopt Robin Hood’s credo for these relationships, subject only to constitutional restrictions on takings.216
Procedure theory’s normative claim offers a narrower, more purposive framework for interpreting the Bankruptcy Clause. It recognizes that the core principle of bankruptcy law is the enhancement and vindication of legal entitlements in a collective proceeding. Deviations from the strict respect for nonbankruptcy entitlements are acceptable only if reasonably calculated to serve this core principle.217
D. The Procedural and Federal Court Jurisdiction Account of Procedure Theory
As the caption of this subpart may appear circular, it is worth a few words to identify its goals and strategy. I continue to use the term “procedure theory” to mean the normative theory of bankruptcy presented in this Article, not to a more general theory of civil procedure. This subpart first considers the structure, vocabulary, and function of bankruptcy law and argues that it mirrors much of more generally applicable, or “trans-substantive,” civil procedure law. I then explain that the history of both bankruptcy law and federal court jurisdiction supports the characterization of bankruptcy law as a branch of civil procedure law. Finally, I move on from the positive account of bankruptcy law to draw on the goals of procedural law to support the normative component of the procedure theory of bankruptcy. From that perspective I argue that bankruptcy law should serve nonbankruptcy legal entitlements and generally should reject redistributive ends that contravene those entitlements. In particular, procedure theory draws support from the normative underpinnings of Erie Railroad Company v. Tompkins.218 An analysis of the similar origins of the Bankruptcy Clause and federal diversity jurisdiction, supported by the lessons of Erie, teach that the applicable rules of substantive law should not be varied based on the identity of the forum of application.
Bankruptcy law in the United States consists of Title 11 of the United States Code (the Bankruptcy Code), several provisions of Title 18 (Crimes and Criminal Procedure)219 and Title 28 (the Judicial Code),220 the Federal Rules of Bankruptcy Procedure,221 the Official Bankruptcy Forms,222 and local rules of federal district courts and bankruptcy courts223-supplemented, of course, with judicial decisions.224 Consistent with its procedural focus, the Bankruptcy Code is structured around a judicial proceeding called a bankruptcy “case” filed in a “bankruptcy court.”225 Many other aspects of bankruptcy law and its terminology also hark of its procedural features. A bankruptcy case is commenced by the filing of a “petition” with the bankruptcy court.226 A bankruptcy petition maybe either “voluntary,” filed by a “debtor,” “joint,” filed by a “debtor” and the debtor’s “spouse,” or “involuntary,” filed by one or more holders of “claims” against the debtor.227 The filing of a voluntary or joint petition “constitutes an order for relief under the “chapter” under which the petition was filed.228 If an involuntary petition is filed, the debtor is entitled to file an “answer.”229 If the involuntary “petition is not timely controverted,” the court “shall order relief against the debtor.”230 If the debtor’s answer does controvert the involuntary petition, then the court must order relief only “after trial” and if at the trial one of two statutory grounds for relief are shown, one of which is that “the debtor is generally not paying such debtor’s debts as such debts become due unless such debts are the subject of a bona fide dispute.”231
There is a bankruptcy court consisting of “bankruptcy judges” in each federal district.232 The United States Court of Appeal in the circuit in which the relevant bankruptcy court is located appoints the bankruptcy judges to fourteen-year terms.233 The powers of the bankruptcy courts and bankruptcy judges derive from Article I and the Bankruptcy Clause of the Constitution, as provided by Congress.234 The district courts have “original” jurisdiction of cases under the Bankruptcy Code, but the jurisdiction is not exclusive as to “civil proceedings arising under” the Bankruptcy Code “or arising in or related to cases” thereunder.235 Each district court determines the bankruptcy cases and “proceedings” under the Bankruptcy Code to be heard by the bankruptcy courts in that district.236 When a bankruptcy court hears a proceeding under the Bankruptcy Code other than a “core proceeding,” absent consent of the parties the bankruptcy court must submit proposed findings of fact and conclusions of law to the district court, which reviews de novo any matters to which a party has objected.237 The district courts must order “personal injury tort and wrongful death claims” against a debtor to be “tried in the district court in which the bankruptcy case is pending” or “in the district court in the district in which the claim arose, as determined by the district court in which the bankruptcy case is pending.”238 The district court in which a bankruptcy court sits has jurisdiction to hear appeals from the bankruptcy court’s orders.239 A bankruptcy petition may be filed only in a bankruptcy court that possesses the proper “venue” over the case, although the venue rules are somewhat flexible.240
This structural and stylistic procedural setting of bankruptcy law extends not only to “proceedings” relating to a bankruptcy case, such as an “adversary proceeding”241 to determine a priority dispute or a hearing on relief from the automatic stay,242 but also to the core elements of the bankruptcy case itself. Proceedings relating to a bankruptcy case, of course, are similar to most other civil disputes subject to litigation. But the case itself relates to the most fundamental functions of bankruptcy law-what it is that bankruptcy law in fact accomplishes. At the functional heart of the bankruptcy case the legal entitlements relating to a debtor-primarily “claims”243 against a debtor and in some cases the “interests” of a debtor’s equity security holders244-are determined and vindicated. In this way bankruptcy serves the interests of a debtor’s rightsholders as civil procedure more generally vindicates the interests of those with legal entitlements who seek judicial reliefer satisfaction.
In a Chapter 7 case, the debtor’s assets generally are liquidated by the trustee in bankruptcy while the net proceeds, if any, are distributed to the holders of claims and then, in the highly unusual case, the balance of distributable assets are paid to the debtor.245 Secured claims are satisfied either fully or to the extent of a relevant collateral value.246 In a Chapter 11 case in which a reorganized debtor emerges under a plan of reorganization,247 distributions of property are made to the holders of claims in satisfaction of the claims and, sometimes, to holders of interests of equity security holders.248 An essential tenet of both Chapter 7 and Chapter 11 is that nonbankruptcy (usually, state) law defines the metes and bounds of what constitutes a claim or an interest: the beneficiaries of the system and those entitled to participate.249 Similarly, nonbankruptcy law delineates what constitutes property and the identity of the holders of property interests that may be involved in bankruptcy.250 And it is the allocation of a debtor’s property, or its value, to the holders of claims and interests that represents bankruptcy law’s core mission.
Any contemporary observer of United States bankruptcy law will ask the inevitable questions. What about debtor relief? What about rehabilitation? What about the individual’s debtor-initiated discharge in bankruptcy? Part IV.G deals with procedure theory and the individual debtor’s discharge. For present purposes of examining procedure theory from the perspective of civil procedure law and the law of federal court jurisdiction, however, it is sufficient to note that a broad discharge provision is a relatively new phenomenon and the Bankruptcy Code’s treatment is far more liberal than laws in most other jurisdictions.
The earliest English bankruptcy legislation contained no provision for discharge.251 It was directed toward overcoming the inadequacy of individual creditor remedies through a collective proceeding and, in particular, protecting creditors against fraudulent debtors.252 Like conventional creditor judicial enforcement, however, it was strictly involuntary-it was creditor-initiated.253 The first English discharge provisions came later in the Statute of 4 Anne254 and were short lived.255 Even so, it seems clear that the principal role envisioned for the debtor’s discharge was to enhance the recoveries of creditors.256
The first bankruptcy act in the United States, the Bankruptcy Act of 1800,257 followed closely the creditor-oriented approach of then existing English bankruptcy law, although it was repealed in 1803.258 The on-again-off-again history of United States bankruptcy laws in the nineteenth century and the Bankruptcy Code in effect today consistently maintained as an essential component of bankruptcy law the goal of enhancing recoveries of those holding legal entitlements, primarily creditors.259
The goal of enhancing recoveries of rightsholders provides a raison d’etre for the efficiencies of collective bankruptcy proceedings as distinct from the enforcement of legal entitlements in general civil litigation.260 But over the period from the earliest English bankruptcy law to the end of the nineteenth century other, distinct sets of normative considerations had become accepted: dissatisfaction with the imprisonment of debtors and more general concerns for the welfare of debtors and their need for a “fresh start.”261 Although the idea of a bankruptcy discharge was originally seen as a means to enhance creditor recoveries, and it generally may serve that function even today, concern for the plight of an insolvent debtor undoubtedly has achieved normative independence.262
The simplest account of procedure theory understands the structural and functional essence of bankruptcy law as a method of enhancing the nonbankruptcy legal entitlements of rightsholders-a goal it shares with civil procedure generally. Along the way procedure theory must explain the rationale for bankruptcy law as a separate branch of procedure as well as role of the discharge. But the normative account of procedure theory of bankruptcy advanced in this subpart is richer than the simple account that states procedural law serves substantive entitlements. It situates bankruptcy law as a part of the structure and law underlying the system of federal courts, federal judiciary, and federal jurisdiction. Bankruptcy scholars have generally overlooked or seriously underemphasized this perspective in the normative debates over bankruptcy theory, philosophy, and policy.263 This account recognizes that the normative underpinnings of bankruptcy law must be viewed as a part of the federal system of justice, the relationship between federal law and state law, the relationship between bankruptcy law, state, and other nonbankruptcy law, and, more generally, federalism and the separation of federal legislative and judicial powers.
Both the Bankruptcy Clause and the Bankruptcy Act of 1800 were influenced by concerns that nonresident commercial interests (read, creditors) were at a disadvantage in seeking to enforce obligations in jurisdictions in which their debtors were located.264 This concern was compounded by the nonuniform bankruptcy laws that prevailed in the colonies and thereafter in the states before passage of that act in 1800.265 The issues of federalism and interstate commerce were at center stage. Joseph Story’s commentary on the Bankruptcy Clause is instructive:
The brevity, with which . . . [the Bankruptcy Clause] is treated by the Federalist, is quite remarkable. The only passage in that elaborate commentary, in which the subject is treated, is as follows: “The power of establishing uniform laws of bankruptcy is so intimately connected with the regulation of commerce, and will prevent so many frauds, where the parties or their property may lie, or be removed into different states, that the expediency of it seems not likely to be drawn in question.” [quoting The Federalist, No. 42, at 56 (McLean ed., 1788)].[T]here are peculiar reasons . . . why the government of the United States should be entrusted with this power [to establish uniform bankruptcy laws]. They result from the importance of preserving harmony, promoting justice, and securing equality of rights and remedies among the citizens of all the states. It is obvious, that if the power is exclusively vested in the states, each one will be at liberty to frame such a system of . . . bankruptcy and insolvency [law], as best suits its own local interests, and pursuits . . . . There will always be found in every state a large mass of politicians, who will deem it more safe to consult their own temporary interests and popularity, by a narrow system of preferences, than to enlarge the boundaries, so as to give to distant creditors a fair share of the fortune of a ruined debtor.266
Story’s concerns relate to inefficiencies arising out of nonuniformity,267 but he also explicitly notes in the quoted passage the inequitable treatment of citizens of different states. Inasmuch as every bankruptcy law ever passed in the United States has placed substantial responsibility for bankruptcy cases in the hands of the United States district courts, it is plausible to surmise that Story’s concerns must have extended as well to the potential for unfair and discriminatory judicial administration of separate bankruptcy laws in the states.268
Consider also Bruce Mann’s lucid description of attitudes of the framers that gave rise to the Bankruptcy Clause:[T]he idea that bankruptcy raised issues that were better addressed on a national level rather than through the mechanisms of interstate comity seems to have taken at least tentative root during the [constitutional] convention. The lawyers and judges in the two Pennsylvania cases,269 and through them some of the key delegates to the convention, clearly recognized the problems inherent in applying state insolvency and bankruptcy rules to debtors and creditors who lived in different states. Credit, like commerce, could not be contained within state boundaries. Full faith and credit helped somewhat, but it could harm out-of-state creditors by imposing on them state bankruptcy discharges that stripped them of their claims without their participation in the process. As [James] Wilson remarked at the Pennsylvania ratifying convention, “Merchants of eminence will tell you that they can trust their correspondents without law; but they cannot trust the laws of the state in which their correspondents live.”
Judges . . . were more concerned with punishing fraud, while merchants, whose business was business and who necessarily included debtors as well as creditors, were more interested in Madison’s “regulation of commerce.” The limited evidence of the Constitutional Convention suggests that the framers had in mind the latter.270
In addition to providing support for the Bankruptcy Clause, the same concerns for fair and equal justice in a federal republic have substantially influenced the civil jurisdiction of federal courts more generally. Article III, section 2 of the Constitution extends federal judicial power to, inter alia “Controversies .. . between Citizens of different States,”271 so-called “diversity” jurisdiction. While the Constitution permitted but did not require Congress “[t]o establish Tribunals inferior to the [SJupreme Court,”272 the first Congress did establish a system of lower federal courts273 and provided for diversity jurisdiction in the Judiciary Act of 1789. The normative basis of diversity jurisdiction generally is accepted to be the avoidance of hostility that might be expected from state courts based on the identities of the litigants. One view is that a state court might be hostile to the interests of a citizen of another state.275 A competing view is that concerns of the Constitutional framers and members of the first Congress were addressed to “class hostility.”276 But both views agree that diversity of citizenship warrants federal jurisdiction.277
The principal normative implications of these parallel rationales for federal systems of bankruptcy law and diversity jurisdiction support procedure theory’s core principle that bankruptcy law, like trans-substantive civil procedure law, generally should serve the interests of and respect rightsholders’ nonbankruptcy legal entitlements. In this respect bankruptcy theorists can draw on lessons learned from experience with federal diversity jurisdiction.
