More Equal Than Others: Defending Property-Contract Parity in Bankruptcy

By Rohrbacher, Blake | The Yale Law Journal, March 2005 | Go to article overview

More Equal Than Others: Defending Property-Contract Parity in Bankruptcy


Rohrbacher, Blake, The Yale Law Journal


INTRODUCTION

  I. DEFINING RIGHTS IN PROPERTY AND CONTRACT
     A. Property or Contract: Distinguishing Features
     B. Property in Contract: Choses in Action
     C. Property and Contract: Intersections and Implications

 II. THE PROPERTY-CONTRACT DISTINCTION IN BANKRUPTCY
     A. Current Law
     B. Justifications for the Property-Contract Distinction

III. PROPERTY, CONTRACT, AND BANKRUPTCY:
     WHAT SHOULD BE DONE?
     A. Property-Contract Parity in Bankruptcy
     B. The Current Approach: Problems and Solutions
        1. Landlords Under [section] 502(b)
        2. Automatic Stay
        3. Executory Contracts

CONCLUSION

All animals are equal but some animals are more equal than others. (1)

[S]ome forms of property are worth more than others. (2)

INTRODUCTION

Imagine you own a successful donut shop, and an entrepreneur named Anthony Jenkins wants to franchise your idea and open a shop in a nearby city. You're worded that Anthony, who seems to have plenty of cash, might open some shops near you in the future. You request that a covenant not to compete be put in the franchise agreement. If Anthony refuses to sign a noncompete clause without a price reduction, how much less should you charge? If he does sign, how protected are you from Anthony's future encroachments?

Or, imagine you're Anthony's insurance company, and your contract explicitly says that you can cancel his fire policy if he doesn't maintain his shops' sprinkler systems. Have you charged enough in premiums to offset your risk? Are you really protected from Anthony's cavalier attitude toward sprinkler maintenance?

It all depends: How likely is it that Anthony will go bankrupt? Where could Anthony file for bankruptcy? Which bankruptcy judge will hear his case? These last three are questions you can't answer. Under current bankruptcy law, you can't, therefore, answer any of the previous questions.

While the common law has recognized property in contract for hundreds of years, bankruptcy law typically does not. Bankruptcy's distinction between property and contract is unjustifiable. It results in disparate treatment depending on what a given court terms a party's interest. This nominalist, form-over-substance reasoning can lead to inconsistent application of bankruptcy law, disregard for bankruptcy's fundamental principle of deference to nonbankruptcy entitlements, disruption of party expectations, and unequal treatment of interested parties in bankruptcy proceedings. Treating contractual property as regular property, I argue, would help rectify these problems and provide a normative policy justification that is lacking in much of bankruptcy law.

The property-contract approach detailed in this Note should improve the current system. Property-contract parity would lead to more efficient contracting ex ante (i.e., before the debtor files for bankruptcy) and more efficient behavior ex post. One example of the current system's flaws is explored in Subsection III.B.3: For executory contracts in bankruptcy, the debtor's right to performance is treated as property, but the debtor's obligation to perform is treated as contract. Furthermore, bankruptcy courts are inconsistent in their treatment of executory contracts--for example, some courts hold that covenants not to compete are rejected in bankruptcy, while some do not. Thus, a party to a contract, who cannot know when or if the other party will file for bankruptcy, cannot be certain of the effect or permanence of his contract.

Ex ante, the current system results in less efficient contracting. When the parties first make their contract, they cannot predict which way a future bankruptcy court will rule. This uncertainty regarding the outcome and effect of contractual relationships precludes contracting parties from correctly calculating their gains and losses from the relationship. Thus, a creditor, or any party contracting with a potential debtor (i. …

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