Judgment Proof Research Articles

Are firms with 'deep pockets' more responsive to tort liability? Evidence from nursing homes.

We provide time series evidence of tort reform's impact on inputs and quality in the nursing home industry. Between 2000 and 2010, 11 state reforms capped noneconomic damages for health care services. Small chain and unaffiliated nursing homes enjoyed "judgment proof standing" and were less apt to be sued, prior to reform. We find that the managers of such homes were relatively unresponsive to the implementation of state caps on noneconomic damages. Large "deep-pocketed" chain-affiliated homes lacked judgment proof standing and implemented greater reductions in their nursing inputs in the aftermath of tort relief. However, we find little evidence of service quality erosion across four measured dimensions of care outcomes. Our findings are consistent with a "defensive care" model in which large chain homes employ unproductive inputs in an effort to meet a negligence standard of care.

Optimal extended liability rule in a competitive financial market with heterogeneous borrower firms

This paper provides a perspective that unifies two controversial arguments about the extended liability rule in a competitive financial market, i.e., the negative arguments about the exaggeration of the judgment proof problem and the positive arguments about the entry deterrence of inefficient firms. This paper also gives the theoretical solution for the optimality of the extended liability rule. In this paper, heterogeneous firms are assumed for the cost parameter of the precautionary effort, and distortions are dependent on the heterogeneities. Then, even considering extended liability with any share to the financier, the extended liability rule never achieves a socially first-best situation. Alternatively, the conditions under which the second-best optimal extended share to the financier should suffice are provided. Furthermore, I discover that the information structure is one of the crucial factors in determining the socially second-best solution for the extended share.

度量空间C(R<sup>n</sup>)中集合列紧性的判定条件及证明

度量空间C(R<sup>n</sup>)中集合列紧性的判定条件及证明

Tracing Equity: Realizing and Allocating Value in Chapter 11

Law and economics scholars have long argued that efficiency is best served when a firm’s capital structure is arranged as a single hierarchical value waterfall. In such a regime, claimants with seniority are made whole before the next-junior stakeholders receive anything. To implement this single waterfall approach, those scholars envision a property-based mechanism: a blanket lien on all of a firm’s assets, and therefore all of its value (including as a going-concern). This view informs current proposals for contractual bankruptcy and relative priority. Coincident with this scholarship, lawyers, scholars, and judges have largely accepted at face value the proposition that Article 9 of the Uniform Commercial Code implements the single waterfall. In other words, they assume that the law allows a secured lender to write contracts that enable it to capture all of a distressed company’s going-concern value. This assumption has placed “senior” secured lenders firmly in the driver’s seat when a firm falls into distress. So-called “senior” creditors claim priority in all of the value, and control over all of the cash. They often advocate a quick sale of the firm as a going concern, or liquidation of its assets, followed by a structured dismissal of the case, giving all of the value to the secured lender. In this article, we illustrate that Article 9 does not, in fact, implement the single waterfall principle. Instead, both Article 9 and the federal Bankruptcy Code maintain a distinction between priority based on the firm’s assets and claims to the residual value of the firm. Whenever the firm continues in operation, there will be two value waterfalls – one tied to assets, and the other not. The second waterfall consists of the going-concern and other value of the firm Chapter 11 preserves. The key legal (often forgotten) concept that maintains this distinction is “equitable tracing” – required by both Article 9 and Chapter 11. The terms “equitable principles” in Article 9 and “equities of the case” in Chapter 11 refer to equitable tracing principles, that, in turn, inform secured creditors’ “fair and equitable” baseline entitlement in a Chapter 11 plan. On the petition date, the value of the firm is therefore divided into two categories: value traceable to encumbered assets; and, other value. This relationship must then be managed over time, as the value of the firm changes. Chapter 11, accordingly, treats realization of value as a two-step process that we call “Equitable Realization.” Equitable Realization uses tracing principles to allocate a firm’s value between asset-based and firm-based claimants and to preserve that allocation over time. First, it fixes the relative positions of secured and unsecured claims when a bankruptcy petition is filed. Second, it delays the fixing of the value of secured claims until collateral is sold or a Chapter 11 plan is confirmed. The value of the secured creditor’s collateral may increase, but the secured creditor’s entitlement to any bankruptcy-created value extends only to “identifiable proceeds” – value that can be traced to assets encumbered on the petition date. As a result, increases in going-concern value of the company in this period, and other bankruptcy-created value more generally, are not within a lender’s collateral package. Any going-concern value created or preserved by Chapter 11 is allocated to the bankruptcy estate for the benefit of all stakeholders—workers, retirees, customers, and more. We then address whether Article 9 and the Bankruptcy Code took the right approach by choosing Equitable Realization over the single waterfall. Many scholars, all the way back to Grant Gilmore, have questioned the wisdom of the single waterfall. Joining and expanding on those scholars’ concerns, we explain the benefits of Equitable Realization, and how the concept resonates with a large family of corporate and commercial law rules that guard against undercapitalization and judgment proofing. Equitable Realization not only implements the Bankruptcy Code’s core goal of equitable treatment of creditors, but, by properly identifying firms’ residual claimants, limits a firm’s ability to externalize risk and increases the prospect of reorganizing troubled companies. The last task of this article is to test our insights against the value-allocation proposals in the Final Report of the American Bankruptcy Institute Commission to Study the Reform of Chapter 11, as well as priority-related proposals in academic scholarship. Many of the Commission’s proposals are consistent with Equitable Realization. But one proposal in particular, redemption option priority, allocates too much to secured creditors relative to our interpretation of current law.