The Judiciary Act of 1789 also contained a provision known as the “Rules of Decision Act.”278 Under that Act, “the laws of the several states” were to apply in “trials at common law” in federal courts. In 1842 the Supreme Court definitively interpreted the Act in Swift v. Tyson.219 In an opinion written by Joseph Story, the Court held that the reference to “the laws of the several states” did not include decisional law of the courts of the states but referred only to state statutes and constitutions. Aside from purely “local” law matters,280 the federal courts would apply the “general” law to matters of general concern.281 The legal question addressed in Swift provides an example of “general” law-whether the transfer and endorsement of a negotiable instrument (a “bill of exchange”) to a transferee on account of a pre-existing obligation provide the appropriate consideration for the transfer so that the transferee took free of the obligor’s defense. The defendant argued that under New York’s “local” decisional law the defense against the original payees was also good as against the transferee.282 Under the “general” law as interpreted by the federal courts, the defense was not good against the transferee. The Court unanimously held that a federal court should follow the rule under the “general” law.283
With hindsight, the incoherence of the rule announced in Swift-applying one body of substantive, federal “general” common law in a diversity case in federal court and another body of substantive, state “local” law in a state court case-was immanent. But Story and the Swift Court appear to have had their hearts in the right place. If the “general” law would be followed by the state courts as well, the system would enhance uniformity of laws among the states.284 If both sets of courts were applying the same rules, even though the state courts were not bound to follow them, the incoherence would be minimal. In general, this vision of uniformity held true to form in practice until after the Civil War, when many state courts increasingly parted ways with the “general” law as laid down by the federal courts.285
In 1938, the Supreme Court decided Erie Railroad Company v. Tompkins,286 squarely overruling Swift. Tompkins had sued Erie in a diversity action in federal district court for injuries sustained while Tompkins was walking along a railroad right-of-way.287 Under then-existing federal “general” law, Erie owed Tompkins a duty of care and could be liable for negligence.288 On this theory, Tompkins recovered judgment on a jury verdict against Erie in the district court. Erie had argued that Pennsylvania law applied, under which Erie contended that it owed Tompkins only the duty that it owed to a trespasser.289 The Second Circuit affirmed the judgment, relying on the applicability of “general” law.290 The Supreme Court reversed.
Except in matters governed by the Federal Constitution or by acts of Congress, the law to be applied in any case is the law of the state. And whether the law of the state shall be declared by its Legislature in a statute or by its highest court in a decision is not a matter of federal concern. There is no federal general common law. Congress has no power to declare substantive rules of common law applicable in a state whether they be local in their nature or ‘general,’ be they commercial law or a part of the law of torts. And no clause in the Constitution purports to confer such a power upon the federal courts.291
Justice Brandeis, writing for the Court, gave three bases for the decision. First, new scholarship demonstrated that Justice Story had misinterpreted the Rules of Decision Act in Swift.292 Second, experience under Swift had demonstrated its “defects, political and social; and the benefits expected to flow from the rule did not accrue.”293 The Court explained that the “mischievous . . . doctrine” had led to widespread forum-based “discrimination,” a result that diversity jurisdiction had been created to prevent.294 The Court, however, further explained that although the Swift doctrine’s “injustice and confusion” had been argued as reasons to change the rule, these first two bases of its decision would not be sufficient alone to convince the Court to abandon the rule.295 But the third basis of its decision was indeed sufficient; the Swift doctrine was unconstitutional.296 The pervasive application of federal “general” law to so many areas of substantive law had “invaded rights which in our opinion are reserved by the Constitution to the several states.”297
The Supreme Court as well as lower courts have struggled to find the appropriate line between substantive state law to be respected by federal courts and procedural federal law that will apply in federal courts even in diversity cases. The rules implicated in Swift-the effect of a good faith purchase of a negotiable instrument for pre-existing value-and Erie-the nature of a railroad’s duty to a person walking along a right-of-way-were straightforward and obviously substantive. But as the Erie doctrine has continued to evolve the Court has dealt with a variety of matters in diversity cases, including state-law statutes of limitations,298 whether the determination of a plaintiffs status as a statutory employee should be made by a judge as under applicable state law or by a jury,299 and the applicability of the Federal Rules of Civil Procedure.300 It is not necessary to dissect fully the whole of Erie jurisprudence for the present purpose of examining the Erie doctrine’s support for the normative underpinnings of the procedure theory of bankruptcy. But it is important to examine Erie’s principal normative components. Justice Harlan may have captured that element best in his concurring opinion in Hanna v. Plumer.301
Erie was something more than an opinion which worried about “forumshopping and avoidance of inequitable administration of the laws, . . . although to be sure these were important elements in the decision. . . . Erie recognized that there should not be two conflicting systems of law controlling the primary activity of citizens, for such alternative governing authority must necessarily give rise to a debilitating uncertainty in the planning of everyday affairs.302
Harlan appreciated the unfairness of a forum-based system (quoting the Court’s reference in its Erie opinion to “inequitable administration”),303 but he also makes an instrumental claim that such a system creates a “debilitating uncertainty.”304 Note however that Harlan is not suggesting, nor does anything in the Erie jurisprudence suggest, that deference is made to state decisional law because the substance of that law is normatively superior-however measured, on instrumental standards or otherwise-to the “general” law that federal courts created and sustained under Swift. The inequity as well as the uncertainty, then, derives from the essential incoherence of having different bodies of law apply to “primary activity” based on the fortuity of the forum involved.
What, exactly, was the nature of the concern over forum-shopping under Swift? Given Swift’s incoherent doctrine of applying substantive rules based on whether the forum was a federal or state court, forum-shopping was simply the manner in which this incoherence was manifested. Parties will always “forum-shop” if the opportunity is present. Forum-shopping thereby gave effect to injustice in the Swift era, but it was the incoherent application of different substantive rules in different fora (not forum-shopping) which was the source of the injustice.305 Indeed, the very rationale of diversity jurisdiction-the avoidance of discrimination against noncitizens in the state courts306-is based on a type of forum-shopping. If this rationale is sound, then diversity jurisdiction appropriately encourages forum-shopping-commencing an action in or removing an action to a federal court-for a better quality of justice.
Edward Purcell’s account of Justice Brandeis’s role in influencing the result in Erie and writing the opinion of the Court further illuminates its normative basis. Brandeis saw in Erie an irresistible opportunity to overrule Swift (and perhaps the last opportunity during his tenure on the Court),307 a result that Brandeis had long advocated.308 A majority of the Court favored the overturning of Swift at the first conference of the Justices following oral argument of the case.309 But it was Brandeis who was the primary advocate for doing so on constitutional grounds.310 His determination to ground Erie’s overruling of Swift on the Constitution accounts for the artful nature of his opinion, which was carefully designed to hold the support of a majority.311 Unlike earlier dissenting opinions in which Brandeis sharply and explicitly advocated for Progressive values and against the entrenched power of large corporate wealth, the Erie opinion is abstract and neutral.312
Significantly, the opinion in Erie also is abstract-even cryptic-concerning the precise nature of the unconstitutionality of the Swift doctrine. Some language evokes concerns about constraints on federal power that might be read to implicate the Tenth Amendment.313 But that was not any part of Brandeis’s analysis.314 Certainly, the opinion evokes a concern for federalism and the respect that the federal government owes to the states.315 But Purcell identifies the core of Brandeis’s objection to Swift as the separation of judicial and legislative powers and the respect that the federal judiciary should observe toward Congress:
Erie’s declaration that Swift was unconstitutional, then, was a conclusion drawn from two premises: first, that the Constitution inscribed the principles of coextensive powers and legislative primacy; and, second, that Swift stood for the proposition that the federal courts could make law in areas where “Congress was confessedly without power” to act . . . . [Brandeis] was only affirming two points. One was that Swift permitted the federal courts to act beyond the constitutional reach of the federal judicial power because it allowed them to make rules presumptively beyond the scope of congressional authority. The other point was that the federal courts should not, without compelling reason, displace state rules with those of their own making because Congress had not passed legislation to cover the facts of Erie.316
Thus, Brandeis believed that it was a constitutional wrong for the federal judiciary to make law in areas that were beyond even the power of Congress to legislate.317 And Brandeis’s views, expressed through Erie, extended even further to condemn federal judicial lawmaking on matters on which Congress could legislate but on which Congress had not acted.318
When the Rules of Decision Act or the Erie doctrine dictates that bankruptcy courts apply state law the result is fully consistent with procedure theory.319 John Cross has explained how the Rules of Decision Act applies in bankruptcy.320 Plank details how the Erie doctrine applies in bankruptcy courts and the constraints that the doctrine imposes by virtue of the limitations imposed on courts, by the Bankruptcy Clause.321 Plank argues that under the “core” Erie principle bankruptcy courts must apply state law when dealing with an issue outside the scope of the Bankruptcy Clause.322 Under the separation of powers strand of Erie, the bankruptcy courts also should follow nonbankruptcy law even when addressing an issue that is within the scope of the Bankruptcy Clause but as to which Congress has not acted.323 In Plank’s view, the Court “applied this [latter] understanding of Erie” in Butner v. United States,324 although the Butner Court did not cite Erie.325 But Plank criticizes Butner’s exception to the application of state law in determining the existence and nature of property rights in bankruptcy.326 Under Butner, state law applies “[u]nless some federal interest requires a different result.” Plank argues that even if a bankruptcy court believes that a federal bankruptcy policy does require a result different from the applicable state property law, a bankruptcy court is constitutionally required to apply state law if implementing the federal policy is outside the scope of the Bankruptcy Clause.327
Procedure theory of bankruptcy is not doctrinally grounded on the Rules of Procedure Act or the Erie doctrine. That act and Erie address only the source of law applicable in federal courts; procedure theory is broader. Procedure theory instructs Congress as well as the courts. But procedure theory is normatively based on the same grounds of coherence and justice as the Erie doctrine. That is, the fortuity of the forum should not control the applicable substantive law. For example, consider the possibility that Congress might enact a law codifying the rule of Swift-that the federal courts can develop and apply a “general” common law unburdened by state-law doctrine-that would be applicable only in federal courts. Although it might run afoul of Erie’s constitutional mandate, that act of Congress would remove the resulting statute from the applicability of the Rules of Decision Act.328 But this codification of the Swift doctrine would be no more coherent and no more just than was the judge-made Swift doctrine itself. And the same normative and legal objections would obtain if the statute provided for the application of the Swift rule only in bankruptcy cases.329
Under this analysis procedure theory also would condemn judge-made, discretionary decisions applying principles in a bankruptcy-only context that have no necessary connection with bankruptcy powers or purposes. The plantclosing example discussed in Part III.A is an example.330 The relevant considerations of community interest and continued employment are present both in and out of bankruptcy and do not differ depending on the context or forum.
A last word on Erie and procedure theory is necessary. One might see a conflict, or at least some irony, in the need for the Bankruptcy Clause and a federal bankruptcy law creating a national system for bankruptcy331 and procedure theory’s normative claim that bankruptcy law generally exists to vindicate nonbankruptcy (mostly state law) legal entitlements. Any conflict, or irony, is superficial, however. Bankruptcy law is a part of a procedural system for the administration of justice, just as are diversity jurisdiction and the Rules of Decision Act. Under Erie, the Rules of Decision Act, and procedure theory alike, the federal courts-and Congress, under procedure theory-must look outside the federal judicial system for the substance of the relevant legal entitlements. Stated simply, a federal system for bankruptcy law makes sense; varying the legal entitlements based solely on the forum, however, does not.332
Finally, Christopher Frost’s thoughtful analysis of the bankruptcy process provides additional support for the procedural account of procedure theory.333 Frost argues that the bankruptcy process in particular and the judicial process more generally are incapable of rationally redistributing losses from rightsholders to nonrightsholders.334 His argument assumes, without conceding, “the social costs accompanying business failure should be spread over a broad base.”335 Frost accepts and elucidates the common critique that under current law indirect redistributions are ubiquitous in Chapter 11 cases by virtue of delay and the institutional biases that favor rehabilitation.336 He concludes that this “method of indirect protection [of noninvestor interests] is incoherent at best.”337 But his most trenchant argument is that any judicial process, including the bankruptcy process, is ill-suited for addressing social problems such as the appropriate allocation of costs of business failure.338 In particular, Frost persuasively explains that a judicial process is incapable of taking into account the interests not directly involved in the case at hand.339
Frost has convincingly taken on the proponents of redistribution in bankruptcy head on. But his analysis differs somewhat from procedure theory as presented here. Implicit in Frost’s argument is that assuming the costs of business failure should (however the “should” might be determined) be spread, it would be normatively acceptable to do so in bankruptcy so long as it were possible to do so rationally. Procedure theory, consistent with the Erie doctrine, teaches that it would be irrational and incoherent to do so based on the identity of the forum (bankruptcy) even if a court could be confident that it was providing a normatively superior and rational result. But this difference does not diminish the persuasiveness of Frost’s principal conclusions.
To summarize, bankruptcy law generally bears the unmistakable hallmarks of civil procedure law. Its history, purpose, and demonstrable function demonstrate that its primary role is the determination, resolution, enforcement, and vindication of legal entitlements relating to a debtor. The historical origin of the Bankruptcy Clause has common roots with the constitutional permission given Congress to establish diversity jurisdiction. The normative purchase of, and in some cases, applicable legal doctrine under, the Rules of Decision Act and the Erie doctrine support procedure theory’s claim that bankruptcy law must respect the nonbankruptcy legal entitlements of rightsholders in the absence of an adequate justification for a bankruptcy-only rule, standard, or consideration that is based on the core principles of bankruptcy.
E. A Public Choice Account of Procedure Theory
Substantive bankruptcy-only legal rules that override nonbankruptcy law without bankruptcy justifications, however implemented and whether or not conceived as “reforms” of nonbankruptcy law, raise additional normative concerns. The enormous power and influence over bankruptcy law that bankruptcy lawyers and other bankruptcy professionals exercise is well known.340 Bankruptcy lawyers and other professionals are paid first out of the bankruptcy estate’s unencumbered assets.341 These are not “neutral” law reformers. The public-choice account of procedure theory assesses this environment, in which bankruptcy-only adjustments of nonbankruptcy entitlements emerge from the proposals and influence of bankruptcy law specialists, the interpretation and application of law by bankruptcy courts, and bankruptcy legislation filtered and massaged by the Senate and House Judiciary Committees. Whether in the legislative arena or in the bankruptcy courts, the legislators, judges, individuals, and groups that influence bankruptcy law are not the appropriate actors to make and shape law that has no rational bankruptcy-only justification.
