Academic journal article Iowa Law Review

One Dollar, One Vote: Mark-to-Market Governance in Bankruptcy

Academic journal article Iowa Law Review

One Dollar, One Vote: Mark-to-Market Governance in Bankruptcy

Article excerpt

I. Introduction

Bankruptcy is a system for maximizing, realizing, and fairly distributing the value of a failed firm to its stakeholders. In chapter 7 of the Bankruptcy code an independent and disinterested trustee liquidates the debtor firm.1 Secured creditors are paid from the proceeds of their collateral, and any remaining realized value is distributed among unsecured creditors and equity holders according to a prescribed statutory waterfall.2 Because the Chapter 7 liquidation system is nondiscretionary, it establishes a distributional baseline and raises relatively few governance questions.

In contrast, Chapter 11 provides a mechanism for restructuring a firm as a going concern.3 Governance questions abound because the firm needs to continue operating while in bankruptcy, while simultaneously formulating a plan for its post-bankruptcy operations and determining how to compensate the various stakeholders. How can the value of the firm be maximized? How should it be allocated? How should asset-based priority be determined when the assets are not being sold? If the firm is not liquidated, how does the Bankruptcy Code allocate any asset value or going-concern value created or preserved by the bankruptcy process?4

To address these strategic and distributional questions, Chapter 11 implements a governance regime that allows pre-bankruptcy managers to remain in control as debtors-in-possession ("DIP"), but gives creditors and other interested parties greater voice in any decisions outside "the ordinary course of business."5 During the case, creditors may challenge the DIP's actions as inconsistent with "business judgment."6 But, most importantly, at the end of the case, creditors (and equity holders) have a vote on whether to accept or reject a plan.7 In theory this vote allows stakeholders to express their preferences on how best to maximize firm value and to negotiate as to how that value should be allocated. The Chapter 11 negotiation takes place against the backdrop of certain statutory minima-the hypothetical liquidation value creditors would receive in Chapter 7 and the "fair and equitable" (also known as "cramdown") standard.8

A fundamental assumption of Chapter 11 's distributional and governance schemes are that a stakeholder's economic interest in the debtor is reflected in the face amount of its claim, and that it will act accordingly. Distribution of value to an individual unsecured creditor is allocated pro-rata, in proportion to the total amount of debt in the class.s This same pro-rata principle is implemented for governance rights through the principle of "one dollar, one vote."10 While Chapter 11 contains a variety of other statutory protections for creditors and other financial stakeholders,11 many are aimed at preserving the integrity of the vote, which is arguably the creditors' most important protection.12

The "one dollar, one vote" principle is simple, and can be viewed as a corollary to the principle of equal (or pari passu) treatment.13 Where a class of creditors' rights are unimpaired, they have no standing to object to plan confirmation and no right to vote.14 But if a class is not being made whole, the distributional burden should be shared proportionally-and so should decision-making power. If a creditor is owed $20 million, and the plan of reorganization proposes paying 10% of the face amount of the claims, that creditor will receive $2 million as a distribution. If there are a total of $80 million in unsecured claims outstanding, that creditor's distribution will represent one-quarter of the assets distributed. That same creditor will also control one-quarter of the votes that decide whether that class will accept the proposed plan.

The assumption that underlies giving creditors governance rights is that the interests of the creditor and the firm are aligned-that the creditor's motivating economic interest is maximizing its recovery on that $20 million claim. The Code assumes that creditors are "long" and favor a larger recovery for the creditor's class, or at least that they are not "short," meaning that the creditor would, because of extraneous interests, prefer a smaller recovery from the debtor or the liquidation of the debtor firm. …

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