The choice of trigger in an insurance linked security: The mortality risk case

In 2003, Swiss Re introduced a mortality-based security designed to hedge excessive mortality changes for its life book of business. The concern was mortality risk, i.e., the risk of premature death. The mortality risk due to a pandemic is similar to the property risk associated with catastrophic events such as earthquakes and hurricanes and the security used to hedge the risk is similar to a CAT bond. This work looks at the incentives associated with insurance linked securities. It considers the trade-offs an insurer or reinsurer faces in selecting a hedging strategy. We compare index and indemnity-based hedging as alternative design choices and ask which is capable of creating the greater value for stakeholders. Additionally, we model an insurer or reinsurer that is subject to insolvency risk, which creates an incentive problem known as the judgment proof problem. The corporate manager is assumed to act in the interests of shareholders and so the judgment proof problem yields a conflict of interest between shareholders and other stakeholders. Given the fact that hedging may improve the situation, the analysis addresses what type of hedging tool would be best. We show that an indemnity-based security tends to worsen the situation, as it introduces an additional incentive problem. Index-based hedging, on the other hand, under certain conditions turns out to be beneficial and therefore dominates indemnity-based strategies. This result is further supported by showing that for the same sufficiently small strike price the current shareholder value is greater with the index-based security than the indemnity-based security.

Economic Perspectives on the Restatement of the Law on Liability Insurance Project

This paper provides perspectives on the Restatement of the Law, Liability Insurance (RLLI) project in view of theory and evidence on the economics of liability insurance and the operation and regulation of liability insurance markets. The RLLI project reflects prodigious effort by the Reporters over six years, and many revisions in response to feedback in the drafting process and the project’s evolution from Principles to Restatement. My focus is on the proposed black letter rules regarding insurers’ defense obligations and other issues that would expand policyholder rights compared with existing law in a significant number or even majority of jurisdictions. These proposed rules reflect an emphasis on the potential advantages to insureds facing legal actions of expanding their post-claim rights and protections, with relatively little attention paid to the potential impacts on insurance prices, coverage terms, and demand for coverage ex ante. Such proposals risk significant disruption of current law with uncertain, unintended, and adverse consequences on liability insurance markets in the form of higher prices, less availability of coverage, reductions in policy limits purchased, aggravation of the judgment proof problem, and increased adverse selection and moral hazard.

Litigation with judgment proof defendants

We consider a model of litigation in which some defendants have insufficient assets to pay a judgment at trial. Because the defendant’s assets are not observable, this serves as a source of asymmetric information which leads to trials in the equilibrium of the model. Unlike many other types of informational asymmetry, the defendant’s assets are not generally subject to discovery and it may be difficult to credibly establish a lack of assets in a voluntary disclosure. Thus, this is a source of asymmetry between the parties which is likely to persist in the presence of these institutions. This suggests that this particular asymmetry is a potentially important explanation for settlement failure, at least in a subset of cases. We describe three possible equilibria in the model with asset constrained defendants. The constrained equilibrium is consistent with high dispute rates between the plaintiff and defendant. The model suggests that fee shifting will either have no effect on the incidence of trial or will increase it.