In his compelling history of United States bankruptcy law, Debt’s Dominion, David Skeel has documented and explained the power and influence of bankruptcy lawyers on the direction of bankruptcy law, particularly in the twentieth century following enactment of our first “permanent” bankruptcy law, the Bankruptcy Act of 1898.342 Skeel blends the perspectives of the interest group branch of public-choice theory with a thoughtful historical study.343 He identifies the bankruptcy bar as the single most influential group in shaping bankruptcy law during the past century.344 Bankruptcy lawyers are scattered around the country, affording widespread national influence.345 On the other hand, within a given local community the bankruptcy bar historically has been concentrated.346 Skeel explains that “[t]he combination of local concentration and a nationwide presence made it much easier for bankruptcy lawyers than for many other groups to coordinate.”347 Moreover, many other interest groups have a narrower scope of interest in bankruptcy than the bankruptcy bar.348 For example, although the bankers’ lobby has been influential, banks generally are pacified if their collateral is protected and the costs of losses can be passed off to their customers.349
Skeel points to other explanations for the influence of bankruptcy lawyers. The apparent complexity and technical character of the subject adds to the influence of the bar.350 This is especially so as to matters difficult for the public and lawmakers alike to understand, even though they may be matters of great importance.351 Lawyers typically are the only witnesses in Congressional hearings on technical matters; their expertise offers “an ongoing opportunity to influence the legislative process.”352 This opportunity extends well beyond testimony at hearings; they also participate in drafting and proposing statutory language and work directly with Congressional staff members.353
In the legislative process, bankruptcy lawyers frequently adopt a familiar feature of their bankruptcy practices-they advocate on behalf of a variety of interests.354 Accordingly, they do not speak with a unified voice, as some advocate for interests of debtors, creditors, or both.355 By representing a range of interests, the bankruptcy bar provides some obvious benefits to the political process; it ensures representation for interests that otherwise “might be underrepresented.”356 But Skeel also identifies a darker side of the representative role of bankruptcy lawyers in the legislative process. First, they “are likely to look out for their own interests” on some issues.357 Second, bankruptcy lawyers’ representative or agency functions leave one important group of players behind without representation. Skeel calls this unrepresented group the “repayers,” or debtors “not likely to ever invoke bankruptcy laws.”358 As the bankruptcy lawyers focus on the bankruptcy process, they lose sight of those outside the process.359 I would add a third concern that derives from the interplay between the bankruptcy lawyers’ representative function and their self-interest. Their representative role tends to mask or at least divert attention away from inherent self-interest, raising a somewhat insidious aspect of bankruptcy lawyers’ dominant role in the process.
Skeel identifies two overarching marks of the bankruptcy bar’s influence in the legislative process. First, the bar has successfully fought off efforts to impose a governmental administrator or overseer for bankruptcy cases.360 Second, the bankruptcy bar “spearheaded the relentless expansion of bankruptcy law over the course of the [twentieth] century.”361
The bankruptcy bar’s influence over bankruptcy law extends beyond the legislative process, of course. Only a select few bankruptcy lawyers actually testify before Congressional committees and engage in drafting proposed legislation, although considerably more are active in organizations that participate in these legislative activities. But most bankruptcy lawyers and bankruptcy judges use, apply, argue, and shape bankruptcy law primarily as actors “on the ground.” It is in the bankruptcy courts, and within negotiations in the courts’ shadows, where bankruptcy law is made and shaped by a particular legal culture.362 Bankruptcy law in a given bankruptcy court also is a function of the attitudes of bankruptcy judges, who have substantial control over the fate of a case, especially in Chapter II.363
The influences of bankruptcy law on the ground are perhaps more subtle than the bankruptcy bar’s visible participation in lawmaking in the legislative sphere. But they are every bit as real. In both arenas the bankruptcy bar has a vested interest in much of the status quo. As Skeel has pointed out, one does not see the bar acting against its interests.364 This statement does not at all suggest that individuals and organizations do not have a public-minded interest in improving the law. But it does suggest that it is unlikely that they would advocate for fundamental changes that would render their professional positions vulnerable or substantially less necessary. Equally unlikely is the advocacy of reforms that would materially reduce the financial rewards that the current system provides to the bankruptcy bar.
Another important feature of the bankruptcy bar’s influence is the emphasis and focus on results of the bankruptcy law on actual bankruptcy cases. This focus comes at the expense of taking into account the instrumental impact of bankruptcy law on the behavior of actors outside bankruptcy.365 The status quo bias and the narrow focus on the effects of bankruptcy law only in bankruptcy cases plausibly account for the redistributive characteristics and effects of the effective bias towards rehabilitation in Chapter 11-in the statute as well as on the ground.366 Keeping the debtor afloat gives rehabilitation a chance. When a debtor floats on the backs of rightsholders that could benefit more from prompt liquidation, the bankruptcy bar collects. This redistributive rehabilitation bias directly offends procedure theory.367
It may be that the grip of the bankruptcy bar on bankruptcy law and the process for “reform” has waned somewhat in recent years. Certainly the bills currently pending in Congress have been influenced substantially by the lobby of the consumer credit industry368 and have met considerable criticism from the bankruptcy bar.369 On the other hand, the bankruptcy bar more or less dominated the work of the National Bankruptcy Review Commission. And none of the major reform bills introduced in recent years have passed.
The public choice perspective on procedure theory goes considerably beyond the influence of the bankruptcy bar and other interest groups and its critique of Chapter 11’s redistributive bias. This perspective complements the jurisprudential/incoherence and civil procedure/federal courts accounts of procedure theory. Simply put, the Judiciary Committees of Congress and the bankruptcy courts are inappropriate actors and fora for the development, promulgation, and implementation of bankruptcy-only legal rules and decisions on matters that have no legitimate bankruptcy-only justification.
This aspect of the public choice perspective addresses both the legislative and judicial processes affecting bankruptcy law. As already discussed, Chapter 11’s redistributive bias that has resulted from these processes cannot be squared with procedure theory.370 But at least the matter of rehabilitating distressed debtors clearly is one within the proper domain of bankruptcy law. Using the bankruptcy lawmaking process to address policies and doctrines of general applicability, on the other hand, enormously exacerbates and widens the problem. On the legislative side, the Senate and House Judiciary Committees have jurisdiction over bankruptcy legislation. Certainly, this jurisdiction is appropriate. Bankruptcy law, including the Bankruptcy Code, is an important branch of the law of procedure and federal courts.371 But these committees and the legislative process, including interaction with the bankruptcy bar and other interest groups, generally are ill-equipped to address issues of general application that are not bankruptcy-specific.
Consider once again plant closings (including employee terminations) and priority rules dealing with conflicting claims that could arise as easily outside bankruptcy as in bankruptcy.372 A law regulating the closing of a plant and the termination of employees now falls under the jurisdiction of the Senate Committee on Health, Education, Labor & Pensions373 and the House Committee on Education and the Workforce.374 In considering the WARN Act,375 for example, the predecessors of these committees376 took into account issues affecting firms generally.377 If the Judiciary Committees took up this topic, however, it is almost certain that the focus would be exclusively on these matters as they relate to firms that actually end up in bankruptcy. And the deliberations would be exposed to the usual redistributive biases in the process. A similar critique applies to priority rules that sort out competing claims to property.378
Professor Edward Rubin’s critique of the legislative methodology employed in the development of the federal Truth in Lending Act379 further illuminates the problem of bankruptcy-only rules in areas of general application.380 Applying “policy analysis,” Rubin develops a legislative methodology that at the outset would identify a problem and the goals of legislation addressing the problem.381 Only after establishing these goals would the process proceed to consider how the goals would be implemented, the substantive elements of a solution, and the data necessary to assess various policy options.382
Consider an example. Assume that a member of Congress wishes to follow Professor Rubin’s methodology. The legislator initially identifies as a problem the instances in which firms and their managers violate their fiduciary duties relating to pension plans for the firms’ employees and retirees. To address the problem, the legislator then identifies two goals of new legislation. First, the legislation prevents, or makes it very unlikely, that firms and managers will violate these fiduciary duties. Second, when they are violated, the legislation ensures, or makes it substantially more likely, that the employees’ and retirees’ claims will be satisfied in full. In order to implement the second goal, the legislator proposes a statutory lien on all of a firm’s assets. The new lien would secure claims of employees, retirees, and their pension plans arising out of these breaches of fiduciary duties. The new lien would be senior to any other liens, including preexisting liens.
The legislator next must consider relevant data. One area of inquiry, out of many, relates to the instrumental effects that would flow from putting the new statutory lien on the books. Would it adversely affect the ability of firms to obtain unsecured and secured credit? Another matter to investigate would be the likely frequency and magnitude that the protected claims would arise. If these claims actually are rare, and the problem is not that serious, perhaps the new legislation is not worth the effort. On the other hand, if the claims frequently arise and present a huge problem, then the new statutory lien’s potential for mischief in the financial and credit markets could be all the more problematic.
Now take another member of Congress who also worries about breaches of pension-related fiduciary duties. This second legislator, however, begins the process not with an identification of goals but with a complete bill, announced with fanfare at a press conference.383 The bill would amend the Bankruptcy Code to provide that employee and retiree claims for pension-related fiduciary breaches would have a super priority and could be satisfied even out of property subject to a valid, nonavoidable lien. This legislator’s focus is on the treatment of employees and retirees in bankruptcy cases, not on the impact of the legislation on the finance and credit markets. Moreover, the second legislator’s bill ignores completely the plight of employees and retirees outside the bankruptcy process, although their interests are no less worthy. The second legislator’s bill has run afoul of Rubin’s methodology by embedding the goal of protecting employees and retirees with the implementation strategy of a bankruptcy priority. Moreover, the second legislator is a member of a Judiciary Committee charged with overseeing bankruptcy legislation, making the legislator’s strategy of implementation through bankruptcy essentially inevitable.384
The public-choice perspective on procedure theory applies not only to the legislative process but to the judicial process as well. The narrow focus on a particular debtor in bankruptcy, that debtor’s creditors and shareholders, and the relevant affected employees and communities are likely to skew the application, interpretation, and development of generally applicable, nonbankruptcy-specific law.385 Even if one were to reject Frost’s conclusion that the judicial process is ill-equipped to take on social engineering, such as spreading the costs of business failure,386 the courts-especially bankruptcy courts-in bankruptcy cases populated by the bankruptcy bar are inappropriate fora for resolving these problems of general application.387
The critique of bankruptcy jurisprudence-both legislative and judicial-that emerges from the public-choice account of procedure theory is consistent with a number of conventional approaches to law. Certainly the critique’s emphasis on the instrumental aspect of bankruptcy law, that is too often suppressed or hidden in the process, is consistent with the ex ante economic efficiency approach favored by the law and economics school.388 The critique also can be squared with major elements of modern legal process scholarship.389
On one level, the public-choice account suggests that both statutory and judge-made bankruptcy-only rules and applications for areas of generally applicable law are less likely to achieve optimal results (however measured). To that extent, the critique has a utilitarian element that addresses how best to achieve “good” law. On the other hand, any critique of a process is likely to fault as well at least some of the results that the process produces. My claim here addresses primarily the judicial and legislative process.
The public-choice account of procedure theory might benefit from a closer examination of advocacy for favoring extraneous interests in bankruptcy at the expense of or risk to a debtor’s rightsholders. This advocacy, whether in the Judiciary Committees of Congress, in bankruptcy or other courts, or in the pages of legal journals and books, is particularly troubling when one considers the source-bankruptcy law specialists. Returning to the plant closing example, I would enjoy as much as the next person a good argument about the pros and cons of legal doctrine that would permit unfettered plant closings and employee discharges. My views one way or another likely would be politically inspired, and my principal action on them would occur in the voting booth. Certainly, I would not hold out my views as legal scholarship without first undertaking a thorough study of the literature dealing with employment law and the relevant data in order to develop a modicum of expertise over a period of years. Now, as someone who has studied bankruptcy law, could I enhance my credibility and expertise on employment law by proposing that the argument focus solely on plant closings and the treatment of employees of firms in bankruptcy? Hardly. Yet advocates of an expansive view of bankruptcy that embraces the extraneous “employment” goal seem much less reluctant.
Interestingly, these advocates do not argue, at least not in their scholarship, for generally applicable laws that would restrict or regulate plant closings, for example. Their agenda (in this context) is limited to advocating for taking into account the employment goal in bankruptcy.390 Moreover, they make no pretense of evaluating the general social benefits of protecting employment in a market economy. Instead, as bankruptcy specialists, these advocates concentrate on an audience consisting of bankruptcy specialists. To be sure, if they believe that regulating plant closings is good public policy, and the field of bankruptcy law is the only forum in which they have a voice, then their advocacy for the employment goal in the context of bankruptcy offers at least an opportunity to improve public policy by moving it in the “right direction.”391 But that advocacy has nothing to do with bankruptcy policy or theory and certainly is not legal scholarship in the field of employment law. It represents only a second-best strategy for imposing a political judgment concerning employment law in a limited context (bankruptcy law, presumably the context in which the advocates may have influence).392
It also is worth noting that much of the impact of legitimizing the role of extraneous interests in bankruptcy would occur outside of actual litigation. Given the bargaining and negotiation context of Chapter 11, those interests would be at work in shaping the negotiations in the shadow of a potential judicial determination.393
Finally, one way to capture the public-choice account of procedure theory is to understand the linchpin of the account as distrust, along the lines of the following story.394 Insolvency is a potentially intractable problem for a market economy. An overriding federal law and federal judiciary constitute a bankruptcy system that seeks to ameliorate certain effects of insolvency, in part by following some of the injunctions of procedure theory but also in part by empowering the insolvent, whether an individual or a firm in business. Those with special influence on and power over the bankruptcy regime-legislators, judges, lawyers, and others-benefit from the bankruptcy system and the empowerment of insolvents that it delivers. They may justify the regime with utilitarian, libertarian, empirical, or other arguments. But the public-choice account warns us not to trust this regime to tinker with nonbankruptcy (mostly state) law, all in the name of their vision of the public good.
