Is Secured Debt Used to Redistribute Value from Tort Claimants in Bankruptcy? an Empirical Analysis
Listokin, Yair, Duke Law Journal
Many scholars question the priority enjoyed by secured debt in bankruptcy. They fear that secured debt will be used to inefficiently redistribute value away from preexisting unprotected creditors of a firm. These scholars advocate a host of legal innovations, such as "superpriority" for tort claimants with respect to other creditors, to mitigate the redistributional problem. Other scholars minimize the redistributional problem, however, and argue that priority for secured credit is efficient. To help resolve this debate, this Article examines the redistributional theory from an empirical perspective. In particular, it focuses on secured debt usage by publicly traded firms facing large tort liabilities ("high-tort" firms). In theory, secured debt should be attractive for high-tort firms because they have a large class of unsecured and uncovenanted creditors (tort claimants) exposed to redistribution in bankruptcy through the use of secured credit. The Article's empirical analysis contradicts the redistributional theory's prediction, however. High-tort firms have unusually low amounts of secured debt. Although this result is very difficult to explain under the redistributional theory, it can readily be explained according to other theories of secured debt. Several important policy implications for bankruptcy priorities follow from these findings.
TABLE OF CONTENTS Introduction I. Explaining the Use of Secured Debt and Evaluating Secured Debt's Efficiency A. The Costs of Secured Debt B. The Benefits of Secured Debt 1. Controlling Monitoring and Agency Costs 2. Redistribution--Priority Related C. The Normative Implications of Theories of Secured Debt for Bankruptcy Priorities II. Empirical Analysis: Secured Debt and Tort Liability A. Theories of Secured Debt and Predictions Regarding Secured Debt Usage and Tort Liability B. Identifying Firms with Large Tort Liabilities C. Financial Data and Summary Statistics III. Statistical Analysis of the Relationship between Tort Risk and Secured Debt Usage A. Simple Statistical Analysis of Secured Debt Usage B. Regression Analysis of Secured Debt Usage: Tobit Model C. Time-Series Analysis 1. Tobacco Industry "Fixed Effects" 2. Secured Debt Usage and the Approach of Bankruptcy IV. Evaluation of the Statistical Results Conclusion
Secured creditors enjoy priority status in bankruptcy with respect to other creditors. (1) Although the rule is well established, its desirability is the subject of decades of scholarly debate. (2) Some academics assert that priority for secured debt promotes inefficient uses of secured debt as a means of redistributing value away from unsecured creditors toward those with collateral. (3) Late-arriving secured creditors can leapfrog earlier unsecured creditors, redistributing value to the benefit of the issuer and the secured creditor but to the detriment of unsecured creditors and, possibly, to social welfare (in the Kaldor-Hicks sense). Other scholars minimize the salience of the redistributive motive and claim that the priority of secured debt mitigates agency conflicts between borrowers and lenders and facilitates efficient loans that could not occur if secured credit were not awarded priority." (4)
In a law review article, Professor Robert Scott summarized the debate as follows:
To some extent, [the] leverage [afforded by secured debt] seems to be a singularly useful means of reducing conflicts of interest inherent in financial contracting relationships. These benefits are efficiency enhancing. To some degree, however, [the] leverage [afforded by secured debt] also appears to be a singularly useful means of enhancing the creditor's probability of repayment relative to other creditors. If, as seems plausible, some (or many) of these other creditors do not adjust to this reduction in bankruptcy share, there is a redistributional benefit to the creditor that the debtor does not fully internalize in assessing its total interest bill. …