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Law Notes > Debt Restructuring Notes
This is an extract of our Debt Restructuring Introduction document, which we sell as part of our Debt Restructuring Notes collection written by the top tier of King's College London students.
The following is a more accessble plain text extract of the PDF sample above, taken from our Debt Restructuring Notes. Due to the challenges of extracting text from PDFs, it will have odd formatting:
Theoretical Framework
Corporate insolvency as a "tragedy of the commons":
● Debtor company has multiple creditors
● Race to first enforce = Each creditor exercising its individual enforcement right =
Forcing the debtor into insolvency = Destroying the going concern surplus in the debtor company
○ The "going concern surplus" = The difference in value between the business being kept together as a single functioning unit, and the business being taken apart and sold of piecemeal basis
○ E.g. A functioning restaurant with a good chef and a good setup can be sold for greater value than taking it apart and selling its assets (such as kitchen equipment, furniture, etc.) separately
● Differentiating cash-flow distress from economic distress:
○ Financial distress may be temporary, such restructuring + keeping the debtor in business may actually preserve the value in its business
○ Economic distress = Fundamentally poor business setup, such that liquidation might be the better option
● The trend of collective enforcement stems from the "prisoners' dilemma":
Creditor 2
Break-up value = 8
Going concern value = 12
Nominal claim = 7
Enforcement and no corporation
Corporation and no enforcement
Creditor 1
Enforcement and no corporation
4;4
7;1
Corporation and no enforcement
1;7
6;6
○ Socially optimal outcome = Both cooperate; preserve the going concern surplus of 12; each get 6
○ But each creditor is incentivised to enforce (because he cannot be assured that, if the cooperates, the other creditor will do the same)
○ Result = The nash equilibrium outcome of the 4;4 split
○ "Tragedy of the commons" because of individual enforcement rights +
absence of any mechanism to facilitate communication and collaboration
● Corporate insolvency law addressed this "tragedy of the commons"
○ Reducing the degree of mismatch between individual enforcement rights and the common pool ■ Privatisation (e.g. administrative receivership, where the rights of the creditors are bundled up and entrusted to a lead creditor, and the lead creditor takes over the insolvency process procedurally). This used to be the main procedure in English insolvency law until 2002.
■ Collectivisation (e.g. administration, where all the creditors forced into collective decision-making, and their individual enforcement rights are transformed into participation and voting rights). A
comprehensive moratorium stops each creditor from enforcing individually and thus preserves the going concern surplus.
And a "tragedy of the anti-commons":
● But collectivisation might also result in a "tragedy of the anti-commons"
○ Veto rights = Incentivising holdout behaviour, because a creditor may attempt to extract more value than he would otherwise get by threatening to thwart any attempt to take action
○ Solution = Majority voting, cramdowns (i.e. overcoming a holdout by any particular class of creditors), and information rights
● The "tragedy of the anti-commons" stems from the "game of chicken":
Creditor 2
Creditor 1
Break-up value = 8
Going concern value = 12
Nominal claim = 7
No cooperation
Cooperation
No cooperation
4;4
7;5
Cooperation
5;7
6;6
Creditor 2
Creditor 1
Break-up value = 8
Going concern value = 10
Nominal claim = 7
No cooperation
Cooperation
No cooperation
4;4
7;3
Cooperation
3;7
5;5
○ What is the difference between the two?
○ The problem becomes more pronounced as the going concern value decreases
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