IV. Bankruptcy Law Under Procedure Theory: Consistencies and (Apparent or Real) Inconsistencies
Procedure theory holds that the normative basis of bankruptcy law is to maximize the recoveries of and benefits for a debtor’s rightsholders in accordance with nonbankruptcy law. By providing a specialized procedural body of law, bankruptcy law can enhance the recoveries and benefits of rightsholders.395 But in some cases the Bankruptcy Code modifies, even overrides, the interests and rights of rightsholders. Indeed, some restrictions on nonbankruptcy rights, such as the automatic stay,396 lie at the core of a successful procedural bankruptcy law.397 Inasmuch as procedure theory generally calls for honoring nonbankruptcy entitlements, it follows that procedure theory must take a position on these substantive modifications of nonbankruptcy rights and interests.
There are at least four strategies available for rationalizing these divergences as consistent with the goals of procedure theory. As will become apparent, these approaches are nonexclusive and overlap to some extent. First, some apparent modifications may actually be procedural, not substantive, thereby serving to provide rightsholders with the substantive benefits contemplated by nonbankruptcy law (the procedural test). Second, other apparent modifications may be generally consistent with nonbankruptcy law, or at least with policies of nonbankruptcy law (the consistency test). Third, some modifications of nonbankruptcy law, though substantive, nonetheless may serve to maximize the collective benefits for rightsholders of a debtor in financial distress in the context of a collective proceeding (the collective maximization test).398 Fourth, other modifications may supplement nonbankruptcy law when it does not provide a resolution for questions that generally arise only in a collective proceeding concerning a debtor in financial distress (the supplemental test). Some features of current bankruptcy law cannot successfully be rationalized with procedure theory.399 Procedure theory calls for elimination or modification of those offending aspects of current bankruptcy law in order to conform bankruptcy law to procedure theory.
The remainder of this Part seeks to reconcile procedure theory with several significant features of current bankruptcy law, some of which apparently or actually modify nonbankruptcy entitlements of rightsholders. These features are (i) property of the estate, (ii) claims and interests, (iii) pro rata sharing among similarly situated rightsholders, (iv)the automatic stay, (v) the bankruptcy trustee’s power to avoid certain prebankruptcy transfers, (vi) the trustee’s power to reject or assume executory contracts and leases, (vii) the individual debtor’s discharge and the fresh start principle, (viii) the provision for a debtor’s discharge in Chapter 11, (ix) priority claims, and (x) adequate protection for undersecured creditors. These features figure prominently in the structure and operation of current bankruptcy law. Moreover, although disagreement exists as to the rationale of these features, there appears to be a general consensus as to the wisdom of most of these attributes of current law (if not as to all details). The two principal classes of rightsholders who share in or benefit from a debtor’s assets are the holders of claims400 and interests401 (shareholders). For convenience, much of the following discussion focuses on the holders of unsecured claims.
One might criticize this reconciliation of procedure theory with some of the important aspects of bankruptcy law because a strict proceduralist would reject every aspect of bankruptcy law that varies any aspect of the nonbankruptcy entitlements of any rightsholder. One might also object on the basis that the rationalization undermines procedure theory to such an extent that it could accommodate even a traditionalist, redistributive approach to bankruptcy. But procedure theory accepts only variations that generally validate and benefit rightsholders. Moreover, these critiques would render bankruptcy law under procedure theory essentially identical to nonbankruptcy procedural law. Finally, as the following discussion illustrates, procedure theory finds current bankruptcy law wanting in several respects.
A. Property of the Estate
The filing of a bankruptcy petition “creates an estate.”402 What constitutes “property” of the “estate” is a core concept in bankruptcy. It identifies the assets potentially available for the benefit of rightsholders in the bankruptcy case. Property of the estate includes “all legal or equitable interests of the debtor in property as of the commencement of the case.”403 Federal law governs what is “property” for this purpose, and the “label” that state law provides does not control.404 But it is nonbankruptcy (usually state) law that determines the attributes of a debtor’s rights or interest.405 Moreover, as interpreted by the Supreme Court in Butner v. United States,406 it is state law that creates and defines “property.”407
It is not difficult to rationalize the Bankruptcy Code’s conception of property of the estate with procedure theory. Inasmuch as the property of the estate generally includes in the assets available for the satisfaction of claims the same assets that would have been available for that purpose under nonbankruptcy law, the concept is fully consistent with procedure theory and easily satisfies the consistency test. To the extent that property of the estate includes more or fewer assets, however, it could offend procedure theory. For example, if the concept were extended so as to cut off the property rights of rightsholders or third parties, as by invalidating state law liens, procedure theory could be offended.408 The same could be true if the concept were narrowed so as to deprive rightsholders of the benefits of certain of the debtor’s assets that would be available under nonbankruptcy law. Dicta in Butner instructs courts not to deviate from the state law property construct “unless some federal interest requires a different result.”409 Procedure theory offers a normative fence that would limit courts from an expansive application of the Butner exception.410
The Butner Court reasoned that if concepts of property applied by courts in bankruptcy varied from those outside bankruptcy it would encourage “forum shopping” and could provide a “windfall merely by reason of the happenstance of bankruptcy. “411 These concerns exemplify the generally procedural nature of bankruptcy law.412 It follows that the concept of property of the estate also reflects procedure theory under the procedural test.413
B. Claims and Non-Claim Entitlements
The attributes of claims against a debtor and the identity of the holders of claims determine the “who” in the “core question of ‘who gets what’ in the bankruptcy distribution.”414 Persons who have legal entitlements to the payment of money by the debtor hold claims.415 These entitlements include even a “right to an equitable remedy for breach of performance if such breach gives rise to a right to payment.”416 Nonbankruptcy law governs the legal entitlements that give rise to claims.417 Only the holders of claims are entitled to share in the distribution in bankruptcy.418 At this level of generality, looking to nonbankruptcy law for the existence of legal entitlements and making distributions to the holders of those entitlements conforms to procedure theory under the consistency test.
Classifying a nonbankruptcy legal entitlement as a claim sometimes is a double-edged sword for either the debtor or the holder of the claim. Although the holder is entitled to participate in the bankruptcy distribution, the discharge granted to an individual debtor in a Chapter 7 case or to a debtor under Chapters 11, 12, or 13 operates to discharge liabilities on claims.419 Consequently, a nonbankruptcy legal entitlement that is not a claim, such as an equitable remedy for breach that does not give rise to a right to payment, is not discharged.420 Moreover, a nonclaim entitlement also is not subject to some aspects of the automatic stay.421 In the case of an individual debtor, then, the holder of the nonclaim legal entitlement can enforce its entitlement following bankruptcy; enforcement may not be stayed, and the entitlement will not be discharged.422 However, if the debtor is not an individual not only will the holder of the nonclaim entitlement receive no distribution in Chapter 7, but following liquidation there will be no surviving, ongoing entity against which to enforce the nondischarged entitlement-unlike the case of an individual, whose existence and whose potential for future income and assets continues.423 In Chapter 11, on the other hand, the nonclaim entitlement holder’s rights will remain fully intact during and following reorganization.424
This treatment of nonclaim legal entitlements in bankruptcy generally conforms to procedure theory. Because these nondischarged and partially unstayed entitlements remain fully intact during and after bankruptcy, their status mimics precisely-indeed, is governed by-nonbankruptcy law. Even when a debtor other than an individual liquidates in Chapter 7, leaving no viable entity following liquidation, the situation mimics nonbankruptcy law. The holder of the nonclaim entitlement is treated no differently than it would have been had the debtor simply shut down outside bankruptcy, leaving creditors to fight over the assets. Procedure theory also supports denying nonclaim entitlement holders the right to participate in bankruptcy distributions. Outside bankruptcy, nonclaim entitlement holders generally would not be entitled to recover a money judgment, otherwise they would be claims.425 Stated otherwise, limiting claims to entitlements giving rise to a right to payment makes sense under procedure theory. Bankruptcy is, at bottom, about money. Although claims in many cases are dealt with other than by cash payments,426 the essential structure of bankruptcy law demands that claims be quantified.427 As Tabb summarized:[E]quitable remedies that cannot be satisfied under applicable nonbankruptcy law by the payment of money are not claims and are not subject to the discharge. The claimant’s right to the payment of money need not be exclusive, however; as the legislative history explains, it is enough if the right to payment is alternative. The example given in the congressional explanation of the Code is a right to specific performance that can be satisfied by the payment of money in the event performance is refused.
The critical inquiry, then, is whether the nonbankruptcy law that gives rise to the equitable remedy gives the holder ofthat equitable remedy the right to be paid money in lieu of equitable enforcement.428
In the real world, distinguishing a claim from a nonclaim equitable remedy has been more troublesome for the courts than this straightforward reasoning might suggest.429 In particular, determining whether rights arising out of an equitable remedy constitute a claim turns on the characteristics of those rights under nonbankruptcy law. For present purposes, it is sufficient to note that procedure theory favors drawing the line that best mimics the nonbankruptcy treatment of equitable remedies.430 But this guideline must be tempered by concern for bankruptcy policies that procedure theory also would accommodate.431 In general, procedure theory supports the Bankruptcy Code’s statutory framework for the treatment of claims and nonclaim entitlements for purposes of distribution, discharge, and the automatic stay.
As discussed above, only claims qualify for participation in the bankruptcy distribution scheme. But not all claims so qualify because only “allowed” claims may participate.432 A claim covered by a proof of claim433 is deemed allowed unless an objection to the claim is made and sustained.434 Subject to exceptions, only claims that exist on the date the bankruptcy petition is filed are allowed and then only in the amount of the claim on that date.435
One ground for disallowance is fundamental and fully consistent with procedure theory. A claim will be disallowed if it is unenforceable under nonbankruptcy law.436 For example, a promise might be unenforceable because it violates public policy or because the applicable statute of limitations has run under nonbankruptcy law. This ground meets the consistency test as well as the procedural test.437 Another purely procedural ground provides for disallowance of a claim if “proof of such claim is not timely filed.”438
Claims for “unmatured interest”-interest that has not accrued as of the petition date-are not allowed.439 Arguably, this practice is consistent with the allowance only of claims existing on the petition date. In effect, the existence and amount of unsecured claims, including any accrued interest, are “frozen” as of the petition date. Of course, if all unsecured claims bore interest at the same rate, whether under a contractual arrangement or at the legal rate under applicable law, the disallowance of a claim for “unmatured interest” would have no effect on the calculation of each claimant’s pro rata distribution in the typical case of an insolvent debtor. But in a world where parties are free to negotiate the applicable interest rates or appeal to legislatures to enact appropriate legal rates, claimants entitled to interest outside bankruptcy shouId be entitled to include interest at the applicable rates as a part of their claims in bankruptcy. Procedure theory, therefore, would reject the disallowance of postpetition interest absent a showing that the burden of calculation would adversely affect rightsholders in the aggregate.440
Two additional grounds for disallowance place caps on the amount of damages that may be included in an allowed claim. One disallows a lessor’s damages based on termination of a lease of real property to the extent that the damages exceed the specified cap.441 The other caps damages for termination of an employment contract.442 Because these provisions disallow damage claims that otherwise would be fully enforceable outside bankruptcy, they appear to clearly contradict procedure theory. They transfer wealth from claimants whose claims are capped to other claimants. There may, however, be a coherent bankruptcy justification for these caps.443 In the case of both real property leases and employment contracts, aggrieved lessors and employees seeking damages may be under a duty to mitigate their damages.444 Allowing these claimants full, uncapped recoveries subject to their mitigation duties arguably could impose unacceptable delay in a bankruptcy case. Therefore, the argument goes, the caps would be justified on the basis of administrative convenience in the bankruptcy process.445
Because in general only claims existing on the bankruptcy petition date may be allowed, it is necessary to determine when a claim arises for bankruptcy purposes and to determine the amount of the claim. A claim may be “contingent” or “unliquidated.”446 An example of the former would be the obligation of an applicant on a letter of credit to reimburse the issuer of a letter of credit if the beneficiary draws on the credit.447 The applicant must reimburse the issuer if the credit is drawn on and honored, but if the applicant files a bankruptcy petition before that time its obligation is contingent-it is possible that the credit will never be drawn on and honored. An example of the latter is a tort claim that has not yet been reduced to judgment against the debtor (and thereby liquidated). The tort claim also may be “disputed” by the debtor but would be a “claim” nonetheless.448 The court must estimate claims for allowance purposes in two situations: If the claim is contingent or unliquidated, otherwise the administration of the case would be “unduly delayfed],” and if the claim is based on “an equitable remedy for breach of performance.”449
The allowance of contingent claims and the estimation of contingent and unliquidated claims and those arising out of equitable remedies are deviations from nonbankruptcy law. Outside bankruptcy, an unmatured and contingent claim generally would not be ripe for the commencement of a civil action.450 In addition, a court outside bankruptcy would adjudicate claims as opposed to estimating them, estimation being a somewhat rougher form of justice.451 But in the case of both unmatured and contingent claims, prebankruptcy events have given rise to a set of legal relationships, even thought they are not yet ripe for obtaining a judicial remedy under nonbankruptcy procedural law. Thus allowing unmatured and contingent claims in bankruptcy generally are deviations from nonbankruptcy procedural law (with a decidedly substantive impact, of course). As such, these deviations are consistent with procedure theory under the procedural test. A narrower conception of allowable claims resolution, more closely resembling nonbankruptcy civil procedure, would not serve as well the need for a collective bankruptcy proceeding to deal with financial distress. Whether in contexts such as an individual debtor’s discharge452 or the restoration of a corporation to viability under Chapter 11,453 it is crucial that the bankruptcy proceeding address as broad a range of the debtor’s financial affairs as feasible, in the absence of a good reason to the contrary.454 The broad scope of allowable claims and the estimation process invoke in bankruptcy the aphorism “it’s now or never.”455
This same reasoning supports an expansive view of the time that a claim comes into existence for bankruptcy purposes. While nonbankruptcy law determines the question whether a legal entitlement exists, in a collective proceeding, federal bankruptcy law must determine the time that a claim arises for bankruptcy purposes. The narrowest approach would limit claims to those that actually have accrued and on which actions could be brought under applicable nonbankruptcy law (the so-called “accrued state law claim test”).456 The accrued state law claim test would disqualify from participation in the bankruptcy process a large range of potential claimants whose fullblown causes of action might accrue in the future based on the debtor’s prebankruptcy conduct and the potential claimant’s prebankruptcy relationships with the debtor. As already noted, that would unduly weaken bankruptcy as a collective procedural mechanism.457 The most expansive plausible approach would include as claims any existing or subsequent obligation or liability arising out of the debtor’s prebankruptcy conduct (the so-called “conduct test”).458 Applied strictly, however, the conduct test could discharge “claims” in which no damages have arisen or have been discovered until long after the bankruptcy case had been closed.459 A strict conduct test could make it impossible to know about, much less administer, a collective proceeding inasmuch as holders of many claims could not participate even though their claims would be discharged. The proper test for when claims exists must, then, balance the need for a broadly applicable collective bankruptcy system with the administrative burdens and procedural unfairness that an overly expansive test would entail.