Ensuring Insurance for Foster Care: Requiring Foster Parents to Obtain Liability Insurance to Cover Harm Done to Foster Children in their Care

This Note proposes that all states should require that foster parents have liability insurance before children are placed in their care. This Note also proposes that the liability insurance needs to cover not just harm to third parties but also harm to the foster children through the negligent acts of the foster parents. This legislation will allow foster children to have standing to bring claims against their foster parents and insurance companies and give them a greater opportunity for recovery. Currently, the policies and statutes governing the policies in place do not cover all types of harm that can occur during the foster parent–child relationship. Certain policies leave children who are harmed by their foster parents’ negligence unable to recover any damages from the people who have harmed them. Because foster parents can be left to defend the actions themselves, they often become judgment proof due to their low income, leaving the children who are harmed with little chance of recovery. Key Points for the Family Court Community: States need to require foster parents to obtain liability insurance, which covers harm done by the foster children to third parties, harm to the home, and any harm done to the child by the foster parents.

Identifying Criminalss Risk Preferences

There is a 250 year old presumption in the criminology and law enforcement literature that people are deterred more by increases in the certainty rather than increases in the severity of legal sanctions. We call this presumption the Certainty Aversion Presumption (CAP). Simple criminal decision making models suggest that criminals must be risk-seeking if they behave consistently with CAP. This implication leads to disturbing interpretations, such as criminals being categorically different than law abiding people, who often display risk-averse behavior while making financial decisions. Moreover, policy discussions that incorrectly rely on criminals’ risk attitudes implied by CAP are ill-informed, and may therefore have unintended negative consequences.In this article, we first demonstrate, contrary to most of the existing literature, that CAP consistent behavior does not imply risk-seeking behavior. A host of considerations that are unrelated to risk-attitudes can generate behavior that is consistent with CAP, including stigmatization; discounting; judgment proofness; the forfeitability of illegal gains; and the possibility of being punished for unsuccessful criminal attempts. Next, we discuss empirical methods that can be employed to gain a better understanding of criminals’ risk-attitudes and responsiveness to various punishment schemes. These methods focus on the various non-risk-related-considerations that may be responsible for CAP consistent behavior. Finally, we discuss the importance of gaining a better understanding of criminals’ attitudes for purposes of designing optimal law enforcement methods, punishment schemes for repeat offenders, plea bargaining procedures and standards of proof.

Litigation with Judgment Proof Defendants

We consider a model of litigation in which some defendants have insufficient assets to pay a judgment at trial. Because the defendant’s assets are not observable, this serves as a source of asymmetric information which leads to trials in the equilibrium of the model. Unlike many other types of informational asymmetry, the defendant’s assets are not generally subject to discovery and it may be difficult to credibly establish a lack of assets in a voluntary disclosure. Thus, this is a source of asymmetry between the parties which is likely to persist in the presence of these institutions. This suggests that this particular asymmetry is a potentially important explanation for settlement failure, at least in a subset of cases. We describe three possible equilibria in the model with asset constrained defendants. One equilibrium is consistent with high dispute rates between the plaintiff and defendant. The model suggests that fee shifting will either have no effect on the incidence of trial or will increase it.

Can Imprisonment Be Cheaper? The Law and Economics of Private Prisons

Custody is the most expensive method of punishment in the western world, as compared to other alternatives. Although expensive, prison is an indispensible instrument to deal with judgment proof or dangerous offenders. Hence, by using the law and economics approach, this paper explores prison privatization as an instrument for less expensive incarceration. This method has the potential to reduce the prison costs without hampering its quality. However, a restructuring of the current contracts is needed to achieve this purpose. The attention given to the topic of private prisons by the law and economics scholars, especially in the European context, is limited and this paper attempts to fill this gap. The present paper applies arguments from the bureaucracy and political science literature to explain the inefficiencies of public prisons. Subsequently, the potential problems of private prisons are presented through the principle-agent model and solutions are offered.

