Does Cork’s expression of aims offer a sustainable and useful statement of objectives for a modern insolvency law? It has not been beyond criticism. The Justice Report of 199414 noted that Cork had failed to formulate a limited number of core principles to which others might be treated as subservient and that, as a result, no sense of direction could be discerned.15

Some notable attempts have been made to provide single or dominant rationales for corporate insolvency processes and a variety of visions will now be reviewed before an alternative approach is suggested.16

Visions of corporate insolvency law

Creditor wealth maximisation and the creditors’ bargain

A number of US commentators, inspired by the law and economics movement,17 have argued that the proper function of insolvency law can be seen in terms of a single objective: to maximise the collective return to creditors.18 Thus, according to Jackson,19 insolvency law is best seen as a ‘collectivized debt collection device’ and as a response to the ‘common pool’ problem created when diverse ‘co-owners’ assert rights against a common pool of assets. Jackson, moreover, has stated that insolvency law should be seen as a system designed to mirror the agreements one would expect creditors to arrive at were they able to negotiate

14Justice, Insolvency Law: An Agenda for Reform (London, 1994).

15Ibid., paras. 3.7–3.8.

16On distinguishing ‘traditionalist’ insolvency scholars (who see insolvency law as unrelated to ‘healthy-state’ corporate behaviour) from ‘proceduralists’ (who ‘worry intensely about how rules in bankruptcy affect behaviour elsewhere’) see D. Baird, ‘Bankruptcy’s Uncontested Axioms’ (1998) 108 Yale LJ 573.

17See e.g. T. H. Jackson, The Logic and Limits of Bankruptcy Law (Harvard University Press, Cambridge, Mass., 1986); D. G. Baird, ‘The Uneasy Case for Corporate

Reorganisations’ (1986) 15 Journal of Legal Studies 127. For a refined creditors’ bargain theory see T. H. Jackson and R. Scott, ‘On the Nature of Bankruptcy: An Essay on Bankruptcy Sharing and the Creditors’ Bargain’ (1989) 75 Va. L Rev. 155. For an extensive collection of key law and economics readings see J. S. Bhandari and L. A. Weiss (eds.), Corporate Bankruptcy: Economic and Legal Perspectives (Cambridge University Press, Cambridge, 1996).

18See e.g. Jackson, Logic and Limits of Bankruptcy Law; D. G. Baird and T. Jackson, ‘Corporate Reorganisations and the Treatment of Diverse Ownership Interests: A Comment on Adequate Protection of Secured Creditors in Bankruptcy’ (1984) 51 U Chic. L Rev. 97.

19See Jackson, Logic and Limits of Bankruptcy Law, chs. 1 and 2.

such agreements ex ante from behind a Rawlsian ‘veil of ignorance’.20 This ‘creditors’ bargain’ theory is argued to justify the compulsory, collectivist regime of insolvency law on the grounds that were company creditors free to agree forms of enforcement of their claims on insolvency they would agree to collectivist arrangements rather than procedures of individual action or partial collectivism. Jackson sees the collectivist, compulsory system as attractive to creditors in reducing strategic costs, increasing the aggregate pool of assets, and as administratively efficient. It follows from the above argument that the protection of the noncreditor interests of other victims of corporate decline, such as employees, managers and members of the community, is not the role of insolvency law.21 Keeping firms in operation is thus not seen as an independent goal of insolvency law.

In the creditor wealth maximisation approach all policies and rules are designed to ensure that the return to creditors as a group is maximised. Insolvency law is thus concerned with maximising the value of a given pool of assets, not with how the law should allocate entitlements to the pool. Accordingly effect should only be given to existing pre-insolvency rights, and new rights should not be created. Variation of existing rights is only justified when those rights interfere with group advantages associated with creditors acting in concert.

The creditor wealth maximisation vision has been highly influential and has been put into legislative effect in some jurisdictions. Thus the German Bankruptcy Code of 1999 (Insolvenzordnung) aims to establish a system that will enhance market exchange processes and rationalise debt collection rather than supersede market processes.22 It is a vision, however, that has been subject to extensive criticism, some of which has been phrased in the strongest terms.23 Major concerns have focused, firstly, on insolvency being seen as a debt collection process for the

20Ibid., p. 17; J. Rawls, A Theory of Justice (Harvard University Press, Cambridge, Mass., 1971); Rawls, The Liberal Theory of Justice: A Critical Examination of the Principal Doctrines in ‘A Theory of Justice’ (Clarendon Press, Oxford, 1973). For further discussion see pp. 38–40 below. See also the discussion in A. Duggan, ‘Contractarianism and the Law of Corporate Insolvency’ (2005) 42 Canadian Bus. LJ 463.