The court in Epstein v. Official Comm. of Unsecured Creditors of Piper Aircraft Corp. sought to strike such a balance.460 The Piper court described the appropriate test-in a products liability context-as follows:[A]n individual has a § 101(5) claim against a debtor manufacturer if (i) events occurring before confirmation create a relationship, such as contact, exposure, impact, or privity, between the claimant and the debtor’s product; and (ii) the basis for liability is the debtor’s prepetition conduct in designing, manufacturing and selling the allegedly defective or dangerous product. The debtor’s prepetition conduct gives rise to a claim to be administered in a case only if there is a relationship established before confirmation between an identifiable claimant or group of claimants and that prepetition conduct.461
Procedure theory accepts this sort of balance under the procedural, collective maximization, and supplemental tests. But procedure theory could accept any of the three tests or variations on any of them.462
C. Equal Treatment for Similarly-Situated Rightsholders: Pro Rata Sharing
Pro rata sharing in bankruptcy also fits well within the consistency, collective maximization, and supplemental tests for rationalizing current bankruptcy law with procedure theory. To some extent, it also can be rationalized under the procedural test. As is well known and commonly accepted, unsecured creditors share pro rata in distributions under the Bankruptcy Code.463 At first blush, pro rata sharing appears to contradict nonbankniptcy law and policy. Under nonbankruptcy law, unsecured creditors have no property interest in their debtor’s assets until such time as they receive a judicial lien, normally following judgment and, as to personal property, the exercise of judicial remedies against the debtor’s assets.464 Priorities generally date from the time that the judicial liens are created.465 This “first-in-time” principle has become known as the “race of diligence” or “grab rule.”466 As discussed above in connection with the procedural benefits of a collective proceeding, through the mechanism of pro rata sharing, bankruptcy stops this race short and puts on an equal footing all unsecured creditors who have not obtained judicial liens.467 On this analysis, then, pro rata sharing trumps nonbankruptcy law’s race of diligence and thereby conflicts with nonbankruptcy law and its principles. But that analysis and its conclusion are flawed.
In circumstances where pro rata sharing is feasible, nonbankruptcy law historically and consistently has employed (or, at least, taken into account) pro rata sharing to allocate scarce resources among similarly-situated persons.468 Examples are state law assignments for the benefit of creditors,469 creditors’ bills,470 and receiverships, including equity receiverships, under both state and federal law.471 The law of decedents’ estates also applies a pro rata sharing approach to heirs of a particular residual class under state law rules of descent and distribution,472 as well as to claims of creditors in the case of insolvent estates.473 There are other examples of systems for sharing that, while not pro rata, are likewise intended to achieve equity, if not strict equality.474
Nonbankruptcy law embraces pro rata sharing, both as a doctrine and as a normatively superior approach. And for good reason. Equal treatment under the law has a significant moral claim and acceptance. We expect there to be a good reason, instrumental or otherwise, for the law to favor one claimant over another.475 Why, then, does nonbankruptcy law opt for a baseline first-in-time rule embodied in the race of diligence? The answer is not that nonbankruptcy law favors a first-in-time rule, and it is left to bankruptcy law to straighten things out (equity is equality and all that).476 To the contrary, nonbankruptcy law should not be understood to hold that the first-in-time judicial lienholder is more deserving than a later-in-time party. It should not be understood to value more highly the satisfaction of the earlier party’s claim. The strong and clear message of the overarching pro rata sharing rule under nonbankruptcy law makes this clear.
The answer to the question posed must be that the first-in-time principle is the only feasible approach under nonbankruptcy law in a garden-variety noncollective proceeding for the judicial enforcement of a substantive legal entitlement. To impose a requirement that every judicial enforcement of a claim necessitates a collective proceeding in order to apply a pro rata sharing rule would cripple the process.477 In a legal system that recognizes private claims and private judicial enforcement, a judgment creditor must have a means to reach a debtor’s assets. And, as explained above, without effective procedural law-including effective remedies-substantive legal entitlements are diminished, if not destroyed.478 The first-in-time rule for judicial lien creditors is the only feasible general approach to the procedural enforcement of legal rights. Moreover, unless a judgment debtor is insolvent, there is a de facto pro rata sharing because every claimant ultimately can be satisfied. When nonbankruptcy law addresses circumstances in which there are insufficient assets to satisfy similarly-situated claimants, such as insolvency, it opts for pro rata sharing. The foregoing demonstrates that one can reconcile bankruptcy law’s pro rata sharing rule with procedure theory under the consistency approach.479
Reconciliation also is possible under the collective maximization approach. It is true enough that some individual creditors might recover less under bankruptcy law’s pro rata sharing approach than under the race of diligence. For example, a creditor might argue that it was in a commanding position to recover through judicial enforcement much earlier than any other creditor.480 On the other hand, for a collective group in a collective proceeding, pro rata sharing can produce the result that a larger number of a debtor’s creditors would receive a larger amount, although pro rata sharing does not affect the aggregate value available for distribution.481 Inasmuch as nonbankruptcy law does not value one claim higher than another, viewed in this light pro rata sharing provides a greater collective benefit.
Pro rata sharing also may be reconciled with procedure theory under the supplemental approach. As an important feature of a collective proceeding, pro rata sharing supplements nonbankruptcy law’s first-in-time system in which sharing would not be feasible. Stated otherwise, because nonbankruptcy law reflects no generalized priority rule among unsecured creditors, pro rata sharing supplements nonbankruptcy law by declaring a “tie.”
Finally, pro rata sharing possesses further supplemental and procedural components. Bankruptcy law must adopt some method for applying the value of the debtor’s assets to the interests of rightsholders in order to achieve its ends. While this explanation does not necessarily point to pro rata sharing, as opposed to some other allocative method, it does identify a justification for departing from (or, more accurately under the supplemental test, supplementing) nonbankruptcy law. Under another procedural conceptualization, the trustee in bankruptcy figuratively obtains a de facto judicial lien for the benefit of all the unsecured creditors.482 That understanding would comport with the race of diligence under nonbankruptcy law inasmuch as the judicial lien for the benefit of each creditor would arise simultaneously upon the bankruptcy filing.
D. Automatic Stay
Upon the filing of a bankruptcy petition, section 362 of the Bankruptcy Code imposes an automatic stay-a statutory injunction, in effect.483 The automatic stay plays a “core role” in bankruptcy484 and is “[a]n integral structural component of a bankruptcy case.”485 It stays a host of acts that would disrupt an orderly bankruptcy process, such as the commencement or continuation of judicial or other actions or proceedings,486 enforcement of judgments against the debtor or the debtor’s property,487 acts to “obtain possession of property of the estate,”488 and the creation, perfection, or enforcement of liens on property of the estate.489 Broad as it is, the automatic stay is not absolute. Several acts that otherwise would be covered by the stay are excepted.490
The automatic stay protects both the debtor and creditors by preserving the status quo. It supplements and complements the rationale for a special wealth preservation (or enhancing) bankruptcy proceeding. It links property of the estate, claims against the debtor, and the baseline rule of pro rata sharing.491 In general, the automatic stay permits an orderly and properly structured bankruptcy process to work for the benefit of the debtor and rightsholders and meets the procedural, collective maximization, and supplemental tests.
In proper circumstances, a party in interest may obtain relief from the automatic stay. Consistent with procedure theory, the grounds for relief are designed to protect the interests of persons other than the debtor, and appropriately applied, they inhibit the automatic stay from a redistributive effect.492 If improperly applied, however, the stay can conflict with procedure theory by impairing a rightsholder’s nonbankruptcy entitlements for the benefit of other rightsholders or third parties.493
E. Trustee in Bankruptcy’s Avoiding Powers
Several provisions of the Bankruptcy Code confer on the trustee in bankruptcy the power to “avoid”-set aside-transfers of property made by the debtor before a bankruptcy filing. An avoidance has the effect of making the transferred property available as a source of value for distribution to the debtor’s rightsholders.494 In addition to the avoiding powers of the trustee, Section 365 of the Bankruptcy Code permits the trustee to “reject”-elect not to be bound by-executory contracts and leases.495 That section also permits the trustee to “assume”-elect to become bound by and preserve-these contracts and leases, in some cases under circumstances in which the debtor could not preserve the contract or lease under nonbankruptcy law.496 As with pro rata sharing, these provisions appear to contravene nonbankruptcy law and to upset the nonbankruptcy entitlements of rightsholders. To a great extent, however, the avoiding powers actually derive from and are closely connected to nonbankruptcy law. This section and the following section explain how procedure theory can accommodate in principle, if not in every detail, both the avoiding powers and the regime for rejection and assumption of executory contracts and leases.
Under the “strong-arm” avoiding power, the trustee in bankruptcy has the rights and powers of a hypothetical judicial lien creditor as well as the rights of a bona fide purchaser of real property.497 By exercising the strong-arm power, the trustee can avoid prebankruptcy transfers, including security interests and other liens, that would be subject to the rights of a judicial lien creditor under applicable nonbankruptcy (normally, state) law. In the most practically significant context, the trustee may use its strong-arm power to avoid the creation of a prebankruptcy security interest in personal property or fixtures if the security interest is unperfected at the time of the bankruptcy filing.498 The metaphor of the trustee as a judicial lien creditor for the benefit of the creditors generally embraces the strong-arm power.499 It preserves the benefits of applicable nonbankruptcy law that, absent bankruptcy, would have been available for unsecured creditors that could have obtained judicial liens against, for example, collateral subject to an unperfected security interest. In effect, the strong-arm power interrupts the nonbankruptcy race of diligence, thereby declaring a “tie” as among the unsecured creditors and freezing the status of an unperfected security interest as such.500 By this operation, it subordinates the unperfected security interest to the trustee’s rights for the benefit of the creditors generally, thereby complementing the pro rata sharing rule.501
By mimicking nonbankruptcy law in the context of a collective proceeding, the strong-arm power is fully consistent with procedure theory. Because it complements the pro rata sharing rule and gives effect in bankruptcy to the nonbankruptcy rights of a hypothetical judicial lien creditor, the strongarm power may be reconciled with procedure theory on essentially the same rationale applicable to pro rata sharing.502
The power of the trustee in bankruptcy to avoid preferences is quite unlike the trustee’s strong-arm power. In particular, it does not derive generally from nonbankruptcy law.503 The trustee-as-judicial- lienholder metaphor does not hold. Indeed, as Professor Carlson has put it, voidable preference law “strikes at transactions that are perfectly legal and even admirable at state law. Voidable preference law undoes payment and security of debt.”504 Following is a description of the generally proffered justifications for voidable preference law, followed in turn by an explanation of how preference law generally comports with procedure theory.
Voidable preference law is codified in Bankruptcy Code section 547.505 It provides for the avoidance of certain prebankruptcy transfers of the debtor’s property “to or for the benefit of a creditor” or “on account of an antecedent debt.”506 A transfer is voidable only if it is made while the debtor is insolvent and within ninety days before the date that the debtor’s bankruptcy petition is filed.507 In addition, to be voidable a transfer must allow the creditor to obtain more than it would have obtained in a Chapter 7 liquidation of the debtor had the transfer not been made and had the creditor received its distribution in the Chapter 7 proceeding.508
Payment of a preexisting debt is a classic example of an avoidable preference. Assume that a creditor is owed $100 by an insolvent debtor and that in a Chapter 7 liquidation of the debtor the creditor would receive a distribution equal to 10% of its unsecured claim or ten dollars. If the debtor were to make a payment to the creditor, whether partial or in full, the creditor would receive payment on a dollar-for-dollar basis to the extent of the payment made, leaving the remaining balance (if any) on the debt as an unsecured claim in a Chapter 7 liquidation. Payment of any portion of the debt on a dollar-for-dollar basis necessarily gives the creditor more than it would obtain (hypothetically, 10%) in the debtor’s Chapter 7 liquidation. In fact, in any case in which the creditor would not receive 100% of its claim in the Chapter 7, any prepetition payment necessarily allows the creditor to improve its position over that which the creditor would obtain in the debtor’s Chapter 7. Inasmuch as providing the creditor with collateral for an antecedent debt before the petition is filed also would allow the creditor to obtain the collateral value on a dollarfor-dollar basis in the Chapter 7, a prepetition grant of collateral for antecedent debts also can be avoided under section 547.