Judgment Proofness and the Choice between Monetary and Nonmonetary Care

This paper studies a unilateral accident model in which potentially judgment-proof agents (agents who may have insufficient assets to satisfy a judgment against them) choose levels of both monetary and nonmonetary care. We show that (i) monetary care may exceed its first-best level under both strict liability and negligence, (ii) social costs may be lowered by the incentive effects resulting from the monetary nature of care, (iii) an increase in the assets of potentially judgment-proof injurers may increase social costs, and (iv) one second-best due-care standard may be in excess of the efficient care level.

Remedying Illegal Actions of Judgment Proof Injurers Via Contracts, Fines and Sanctions

This paper studies the impact of the judgment proof problem on the design of incentives to prevent illegal behavior when the principal delegates a risky production activity to the agent in the presence of moral hazard and adverse selection. The agent can reduce costs by engaging in an illegal action that generates liability. When insolvency is endogenously determined, the principal neither provides incentives to the agent to induce a fully legal action nor designs a contract that makes either party insolvent. The social optimum can be achieved by a fine or non‐monetary sanction. If the fine cannot correct inefficiency, non‐monetary sanction achieves the social optimum by the fully legal action. Copyright © 2013 John Wiley & Sons, Ltd.

The Shale Oil and Gas Revolution, Hydraulic Fracturing, and Water Contamination: A Regulatory Strategy

The United States is expected to become the world’s largest oil producer by 2020, overtaking Saudi Arabia, and the world’s top natural gas producer by 2015, surpassing Russia. In the past decade, energy companies have learned to tap previously inaccessible oil and gas in shale with “hydraulic fracturing” (“fracturing” or “fracking”), pumping fluid at high pressure to crack the shale and release gas and oil trapped inside. This “shale revolution” has created millions of jobs, enhanced our energy independence, and reduced U.S. greenhouse gas emissions by substituting natural gas for coal. Even so, fracturing is controversial. It may undercut the renewable energy industry, exacerbate air pollution and congestion, and use significant amounts of water. The most unique risk, which is the focus of this Article, is the potential contamination of groundwater. The fluid used in fracturing contains toxic chemicals. There is little evidence so far that subterranean fracturing can directly contaminate groundwater, and this risk may never materialize. The layer of shale that is fractured is usually thousands of feet below the water table, with a buffer of dense rock or clay in between. But there are other ways in which fracturing might contaminate groundwater, including surface spills of fracturing fluid, improper handling of waste, and the migration of natural gas into water wells. Some of these risks are familiar from decades of conventional oil and gas production, while others are new. In response, this Article proposes a strategy for regulating water contamination from fracturing. For issues that are already well understood, we would rely on best practices regulations. For issues that are unique to fracturing and are not yet well understood, we would rely on liability rules – and, specifically, a hybrid of strict liability and a regulatory compliance defense – to motivate industry to take precautions, develop risk-reducing innovations, and cooperate in the development of best practices regulations. To facilitate more accurate determinations of causation, we recommend information-forcing rules (e.g., requiring energy companies to test water quality before they begin fracturing). We also suggest other design features for the liability system, such as one-way fee shifting and provisions to ensure that defendants will not be judgment proof. To ensure that the regulatory regime draws on existing regulatory expertise and is both dynamic and tailored to local conditions, we recommend keeping the regulatory center of gravity in the states, instead of fashioning a new federal regime.

