A Normative Theory of Bankruptcy Law: Bankruptcy as (is) Civil Procedure

Abstract

This paper develops a normative theory of bankruptcy law. The core of the theory is that bankruptcy law exists in order to maximize the recoveries of and benefits for those who have legal entitlements (rightsholders) in respect of a financially distressed debtor. It recognizes that bankruptcy law in the United States is a branch of civil procedure, in general, and the jurisdiction of federal courts, in particular; hence, I call the theory 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 is wrong to rearrange priorities in bankruptcy as among a debtor's rightsholders in a way that is inconsistent with nonbankruptcy entitlements. Procedure theory explains what bankruptcy law is supposed to achieve. It does not address how bankruptcy law is to achieve its proper ends (e.g., status quo, adoption of market-based or contract-based structures to maximize wealth, etc.).Procedure theory draws support from three perspectives. First, it argues that it simply is incoherent to provide different substantive rules in bankruptcy when those substantive rules are equally applicable outside bankruptcy (e.g., an employer's right to close a plant or a nonbankruptcy priority rule). This incoherence offends notions of justice as well as Dworkin's value of liberty. 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 (e.g., state court or bankruptcy court). Third, a public choice analysis reveals the enormous power of the bankruptcy bar over bankruptcy law, as formulated by Congress or as implemented in the courts. The Judiciary Committees in Congress and the bankruptcy courts, populated by bankruptcy mavens, are improper venues for the development of baseline legal principles that are not bankruptcy specific.If there is a justification for bankruptcy law it must be that, as a collective proceeding, it can maximize or enhance recoveries and benefits for rightsholders when compared to nonbankruptcy law. The paper finally 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, including the concept of property of the estate, the claims that are recognized in bankruptcy, the automatic stay, pro rata sharing among creditors, and the trustee's avoidance powers, among others. In several cases procedure theory calls for a modification of current law.