The flip side of voidable preference law is the effect of a prepetition transfer on the debtor’s other, nonpreferred creditors. To the extent that the debtor’s assets are depleted before the bankruptcy petition is filed to satisfy a creditor’s debt, they are unavailable in the Chapter 7 liquidation to satisfy a portion of the other creditors’ claims. Hence, the creditor that benefits from the prepetition transfer is said to have been preferred to the detriment of the other creditors. Voidable preference law, then, reverses the preference and brings the assets back into the debtor’s estate for the benefit of all creditors, who will share pro rata in the recovered assets.
There are two principal accounts for the purpose of voidable preference law. The first is deterrence. Because a creditor may not be able to retain a payment made or collateral granted if the debtor files a bankruptcy petition within ninety days, the creditor may be deterred from grabbing the debtor’s assets on the eve of bankruptcy.509 While this vision may be plausible in some contexts, most agree that deterrence is, at best, an incomplete explanation and justification. For example, many creditors no doubt strongly encourage a payment sooner rather than later in the hopes that the ninety-day period will elapse before a bankruptcy petition is filed.510
The other justification is that voidable preference law promotes a policy of equality among creditors. ” Second, and more important [than deterrence], the preference provisions facilitate the prime bankruptcy policy of equality of distribution among creditors of the debtor.”511 By forcing the transferee to regurgitate the payment (or collateral) to the end that the debt becomes once again unpaid (or unsecured), voidable preference law steps in to set things as they were when it has failed as a deterrent. To the extent that equality is the principal, or a principal, goal of voidable preference law, of course, the deterrence function (when effective) directly serves the equality policy by causing the assets to remain in place.
In adopting the Bankruptcy Code in 1978, Congress appeared to favor the policy of equality over that of deterrence, as suggested by the language quoted above from the House Report. An additional indication was the rejection by Congress of the element of the transferee’s knowledge or notice of insolvency, which featured in the avoidability of preferences under the Bankruptcy Act.512 The transferee’s state of mind would be significant only if the goal is deterrence-one wholly ignorant of the debtor’s financial distress would not be motivated to “grab” assets on the “eve of bankruptcy.”513 Professor Tabb has argued, however, that one of the exceptions to voidability demonstrates that preference law is not primarily worried about equality. Because section 547(c)(2) excepts from avoidance ordinary course payments of debts incurred in the ordinary course, leaving only “unusual” payments to be avoided, he believes that this exception “eviscerates equality.”514 In effect, the ordinary course exception “resurrected the same core principal of culpability” that was found in the Bankruptcy Act’s “reasonable cause to believe” test.515 Professor Tabb may overstate the case inasmuch as many payments made shortly before a bankruptcy filing will not find cover under the ordinary course exception. Moreover, transfers such as security interests and other liens will remain vulnerable.516 But he surely is correct that the equality goal has not entirely squeezed out the culpability principle and the deterrence goal.517
Focusing on the exceptions in Section 547(c) also is useful in considering voidable preference law in the context of procedure theory. Recall that voidable preference law addresses transfers that are valid under nonbankruptcy law as between the transferor and transferee and, in general, as against third parties. These transfers are not necessarily tainted under nonbankruptcy law by wrongful intent or insufficient value as are transfers avoidable under fraudulent transfer law. Voidable preference law, however, can be reconciled with procedure theory under the same analysis applicable to pro rata sharing in a collective proceeding.518 To the extent that it promotes equality it furthers the goal of pro rata sharing, and, as noted above, to the extent that it effectively promotes deterrence, that also promotes equality and pro rata sharing. The section 547(c) exceptions, however, recognize that preference law will not disrupt all transfers that are valid under nonbankruptcy law and that otherwise meet the elements of voidability under section 547(b). Drawing on Professor Tabb’s views of the impact of section 547(c)(2), procedure theory can be rationalized best with the exceptions to avoidance by viewing them as establishing a set of nonculpability tests, When the excepted transfers are viewed as examples and proxies for circumstances in which any gun-jumping manipulation of the bankruptcy process would be unlikely, excepting these transfers from avoidance and respecting the transfers, valid under nonbankruptcy law, recognizes the appropriate domain for a bankruptcy-only voidability rule in the context of voidable preference law.519 Under this nonculpability standard, then, equality would give way to legitimate prebankruptcy transfers that do not jeopardize the bankruptcy process. It follows that procedure theory would be served best by a broad and general exception for routine, ordinary transfers that would not be limited (as is section 547(c)(2)) to payments alone.520
3. Fraudulent Transfers
Another important avoiding power is the trustee’s power to avoid fraudulent transfers. But fraudulent transfers are avoidable outside bankruptcy as well. An avoidable fraudulent transfer may involve a debtor’s actual intent to defraud its creditors by attempting to put assets out of the creditors’ reach.521 Alternatively, while “innocent,” a transfer nonetheless may amount to constructive fraud because the debtor receives nothing in exchange for a transfer of assets or receives less than the value of the assets.522 In each case, were the transfers to stand, the transferred assets would be unavailable for the satisfaction of creditor claims and no assets-or assets of a lower value-would remain.
Under Bankruptcy Code section 548, the trustee can avoid certain transfers made within one year before the date on which a bankruptcy petition is filed.523 Although section 548 is a federal rule applicable only in bankruptcy, it embodies longstanding principles of nonbankruptcy fraudulent transfer law.524 For this reason, section 548 generally may be squared with procedure theory under the consistency test. Like the strong-arm power, section 548 also complements pro rata sharing. In effect, it puts the value of assets back in the debtor’s estate that were transferred wrongfully or to the extent that insufficient value was received by the debtor in exchange for the transfer. It mimics the rights of creditors to avoid fraudulent transfers under nonbankruptcy law and preserves the benefits for the debtor’s creditors generally, following the collective judicial lien paradigm.525
In general, these observations concerning section 548 apply as well to the avoidance of fraudulent transfers under Bankruptcy Code section 544(b)(1), which empowers the trustee to avoid a transfer of property by the debtor which “is voidable under applicable law by a creditor holding an unsecured claim.”526 Unlike Section 544(a)(1), under which the trustee receives the powers of a hypothetical judgment lien creditor, Section 544(b)(1) permits the trustee to assert the avoidance rights only of an actual creditor of the debtor.527 Like Section 544(a)(l), however, under Section 544(b)(1) the trustee must find the substance of its avoidance power under “applicable law”-nonbankruptcy law.528
From the foregoing it appears that one can reconcile avoidance of fraudulent transfers with procedure theory. Not only are the application of Bankruptcy Code Sections 544(b) and 548 generally consistent with nonbankruptcy law, but they fit the model of trustee as judicial lienholder for the benefit of all creditors. They thereby complement the goal of pro rata sharing and, as with the strong-arm power, can be reconciled with procedure theory on the same basis. Nonetheless, in some respects the application of these sections does not comport with procedure theory. Accordingly, procedure theory calls for modifications.
As noted above, both the section 544(a)(l) strong-arm power and the derivative (from nonbankruptcy law) power of the trustee under section 544(b)(1) to avoid transfers that an actual creditor could avoid each depends on substantive nonbankruptcy priority rules. These sections adapt those rules to bankruptcy’s collective proceeding. section 548, however, is quite different in concept. Although its substantive provisions are quite similar to widely accepted nonbankruptcy systems of fraudulent transfer law, Section 548 is, nonetheless, a freestanding, bankruptcy-only rule. Its provisions can apply to override some transfers that would be unassailable under nonbankruptcy law.529 That is to say, in some cases nonbankruptcy law commands that a prebankruptcy transfer must stand, and Section 548 commands that it must fall.530 To that extent, Section 548 offends procedure theory.531
Granted, it is entirely possible that Section 548 provides a superior framework for fraudulent transfer law. One also can imagine collateral benefits from a modern, well-drafted, nationally applicable, uniform standard. By virtue of Section 544(b) and varying fraudulent transfer regimes under nonbankruptcy law, section 548, however, does not impose uniformity; it creates a separate stand-alone regime that deviates from nonbankruptcy law. Moreover, were Congress actually to seek a uniform and well-designed fraudulent transfer regime, it could enact a single federal fraudulent transfer statute that would apply generally, not solely in bankruptcy.532
For similar reasons, the operation of Section 544(b) also offends procedure theory. To the extent that a transfer is avoidable only in part under nonbankruptcy law, one would think that the derivative power of the trustee under Section 544(b) would be avoidance only to the extent avoidable under nonbankruptcy law-limited to the aggregate amount of the claims held by the actual creditors in whose shoes the trustee stands. Similarly, one would expect that if the transfer were avoidable under nonbankruptcy law only by certain creditors and not by others, that the value captured by the trustee under Section 544(b) would be distributed only to the actual creditors who possessed the nonbankruptcy avoidance rights. But the famous case of Moore v. Baym teaches otherwise.
As Moore is generally understood and applied, the trustee in bankruptcy can avoid an entire transfer; the avoidance is not limited to the extent to which the actual creditor or creditors in whose shoes the trustee stands could have avoided the transfer.534 For example, if property worth $100 is transferred and the creditors eligible to avoid the transfer under nonbankruptcy are owed only $50 in the aggregate, outside bankruptcy the transfer could be avoided only to the extent of $50.535 But under Section 544(b)(1), interpreted according to Moore, the trustee could avoid the entire $100 transfer-a result that punishes the transferee and transfers the additional $50 of value from the transferee to the debtor’s creditors.536 Similarly, outside of bankruptcy only the creditors in the class entitled to avoid the transfer could share in the value of the transferred asset. Under the Moore analysis of section 544(b)(1), however, all of the unsecured creditors will share the $100 in reclaimed value, thereby transferring wealth from the entitled-to-avoid class to the other unsecured creditors.537 Clearly, the application of section 544(b)(1) under Moore contravenes procedure theory.
F. Assumption and Rejection of Executory Contracts and Leases
Whether considered against the backdrop of procedure theory, as a doctrinal matter alone, or from any other perspective, the treatment of executory contracts and leases under the intricate provisions of Bankruptcy Code section 365 is one of the most bewildering artifacts of bankruptcy law. Conflicting case law and a legacy of wrongheaded, poorly reasoned judicial decisions have compounded the confusion. An article of broad scope such as this one can only hope to address the most basic features of this body of law. The following discussion considers the extent to which these basic features of section 365 conform to the procedure theory of bankruptcy law.
For present purposes, it is sufficient to adopt the standard conception of an “executory contract” developed by Professor Countryman; a contract as to which both the debtor’s and the other party’s obligations are “so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.”538 A typical example is a contract for the sale of goods-say, apples-under which the seller has not yet delivered the goods, and the buyer has not yet paid. The debtor in a bankruptcy case could, of course, be either the seller or the buyer. For now, assume that the debtor is the buyer. If the contract is a burdensome one, say, because the contract price of the apples is $10 per bushel but the market price is $8, the debtor would prefer to be relieved of the contract. Then it could buy the apples in the market at a lower price. It is true that if the debtor is in breach of the contract it must answer in damages, which outside bankruptcy likely would consume the benefits of the opportunity to buy at a lower market price following the buyer’s breach.539 But, assuming the debtor is insolvent, in bankruptcy the debtor would only be required to satisfy the seller’s pro rata share of the damage claim. In this example, the debtor’s trustee likely would seek to “reject” the contract. Now assume that the contract and market prices are reversed-the contract price is $8, and the market price is $ 10. Under these circumstances, the trustee likely will wish to “assume” the contract. By doing so, it can buy at the below-market contract price of $8, thus preserving for the estate the value of the favorable contract.
Under Section 365(a), subject to court approval, the trustee “may assume or reject any executory contract or unexpired lease of the debtor.”540 Following assumption, the trustee also could seek to assign the contract to a third party.541 Or, at least for some period of time, the trustee might do nothing.542
If the trustee rejects the contract, as in the first variation of the example, the rejection “constitutes a breach” that is given effect as if it occurred “immediately before the date of the filing of the petition.”543 This deemed prebankruptcy breach, then, entitles the other party to an “allowed” claim, thereby entitling it to a pro rata distribution along with the other unsecured creditors.544 This structure fits well with procedure theory. As under nonbankruptcy law, a party to a contract may repudiate it, and the resulting breach will trigger the other party’s remedies-damages, in the example. If the other party in our example, the seller, was entitled to force the trustee to comply with the contract following bankruptcy, by taking and paying for the apples at the $10 above-market contract price, then the seller would be fully satisfied because it would receive the entire benefit of its bargain to the detriment of the other creditors. The statutory structure for rejection, then, ensures that a party to an executory contract will not receive a windfall merely because the debtor was not in default when the bankruptcy petition was filed.
But what treatment does section 365 afford equitable remedies? These might include a right to an injunction to enforce a debtor’s covenant not to compete in connection with a rejected franchise agreement or a right of a buyer to specific performance of a contract to buy unique goods from the debtor under a rejected contract for sale. In short, nothing of general applicability in Section 365 appears to provide differing treatment based on whether the other party to an executory contract is entitled to equitable relief or solely money damages. Instead, the proper question is whether the rejection gives rise to a “claim.”545 If the equitable remedy gives rise to a right to payment, then it is a “claim.”546 As among the holders of unsecured claims, bankruptcy law’s equality policy dictates that the holder of a claim arising out of an equitable remedy, as with the holder of any other unsecured claim, should receive a pro rata distribution and should not have the equitable remedy actually imposed.547 Moreover, because the equitable remedy gives rise to a claim, it can be discharged.548 This treatment of claims arising out of equitable remedies does not offend procedure theory.549 It merely applies the policy of equality as among money claimants as reflected by pro rata sharing.550 The chief point for present purposes is that determining whether a breach arising out of a rejection of an executory contract creates a “claim” depends on an analysis of nonbankruptcy law.551
Rejection of an executory contract or lease gives rise to a “breach,” but procedure theory dictates that rejection should not deprive the nondebtor other party of a property interest that it may have received pursuant to the contract or lease. Procedure theory views setting aside prebankruptcy transfers of property as the domain of the trustee’s avoiding powers.552 For example, a lessee of personal property acquires a property interest in the leased goods.553 Rejection of the lease by the debtor-lessor would constitute a breach but, under procedure theory, should not deprive the lessee of its property rights, including possession and use of the goods, so long as it complies with the terms of the lease.554 Nonetheless, some courts have held, contrary to procedure theory’s approach, that rejection effects a termination or rescission and that the other party to a contract or lease is entitled only to damages arising out of a breach.555
A debtor’s assumption of an executory contract or lease binds the estate to perform the contract in full and entitles the estate to the benefits of the contract.556 An assumption under section 365 generally respects the nonbankruptcy entitlements of the nondebtor party. Consequently, it is the quintessential embodiment of procedure theory’s goals. And inasmuch as the benefits will inure to the debtor’s rightsholders generally, it also is consistent with the equality policy of pro rata sharing. Nonetheless, the assumption scheme of section 365 overrides some aspects of a nondebtor party’s nonbankruptcy legal entitlements. The following discussion tests these features against procedure theory.
