The Inherent Irrationality of Judgment Proofing

Abstract

In recent articles in the Yale Law Journal and the Stanford Law Review, Professor Lynn M LoPucki has sparked much academic discussion arguing that recent developments in corporate law have led to an erosion in the system of corporate liability, such that it might one day prove impotent. LoPucki has argued that transactions such as asset securitizations, sale-leasebacks, and corporate structures in which liabilities are placed in asset-poor subsidiaries are driving this change. One early critic to the LoPucki thesis, Professor James J. White, has argued that empirical data show no evidence of increasing use of judgment proofing techniques. In this article, Professor Steven L. Schwarcz joins this debate, arguing that an economic analysis of these transactions suggests that Widespread use of these judgment proofing techniques is unlikely. A key distinction in the analysis, Schwarcz argues, is between arm's length and non-arm's length transactions. Arm's length transactions are unlikely to lead to judgment proofing because corporations will receive value-often cash-for the assets they sell. It is only by paying out this value in dividends that a corporation begins to judgment-proof itself. The theoretical possibility to take value away from future involuntary creditors through such transactions will rarely be realized because of the costs-taxes, negative publicity, personal and criminal liability-of entering into such agreements. By contrast, in non-arm's length transactions, corporate owners do have the incentive to create judgment-proof structures. However, these structures are not innovative, and they will continue to be well-regulated ex post by existing legal doctrines in bankruptcy, corporate law, tort law, and criminal law. Following this article are a response from Professor Lynn LoPucki, a comment by Professor Charles Mooney and a brief rejoinder from Professor Schwarcz.