21See Jackson, Logic and Limits of Bankruptcy Law, p. 25.

22See C. Schiller and E. Braun, ‘The New Insolvency Code’ in J. Reuvid and R. Millar (eds.), Doing Business with Germany (Kogan Page, London, 1999). (At the time of writing, a bill to amend the insolvency code has been passed by the German Parliament.)

23See e.g. D. G. Carlson, ‘Thomas Jackson has written an unremittingly dreadful book’, in ‘Philosophy in Bankruptcy (Book Review)’ (1987) 85 Mich. L Rev. 1341; see also V. Countryman, ‘The Concept of a Voidable Preference in Bankruptcy’ (1985) 38 Vand.

benefit of creditors. This, it has been said,24 fails to recognise the legitimate interests of many who are not defined as contract creditors: for instance, managers, suppliers, employees, their dependants and the community at large.25 Creditor wealth maximisation, moreover, fails to focus on the non-efficiency objectives that are often recognised in legislation.26 To see insolvency as in essence a sale of assets for creditors (what might be termed a ‘fire sale’ image), moreover, fails both to treat insolvency as a problem of business failure and to place value on assisting firms to stay in business. Thus, it has been argued that to explain why the law might give firms breathing space or reorganise them in order to preserve jobs requires resort to other values in addition to economic ones. The economic approach, as exemplified by Jackson, is alleged to demonstrate only that its own economic value is incapable of recognising non-economic values, such as moral, political, social and personal considerations.27

The idea, moreover, that a troubled company constitutes a mere pool of assets can also be criticised. Such a firm can be seen not purely as a lost cause but as an organic enterprise with a degree of residual potential: ‘Unlike mere property, a corporation, whether in or out of bankruptcy, has potential. A corporation can continue as an enterprise: as an enterprise, it can change its personality and, perhaps more importantly, whether the corporation continues and how it changes its personality

L Rev. 713, 823–5, 827; J. L. Westbrook, ‘A Functional Analysis of Executory Contracts’ (1989) 74 Minn. L Rev. 227, 251 n. 114, 337; T. A. Sullivan, E. Warren and J. L. Westbrook, As We Forgive Our Debtors: Bankruptcy and Consumer Credit in America (Oxford University Press, New York, 1989) p. 256.

24See D. R. Korobkin, ‘Contractarianism and the Normative Foundations of Bankruptcy Law’ (1993) 71 Texas L Rev. 541, 555; E. Warren, ‘Bankruptcy Policy’ (1987) 54 U Chic. L Rev. 775, 787–8.

25See K. Gross, ‘Taking Community Interests into Account in Bankruptcy: An Essay’ (1994) 72 Wash. ULQ 1031.

26See D. R. Korobkin, ‘The Role of Normative Theory in Bankruptcy Debates’ (1996–7) 82 Iowa L Rev. 75, 86.

27See D. R. Korobkin, ‘Rehabilitating Values: A Jurisprudence of Bankruptcy’ (1991) 91 Colum. L Rev. 717, 762. Certain economic approaches may, of course, favour a particular corporate reorganisation and job preservation arrangement because this maximises social wealth: though in other circumstances there may, on this basis, be arguments for allowing jobs to move into new, more efficient and profitable contexts. (Jackson, in contrast, seeks to maximise creditor wealth.) On wealth maximisation as an ethical basis see generally R. Posner, ‘Utilitarianism, Economics and Legal Theory’ (1979) 8 Journal of Legal Studies 103, but cf. R. M. Dworkin, ‘Is Wealth a Value?’ (1980) 9 Journal of Legal Studies 191; Dworkin, A Matter of Principle (Clarendon Press, Oxford, 1986) chs. 12, 13.

affects people in ways that are not only economic.’28 Insolvency law, indeed, has for some time on both sides of the Atlantic recognised that the rehabilitation of the firm is a legitimate factor to take on board in insolvency decision-making.29

Does it make sense, in any event, to point to a common pool of assets to which creditors have a claim before insolvency? Unless credit is secured, it is arguably extended on the basis that repayments will be made from income and not from a sale of fixed assets. Income, moreover, cannot be said normally to be produced by the assets themselves but, in the case of an enterprise, from ‘an organisational set-up consisting of owners, management, employees plus a functioning network of relations with the outside world, particularly with customers, suppliers and, under modern conditions, with various government agencies’.30 It is, indeed, insolvency law itself that creates an estate or pool of assets and this undermines any assertion that insolvency processes should maximise the value of a pre-existing pool of assets and should not disturb preinsolvency entitlements.