If no default exists under an executory contract, then the nondebtor party has no basis to complain that an assumption interferes with its nonbankruptcy entitlements. But if a default exists, the nondebtor party may have reason to object. Section 365(b)(1) requires the trustee, as a condition precedent to an assumption, to cure all defaults and compensate the nondebtor party for actual pecuniary losses arising out of the default.557 Alternatively, the trustee may “provide adequate assurance” of a prompt cure and compensation for losses. In addition, the trustee must provide “adequate assurance of future performance.”558 On one view, these protections benefit the nondebtor party, who might not wish to be held to the contract except with a reasonable expectation that the future will not hold additional defaults or nonperformance. On the other hand, what is implicit in this structure is the nondebtor party’s inability to exercise any otherwise applicable right to terminate or cancel the contract pursuant to its terms, applicable law, or both.559 The goal of assumption nonetheless is to make the nondebtor party whole and to put it in as good a position as if no default ever occurred. The mandatory cure rights for the trustee represent a rational and reasonable procedure for ensuring respect of the nondebtor party’s nonbankruptcy entitlements, the essential goal of procedure theory, while permitting the trustee to preserve a valuable asset.560 Of course, had the nondebtor party exercised a right to terminate or cancel before the filing of the bankruptcy petition, there would be no contract left to be assumed.561
Ironically, procedure theory does find fault with the scheme for assumption in Section 365 when the contract of lease is not in default. In that situation, the trustee is entitled to assume without providing adequate assurance of future performance even if those assurances would be required under nonbankruptcy law.562
There is another important exception to the requirement that the trustee cure defaults (or provide reasonable assurance of a prompt cure) as a condition of assumption. The trustee need not cure defaults arising from a breach relating to the debtor’s insolvency or financial condition, the commencement of a bankruptcy case, or the prepetition appointment of or taking possession by a trustee or custodian. These so called “ipso facto” or “bankruptcy” defaults generally permit the nondebtor party to terminate the contract or lease or provide for automatic termination.563 Before this exception was built into Section 365, when the Bankruptcy Code was enacted in 1978, courts generally enforced these defaults under the Bankruptcy Act, resulting in the unavailability for assumption of many otherwise valuable contracts and leases.
By reading these ipso facto provisions out of the parties’ bargain, this exception to the cure-of-default requirement clearly tramples on the nonbankruptcy entitlements of the nondebtor party. Can it be reconciled with procedure theory? Perhaps it can, based on reasoning similar to that applied to the cure-of-default requirement. Because bankruptcy is a procedural system designed to maximize the recoveries and benefits for rightsholders, preserving valuable assets such as executory contracts and leases furthers that goal. Inasmuch as ipso facto defaults and terminations, if effective in bankruptcy, would be common, if not ubiquitous, overriding these clauses provides substantial assistance in preserving this value. While ordinarily putting one person’s (the nondebtor party’s, here) entitlements at risk to benefit others (unsecured creditors and other rightsholders, here) offends procedure theory, in the assumption context it may not. In that context, the protective provisions-“adequate assurance”-are such that the nondebtor party can expect to receive all of the benefits that it would have received outside bankruptcy and absent any default.564 This rationalization is roughly analogous to procedure theory’s consistency with “adequate protection” in the context of a debtor’s use of property.565 In the end, this conclusion is somewhat tentative. If not offended, procedure theory is at least annoyed that section 365 overrides ipso facto provisions to which parties have agreed.
Section 365 appropriately recognizes that an executory contract or lease may have a greater value if assigned to a third party than would be the case if it was retained by the debtor. For example, a trustee, including a Chapter 11 debtor in possession, may lack sufficient financing and other resources necessary to perform the contract or lease itself, even though it would be profitable or otherwise valuable to another party. Accordingly, Section 365 facilitates the assignment of a contract or lease by the trustee in order to preserve its value. But section 365 also recognizes the interests of the nondebtor party. It requires, as a condition of assignment, that the trustee assume the contract or lease, thus invoking the protective provisions such as curing defaults and compensation for the nondebtor party’s losses,566 as well as providing adequate assurance of the assignee’s future performance.567 Notwithstanding its significant appreciation of the risks that might be imposed on a nondebtor party by an assignment, section 365 nonetheless interferes with a nondebtor party’s nonbankruptcy entitlements in two material respects. These infringements must confront procedure theory’s baseline insistence that substantive nonbankruptcy entitlements be respected.
First, Section 365 overrides and nullifies contractual restrictions on assignment, such as provisions that prohibit assignment or that would terminate or modify the contract or lease upon assignment, even though those restrictions may be effective under nonbankruptcy law.568 second, it imposes a novation on the nondebtor party following an assignment-the trustee and the estate are relieved from liability, and the obligations of the assignee are substituted for that liability.569 Consequently, the nondebtor party’s future interests depend on the adequate assurance of the assignee’s future performance, mentioned above. For the same reasons and on the same analysis presented above,570 these adequate assurance and other nondebtor party protections arguably could reconcile procedure theory with a novation that substitutes the assignee’s performance for that of the trustee following assignment. But procedure theory probably should condemn the nullification of contractual restrictions on assignment which force a nondebtor party into an ongoing relationship with a stranger. There may be important reasons why the nondebtor party may wish to pick and choose its business relationships notwithstanding assurances of performance.571 Indeed, Plank argues that overriding the otherwise effective restriction on assignment is unconstitutional.572
4. Timing and Delay
In addition to opting for rejection, assumption, or assignment and assumption of an executory contract or lease, the trustee has a fourth option-take no action. The timing of the trustee’s decision often is of extreme importance and concern to a nondebtor party. Several specific rules in section 365(d) address the timing issue. The baseline rule in a Chapter 11 case permits assumption or rejection “at any time before confirmation of a plan,” but it authorizes the court to order the trustee to decide “within a specified period” if requested by a nondebtor party to a contract or lease.573
One could hardly imagine a more procedural aspect of bankruptcy law than the timing issue. Obviously, the trustee must have an opportunity to investigate, analyze, and assess the potential value or burden of the debtor’s contracts and leases, and procedure theory should be accommodating. However, a general reconciliation of procedure theory with the central features of the statutory scheme for rejection, assumption, and assignment of executory contracts and leases depends primarily on its protection of the nonbankruptcy entitlements of the nondebtor party. Accordingly, what procedure theory can accept in concept, a reasonable delay, could be rendered unacceptable by the exercise of judicial discretion that fails to afford reasonable protection for these entitlements. It follows that procedure theory would favor more precise, clearly drawn time limitations with less judicial discretion to grant extensions.574
G. The Individual Debtor ‘s Discharge and the “Fresh-Start ” Principle
Procedure theory calls on bankruptcy law to provide a system that enforces nonbankruptcy legal entitlements and enhances the recoveries of a debtor’s rightsholders. Yet a central feature-if not the central feature-of an individual’s Chapter 7 bankruptcy case is the debtor’s entitlement to a discharge of prebankruptcy claims.575 Following discharge, creditors are enjoined from seeking to recover on their discharged claims.576 At first blush an individual’s right to a discharge seems to conflict directly with procedure theory. Unsatisfied claims essentially are abolished.577 This section addresses the relationship between procedure theory and the individual’s bankruptcy discharge.
The bankruptcy discharge of claims against an insolvent debtor is a venerable concept.578 The first bankruptcy law providing for a discharge under English law was contained in the Statute of 4 Anne.579 Bankrupts who were honest and cooperative were entitled to a discharge of prebankruptcy debts, however, only if a majority of the bankrupt’s “commissioners” certified that the bankrupt had acted in conformity to the act.580 While there is some disagreement as to the underlying motivations for Parliament’s enactment of the Statute of 4 Anne, the most compelling view is that its overarching goal was to enhance the recoveries of creditors (perhaps supplemented by some human compassion for distressed debtors).581 As Charles Tabb explained:
The discharge was the “carrot” offered to induce debtors to cooperate in disclosing and turning over their estates; the death penalty was the “stick.”
Certainly, the primary purpose of the act was to facilitate creditors’ recoveries; the title of and preamble to the statute make that abundantly clear. One scholar states that the bill was introduced in direct response to the notorious frauds of Thomas Pitkyn in 1704. The prerequisite to the debtor receiving a discharge-“conforming” to the act-shows the fundamentally creditor-oriented basis of the law, since the required conforming activities were designed to enlarge and ease the creditors’ recoveries. Furthermore, the very rapid retreat taken by Parliament, which soon required creditor consent to the discharge, indicates that the interests of the creditor were paramount. Finally, the predominance of the creditors’ interests is shown by the limitation to traders, and the reservation to creditors of the right to institute bankruptcy proceedings.582
Offering a discharge as a tool for inducing debtor cooperation also was a justification advanced for the Bankruptcy Act of 1800 in the United States.583 And this concept continues to play a role in the availability of a discharge under current law.584
The debtor cooperation paradigm meshes well with procedure theory. It illustrates that a debtor’s right to a discharge in bankruptcy, while on one level serving to disadvantage the debtor’s creditors, also could provide a net gain for the creditors. Perhaps, as an empirical matter, the discharge of individuals in bankruptcy has the effect of increasing recoveries of creditors, although that is far from clear.585 While it may continue to be recognized as a material justification for discharge, the debtor cooperation model does not provide a complete explanation of discharge (and exceptions to discharge) or a complete normative theory of discharge under past or current law.
In the years before and after enactment of the Statute of 4 Anne, considerable concerns were expressed for the plight of the insolvent debtor.586 The same can be said of the period that preceded the enactment of the Bankruptcy Act of 1800 in the United States.587 Today, as well, the debtor’s interests are at the heart of some arguments that have been advanced to explain and justify the bankruptcy discharge. Discharge can be explained as a humane policy that relieves an honest but insolvent individual from burdensome debt, thereby restoring the debtor’s self-worth and promoting morality.588 Somewhat related to a humanitarian justification for the discharge, but conceptually distinct, is a policy of rehabilitation or social utility. Under this approach, the discharge is seen as furthering the policy of returning the debtor to productive participation in the economy while removing the disincentive to work caused by excessive debt.589 That is, of course, good news for the debtor. But rehabilitation theory focuses mainly on the benefits that the discharge brings to society more generally.590 Another instrumental justification for the bankruptcy discharge points to the discharge as a proxy for limited liability that encourages entrepreneurs to take risks and encourages consumers to obtain credit.591 Yet another rationale focuses on the impulsive tendencies of individuals to obtain excessive credit and their systematic underestimation of the risks inherent in credit.592 Unsurprisingly, reactions among commentators to this perplexing array of justifications for the discharge have varied.593 Moreover, some of the justifications for discharge either do not adequately explain or support, or actually conflict with, the various exceptions to the discharge under current law.594
Clearly no consensus exists as to the justification for the bankruptcy discharge and the debtor’s corresponding fresh start. Theories abound-some are competing, some are complementary. Interestingly, there does seem to be agreement approaching consensus among many (but not all) academics that the discharge generally is justified, that current law has it about right, and that no major overhaul is needed.595 Any attempt here to pose a resolution of the current debates would push this project far beyond its feasible scope.
What, then, can procedure theory offer concerning the bankruptcy discharge? First, it supports the retention, even expansion, of the debtor cooperation paradigm in bankruptcy law.596 second, procedure theory urges that whatever purpose or purposes may be served by the bankruptcy discharge, the discharge should be circumscribed as much as possible without undermining those ends. For example, Jean Braucher and I recently proposed, as a substitute for means testing proposals pending in Congress,597 a modification to the discharge provisions featuring a novel approach.598 Our system would capture postdischarge earned income, assessed along the lines of a progressive income tax, for a period of three to five years following an individual’s discharge in Chapter 7.599 In effect, the system would assess a progressive bankruptcy surcharge based on a debtor’s postbankruptcy taxable income.600 It would balance a debtor’s interest in a discharge and a fresh start against the normative principle that a debtor that can pay some or all of her prepetition discharged debt should be required to pay.601
Limiting the assessment period following bankruptcy to a few years is a concession to political realities,602 but procedure theory would support an indefinite surcharge so long as the discharged claims had not been satisfied in full. Thus, procedure theory can inform the dischargeability debates at the margin. But even under an unlimited assessment period, were the debtor never to earn sufficient income for the assessments to be applicable the discharge would be effective to prevent any postbankruptcy collections (the same result as under current law). It follows that there remains a residual tension between procedure theory and the bankruptcy discharge.603 As the foregoing summary of the theoretical debates suggests, the bankruptcy discharge under current law, including the exceptions to discharge (general and specific), represent compromises among a number of competing values. As Charles Tabb has observed, “[t]he rub, of course, is how to reconcile the conflicting demands of justice and mercy. Justice says that a debtor should be compelled to pay his debts whenever possible . . . . Mercy says that the debtor should be relieved of his debts.”604
The bankruptcy discharge is based in part-perhaps in large part-on normative grounds that are independent of procedure theory’s concern for the vindication of legal entitlements. As it relates to an individual Chapter 7 debtor, bankruptcy law generally is bifurcated between matters relating to the application of prepetition assets toward the satisfaction of prepetition claims and those concerning the individual debtor’s postpetition life, including the discharge and the related injunction. Procedure theory may inform the latter segment, as discussed above, but it addresses and instructs primarily the former. That procedure theory cannot fully explain or justify the bankruptcy discharge, however, in no way undercuts procedure theory’s clear normative and explanatory purchase with respect to these other aspects of bankruptcy law, which is its primary focus.605
H. Chapter 11 Discharge
Confirmation of a plan in Chapter 11 “discharges the debtor from any debt that arose before the date” of the order confirming the plan.606 Although the discharge appears to override the legal entitlements of a debtor’s rightsholders, properly viewed it is fully consistent with procedure theory. Absent consent, under the “best interests” test, confirmation generally requires that each holder of a claim or interest receive property of a value not less than the holder would receive in a Chapter 7 liquidation of the debtor.607 This policy is consistent with the goal of reorganization and of procedure theory, to enhance and preserve value for the benefit of the rightsholders. In exchange for the discharge, then, holders of claims or interests receive the modified package of property and rights provided under the plan.608
In Chapter 11, as with the nonbankruptcy judicial enforcement of any claim, recoveries are applied to and discharge the claim. But there is a difference with a Chapter 11 discharge because debts are not discharged pro tanto based on the value received as in judicial enforcement outside bankruptcy; they are discharged entirely. While the discharge prevents a rightsholder from maintaining its prebankruptcy legal entitlements indefinitely, as a practical matter that ability would not exist in any event under nonbankruptcy law even in the absence the Chapter 11 discharge. Without the power to modify its financial structure, the debtor would have little incentive to file under Chapter 11. And assuming in most cases that the alternative to reorganization would be liquidation, in Chapter 7 or otherwise, the absence of a discharge in liquidation would represent a distinction without a difference.609 Following liquidation, no one could expect that additional investments or operations would provide renewed value for the vestigial “shell” firm.