Judgment Proofness and the Choice between Monetary and Nonmonetary Care

Judgment Proofness and the Choice between Monetary and Nonmonetary Care

Small Business Financial Distress and the “Phoenix Syndrome”—A Re‐evaluation

AbstractIn a typical “phoenix syndrome” scenario, a small business entrepreneur who controls the financially distressed Company A registers Company B, to which the assets of Company A are transferred in what appears to be fraudulent conveyance. Company B serves as a vehicle through which the business is kept running, without the pressures of the business creditors. If necessary, the entrepreneur will also register Company C and repeat the process. The law usually considers the execution of a “phoenix syndrome” scheme (“phoenixizing”) to be fraud against Company A's unaware creditors. Two major problems undermine, however, the efficient regulation of “phoenix syndrome” schemes. First, although criminal sanctions are available, “phoenixizing” entrepreneurs are not regularly prosecuted and are usually only subject to monetary sanctions (e.g., personal civil liability to creditors). Because defrauders tend to be judgment proof, the result is sub‐optimal deterrence. Second, lawmakers have not considered a more sympathetic explanation to account for the “phoenix syndrome” phenomenon: an entrepreneur resorting to a “phoenix syndrome” scheme might actually be arranging for a last‐resort “home‐made” bankruptcy proceeding, that is, the entrepreneur might be mimicking the role of a formal bankruptcy stay on unsecured creditors' collection efforts, against the background of a cost prohibitive formal bankruptcy proceeding. Put simply, the “phoenix syndrome” scheme is, occasionally, “a poor man's” bankruptcy proceeding. Deterring a “phoenixizing” entrepreneur attempting to rescue a viable business is, of course, unwarranted, as the result is viable businesses being lost. These two problems of under‐deterrence and over‐deterrence mandate a re‐evaluation of the manner in which “phoenix syndrome” schemes are regulated. Obviously, the main question concerns implementation: How can “good” entrepreneurs, attempting to rescue a viable business, be separated from “bad” ones, who attempt to defraud or to rescue a non‐viable business? The paper discusses and evaluates several solutions. Copyright © 2012 INSOL International and John Wiley & Sons, Ltd.

Accidental death and the rule of joint and several liability.

Most U.S. states have enacted JSL reform, the move from a regime of joint and several liability (JSL) that allows plaintiffs to claim full recovery from any one of multiple defendants to one where defendants are held liable only for the harm they cause. Contrary to previous theoretical work, we show that JSL reform can increase precaution by judgment proof agent by giving "deep pockets" an incentive to reduce their own liability by bringing judgment-proof agents into court. This result can help explain our empirical findings showing that JSL reform reduces death rates (and hence increase precaution) for many types of accidents. Together, these results highlight the role that litigation costs and judgment-proof agents play in the functioning of the American tort system.

Mitigating Judgment Proofness: Information Acquisition vs. Extended Liability

We present a simple lending model of judgment proof borrowers with private information and heterogeneous wealth, where large and small lenders coexist. Lenders subject would-be borrowers to pre-lending screening, which is not observable and cannot therefore be committed to ex ante. We document market segmentation and credit rationing: borrowers with limited wealth, who face a less severe moral hazard, are funded by large lenders; wealthy borrowers turn to small lenders who face a higher cost of capital; borrowers with abundant wealth do not get any financing. With advances in the screening technology, large lenders (small lenders) contract (expand) their loan portfolio. In contrast, as a result of an increase in the liability of lenders, large lenders (small lenders) increase (decrease) the number of loans that they make. The qualitative impact on social welfare of an increase in lender liability or advances in information technology is ambiguously tied to the quality of the borrower pool.

On information, extended liability and judgment proof firms

We use a simple lending model with endogenous screening to compare the impact of improvements in the cost of acquiring information and increases in the liability of lenders for environmental harm caused by their borrowers. In the model, judgment proof borrowers have private information about their underlying risk (represented by the probability of an accident). Screening enables lenders to receive a noisy signal about their borrowers’ risk type ex ante. We show that a decrease in the cost of information exacerbates credit rationing. By contrast, an increase in lender liability leads to a reduction in the extent to which credit is rationed. The impact on social welfare crucially depends on the mix of borrower-type in the population: an increase in extended liability is likely to improve social welfare if there is an abundance of good borrowers in the population; improvements in the information system are likely to enhance social welfare if the proportion of good risks is sufficiently low.

Excessive spending by firms to avoid accidents: Is it a concern in practice?

Shavell’s [Shavell, S. (1986). The judgment proof problem. International Review of Law and Economics, 6, 45–58] original model of the judgment proof problem treats costs of care to prevent accidents as non-monetary. Noting that this is unrealistic when injurers are firms, several authors have found that with monetary care costs, some judgment-proof firms perversely take excess rather than insufficient care. In this paper, we make explicit the quite specific assumptions required for the excess-care result to arise even in theory, and demonstrate that, even under these assumptions, the result is likely to be quantitatively unimportant. We also suggest an alternative model that, while treating care costs as monetary, avoids the excess-care result.