Coase-Sandor Institute for Law & Economics Research Paper Series

Publication Date

2025

Publication Title

Coase-Sandor Working Paper Series in Law and Economics

Abstract

Nearly every chapter 11 is “voluntary” in that it’s initiated by the company’s managers. Yet the Bankruptcy Code also allows unsecured creditors to force a company to reorganize under an “involuntary chapter 11.” Involuntary chapter 11s are rare and largely ignored by scholars. That’s potentially because bankruptcy and corporate law largely defer to managers’ business judgment as to how to maximize the company’s value, and investors have several contract and corporate law tools designed to discipline underperforming managers. So, what work can involuntary chapter 11s do?

This Article shows that an involuntary chapter 11 can be the optimal solution for a company with going concern value that simultaneously faces two kinds of distress: financial distress ¾ such as running out of cash or taking on too much debt ¾and what this Article calls “managerial distress,” which is when a company’s management is so deadlocked, absent, or dysfunctional that it can’t run the company. When both kinds of distress simultaneously set in, ordinary contract and corporate law solutions misfire, jeopardizing the company’s value. What the company needs is for someone to force it into chapter 11, which provides a toolkit designed to comprehensively address both financial and managerial distress.

This Article makes three main contributions. First, it shows that involuntary chapter 11s have an important, but underappreciated, role to play in salvaging firms with going concern value. Second, it reveals how the current involuntary chapter 11 system isn’t geared to serve that role because it allows a narrow class of investors to throw a company into chapter 11 without having to show that the company faces managerial distress. Third, it sketches a new involuntary chapter 11 system, one that would incentivize a wide range of investors to file involuntary chapter 11s against companies that face both kinds of distress and penalize them for filing such cases against companies that face only one or neither kind of distress

Number

25-16

Download


Included in

Law Commons

Share

COinS