I. Priority Claims Under Bankruptcy Code Section 507
As a general matter, procedure theory regards the priority scheme for unsecured creditors in Bankruptcy Code section 507(a) to be the most noxious feature of bankruptcy law.610 This view is not because that section blatantly benefits congressional favorites (which it does)61 ‘ or because the beneficiaries necessarily are undeserving (they may be),612 but because it is wrong.613 It is wrong for Congress to allocate assets first to those who have no legal entitlements to be paid first under nonbankruptcy law.
There is room for some exceptions to procedure theory’s general hostility to bankruptcy-only priority rules. A priority could be justified to the extent that the priority afforded in bankruptcy would have the result of improving, or at least not detracting from, the recoveries and benefits of the rightsholders who are subordinated to the priority claimants. For example, the collective benefits of bankruptcy would be substantially hindered, whether in liquidation or reorganization, were professionals and others who transact postpetition business with the debtor not entitled to an administrative priority under section 507(a)(1).614 Similarly, one might argue that the priority rule for prepetition wage claims provides an incentive for employees to remain on the job and that it thereby furthers the goal of a successful reorganization.615
For the most part nonbankruptcy law could, if the relevant lawgivers so wished, accommodate the apparent policies underlying the section 507(a) priorities. For example, state law or general, nonbankruptcy federal statutes providing for nonconsensual general liens on a debtor’s assets could provide substantial protection for employee claims, employee benefit contribution claims, and the claims of grain farmers and fishers. Moreover, liens for taxes under both state and federal law already are common.616 Of course, exceptions and priority rules might be necessary to accommodate the interests of buyers and secured creditors and the resulting structure might not replicate exactly the section 507(a) priorities.
Procedure theory would push the argument even further. Given the substantial deference that the Bankruptcy Code gives to nonbankruptcy law with respect to property transfers,617 there is no principled reason, given the essentially procedural functions of bankruptcy law, why nonbankruptcy law should not effectively establish priorities that would be binding in bankruptcy.618 This approach would contravene not only doctrine but a longstanding cultural aspect of bankruptcy policy.619 But on consideration of the general respect that the Bankruptcy Code maintains for nonbankruptcy liens, this move would not be as radical as it might appear at first blush. Moreover, the same argument would apply equally to the creation of nonbankruptcy law statutory liens triggered by insolvency. Of course, respecting those liens would require a modification of Bankruptcy Code section 545.620
The foregoing discussion bears directly on arguments made by a handful of academics that in bankruptcy contract claims (and, perhaps, even secured contract claims) should be fully or partially subordinated to tort claims-the “tort-first” argument.621 Elsewhere I have expressed skepticism about the merits of the tort-first proposals.622 But procedure theory, by its nature, would assess the tort-first argument while conceding that tort-first could provide a normatively superior regime, whether evaluated on efficiency grounds or on another basis. Yet procedure theory maintains that tort-first proposals are the domain of nonbankruptcy law.
One apparent advantage of importing a tort-first priority regime into bankruptcy law, even an advantage quasi-procedural in its effect, is the relative convenience of administration in a collective proceeding. This argument follows the same line of reasoning applied to justify and reconcile with procedure theory pro rata sharing in bankruptcy.623 It would be easier to administer a priority regime in a collective proceeding than in individual lawsuits (such as a suit grounded in tort) in which the subordinated class of parties (such as general contract creditors) are not involved.624 Moreover, it is the scarcity of resources presumed to exist in a bankruptcy case involving an insolvent debtor that would drive the need for a tort-first priority rule.
Procedure theory can marshal several responses to this argument. First, it would be much easier to impose tort-first as a matter of nonbankruptcy law than it would be to impose pro rata sharing. Statutory liens, incorporating a lis pendens feature or other notice systems, are common under nonbankruptcy law.625 But pro rata sharing necessarily involves a collective proceeding inasmuch as it affects all unsecured creditors.
Second, unlike pro rata sharing, which is ubiquitous in nonbankruptcy collective insolvency contexts, in the United States there is no nonbankruptcy tradition or historical normative support for tort-first. Instead, nonbankruptcy law must be understood as commanding equality among unsecured creditors, irrespective of the doctrinal nature of those claims, while accepting the race of diligence as an essential component of enforceability in the absence of insolvency.626 Pro rata sharing gives effect to the essential equality of unsecured creditors outside bankruptcy. Tort-first, on the other hand, would promote some otherwise equal creditors to the detriment of other, demoted creditors. Moreover, if anything, some nonbankruptcy and bankruptcy doctrine would support a tort-second approach.627
Third, similar to but distinct from the second response, tort-first would not affect, but would detract from, procedure theory’s goal of enhancing the benefits for rightsholders. It would punish some and reward others. If society wishes to “tax” some to benefit others, then it should adopt a comprehensive across-the-board system for providing benefits to victims of torts, not a bankruptcy-specific redistribution of wealth.628
Procedure theory must recognize that it is not merely in bankruptcy that tort-first might have its principal effects. Indeed, advocates generally have pointed to the caution-inducing instrumental effects that they claim would result from a tort-first regime.629 Procedure theory alone cannot refute these instrumental arguments. Instead, it maintains that the process of creating bankruptcy law is not the proper crucible for addressing these problems.630 I suspect that the likelihood that the process of reforming and administering bankruptcy law will develop pathbreaking and revolutionary solutions, even partial solutions, to the problems of deterring tortious conduct and compensating victims of torts is about the same as the probability that it will improve the world by radically overhauling employment law-slim to none.631
Finally, consider the position that objectors to procedure theory must embrace. The counter to procedure theory necessarily must hold that the proper domain for bankruptcy-only priority rules includes any modification of nonbankruptcy entitlements whatsoever so long as the move is socially beneficial and susceptible to better administration (presumably, no matter how slight the advantage) in a collective proceeding. That is a plausible political position for anyone who thinks that they and their ilk might manipulate the bankruptcy reform process to their desired ends. The argument here, however, is not about the merits of proposals such as tort-first but the proper scope of bankruptcy law. The unbounded view of bankruptcy holds that once all of the assets and rightsholders are in court, bankruptcy’s job is to do social justice without regard to whether it tramples on nonbankruptcy legal entitlements.
J. Adequate Protection for Undersecured Creditors
Both the trustee in bankruptcy, or debtor in possession, and the holder of a secured claim have a property interest in the property of the estate that is secured by the secured claim.632 In effect, a secured claim extends only to the value of the collateral. If that value is less than the claim, the claim is bifurcated into a secured claim (equal to the collateral value) and an unsecured claim for the shortfall or deficiency.633 The creditor holding such a secured claim is said to be an “undersecured” creditor. When a debtor in possession possesses and uses a secured creditor’s collateral the creditor is entitled to “adequate protection” of its interest in the collateral.634 Fully consistent with procedure theory, this right to adequate protection preserves the value of the secured creditor’s nonbankruptcy entitlement and avoids a redistribution ofthat value for the benefit of the unsecured creditors.635
Outside bankruptcy the secured creditor would be entitled to enforce its lien, such as by a disposition in a foreclosure proceeding, following the debtor’s default.636 By virtue of the automatic stay,637 however, the secured creditor is denied this opportunity. Is the secured creditor entitled to adequate protection for the delay caused by the stay in this context-for the time value of money? The Supreme Court unanimously answered “no” to this question in United Savings Association v. Timbers of Inwood Forest Associates, LTD. Although I believe that the court incorrectly decided the case as a matter of statutory interpretation, that is beside the point for present purposes.639 The result in Timbers (or in the Bankruptcy Code, assuming a correct interpretation in Timbers) clearly contravenes procedure theory. Outside bankruptcy, the creditor would be entitled to the liquidation value of the collateral on day X, and by virtue of the automatic stay, the secured creditor receives the value on day X plus K and, under Timbers, the creditor is not compensated-adequately protected-for the delay.640 The secured creditor’s property rights are being sacrificed for the benefit of the unsecured creditors, plain and simple.
The effect of Timbers is not merely wrong, it is outrageous. But even if the Court overrules it or rectifies it with an amendment to the Bankruptcy Code, I suspect that the judiciary often would find the means to offend procedure theory in practice.641 Procedure theory provides a normative bottom to argue for a more radical adjustment of the treatment of secured claims in bankruptcy, such as a requirement that the trustee or debtor in possession cure all defaults within a specified period as a condition to retaining possession or control of collateral.642
This Part has examined some of the most important features of bankruptcy law. In many respects, it found these features generally compatible with procedure theory, although it also identified some details of current doctrine that cannot be reconciled. Those aspects should be conformed to procedure theory. These aspects of bankruptcy law, while important, nonetheless are illustrative. Much of the legal landscape of bankruptcy remains to be examined through the normative principles of procedure theory.
Additional aspects of bankruptcy law that could be informed by procedure theory include corporate governance and securities regulation in Chapter 11, additional issues relating to what constitutes a claim (including environmental injunctions and covenants not to compete), postpetition financing, equitable subordination, mass torts issues (including Bankruptcy Code Section 524(g), future claims, and third party injunctions and releases), successor liability, additional avoidance and related powers-including statutory liens, turnover orders, postpetition after-acquired property and proceeds, and setoff-federal and state exemptions, and first-day orders under the “doctrine of necessity.”
This Article develops a normative theory of bankruptcy, procedure theory that understands bankruptcy law as a subset of civil procedure law. The proper domain of bankruptcy law is in service to the interests of rightsholders that have a relationship to a financially troubled debtor. Procedure theory holds that it generally is wrong to impair the interests of rightsholders for the benefit of nonrightsholders or to reorder nonbankruptcy priorities in bankruptcy. Procedure theory allows for exceptions to its baseline injunctions when necessary and appropriate for bankruptcy law to fulfill its purpose. It identifies what bankruptcy law should do, in general terms, but it does not resolve the optimal means for a bankruptcy law to achieve its appropriate goals of serving the interests of rightsholders.
Procedure theory does not rely on a simplistic, label-based procedure versus substance dichotomy for its normative content. It draws its normative core from three similar but distinct accounts: The philosophical and jurisprudential account, the civil procedure and federal court jurisdiction account, and the public choice account. Each account condemns the existence of one set of laws applicable in bankruptcy and another applicable outside bankruptcy, unless there is a rational bankruptcy-related basis for a bankruptcy-specific or bankruptcy-only rule.
After establishing the content and normative grounds underlying procedure theory, this Article examines several important features of United States bankruptcy law. It rationalizes the existence of several bankruptcy law deviations from nonbankruptcy law and concludes that there are bankruptcyrelated reasons that justify these deviations. In other cases, however, procedure theory identifies aspects of current bankruptcy law that cannot be justified and it calls for change. This Article demonstrates the utility of procedure theory as a framework for a principled critique of current bankruptcy law and of changes to bankruptcy law that might be proposed.
Charles W. Mooney, Jr.*
* Charles A. Heimbold Jr., Professor of Law, University of Pennsylvania Law School. I am grateful to the Handler Foundation and to the University of Pennsylvania Law School for generous research support. I also wish to thank Laura Bartell, Stephen Burbank, David Carlson, Geoffrey Hazard, Melissa Jacoby, Edward Janger, Stephen Perry, Reed Shuldiner, Paul Shupack, Charles Tabb, Elizabeth Warren, participants at faculty workshops at the University of Arizona James E. Rogers College of Law, the University of Illinois College of Law, and the College of William and Mary, Marshall-Wythe School of Law, and participants at the 2003 faculty retreat of the University of Pennsylvania Law School for helpful suggestions and comments on earlier drafts, as well as Erin Miller, J.D. 2001, University of Pennsylvania Law School; Chi-Wei Huang, LL.M. 2000, S.J.D. candidate, University of Pennsylvania Law School; Derek Santos, J.D. 2003, University of Pennsylvania Law School; Michael Doak, J.D. 2003, University of Pennsylvania Law School; and Sun Lim, J.D. 2004, University of Pennsylvania Law School, for valuable research assistance. Errors that remain are mine.
Copyright Washington & Lee University, School of Law Summer 2004
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