Security Interests and Bankruptcy Priorities: A Review of Current Theories

Abstract

In recent years, finance economists have begun to study several practices that the law traditionally regulates. Examples include attempted explanations of the variety of debt and equity instruments that firms issue, the nature of bond covenants, the functions that trade credit serves and the likely actions of creditors when their debtor becomes insolvent. These studies are illuminating and provocative, but represent only the beginning of coherent explanations of the phenomena. Also, the normative implications of this relatively incomplete understanding have been unexplored. Lawyers assume these financial practices to be well understood and, consequently, have erected regulatory structures that presuppose the truth of what now seem preliminary or questionable positivist theories. This paper explores a particular financial practice-the issuance of debt secured by personal property--and a regulatory scheme relevant to this practice--the setting of distributional priorities when an insolvent firm is liquidated. My principal purpose is to illuminate the unresolved problems in this field and to illustrate the relevance of the achievements and unaccomplished tasks of modern finance to areas of business law that have developed largely independently of this discipline.