The idea that insolvency law can be justified in a contractarian fashion with reference to a creditors’ bargain has also come under heavy fire.31 The creditors’ bargain restricts participation to contract creditors. In this sense the veil of ignorance used by Jackson is transparent since the agreeing parties know their status in insolvency. It is not surprising that in an ex ante position such creditors would agree to maximise the value of assets available for distribution to themselves.32 Jackson, moreover, focuses exclusively on voluntary and bargaining creditors, while assuming a perfect market, and leaves out of account other types of creditor, for whom there is no market at all.

28Korobkin, ‘Rehabilitating Values’, p. 745. See also Warren, ‘Bankruptcy Policy’, p. 798.

29See Korobkin, ‘Rehabilitating Values’, pp. 749 and 751. On the UK, see S. Hill, ‘Company Voluntary Arrangements’ (1990) 6 IL&P 47; Cork Report, paras. 29–33 (re administration); H. Rajak ‘Company Rescue’ (1993) 4 IL&P 111; Insolvency Service, Company Voluntary Arrangements and Administration Orders: A Consultative Document (DTI, 1993); Revised Proposals for a New Company Voluntary Arrangement Procedure (DTI, 1995); A Review of Company Rescue and Business Reconstruction Mechanisms (DTI, 1999); A Review of Company Rescue and Business Reconstruction Mechanisms: Report by the Review Group (DTI, 2000).

30See A. Flessner, ‘Philosophies of Business Bankruptcy Law: An International Overview’ in J. S. Ziegel (ed.), Current Developments in International and Comparative Corporate Insolvency Law (Clarendon Press, Oxford, 1994) p. 19.

31See Carlson, ‘Philosophy in Bankruptcy’, p. 1355: ‘even less than a hollow tautology’.

32See Korobkin, ‘Contractarianism and the Normative Foundations’, p. 555. See also Gross, ‘Community Interests’, p. 1044.

The circular nature of the bargain has been exposed by critics. Creditors in the bargain are assumed to be de-historicised and equal. The creditors’ bargain model explains the rule of creditor equality only by presupposing what it sets out to prove.33 In real life, in contrast, creditors differ in their knowledge, skill, leverage and costs of litigating. The assumption that powerful creditors (e.g. secured creditors) would agree to collectivise their claims to the pool alongside their weaker brethren is highly questionable. It is more likely that what parties will agree to will inevitably mirror those disparities in rights, authority and practical leverage that shape their perspectives.34 Jackson’s solution to this problem is to suggest that secured creditors should receive from the pool no less than what they would be entitled to outside insolvency. This is the equality of Animal Farm, though, and is inconsistent with the homogeneity of creditors originally posited. To assume, moreover, that all creditors have purely economic interests is also questionable. Thus, for instance, employee creditors who face displacement costs that are separate from their claims for back wages might not agree to creditor equality because they could well consider that such costs should be reflected in a higher priority for their back-wages claims. They might, additionally, consider that their claims on assets morally outrank those of secured creditors and for this reason also insist on priority for wage claims.35

A further major weakness of the creditor wealth maximisation vision is its alleged lack of honesty on distributional issues.36 The collectivism advocated by Jackson is treated as neutral but it begs distributional questions. By purporting merely to enforce pre-insolvency rights Jackson presupposes the defensibility of the state-determined collection scheme without further argument; by this process distributive elements are worked into his theory via the back door. The inappropriateness of transplanting the system of state allocation of rights becomes clearer on noting the very different functions of

33See Carlson, ‘Philosophy in Bankruptcy’, pp. 1348–9; Korobkin, ‘Rehabilitating Values’, pp. 736–7.

34See Korobkin, ‘Contractarianism and the Normative Foundations’, p. 552.

35See Carlson, ‘Philosophy in Bankruptcy’, p. 1353. It might be argued from an economic perspective that employees could be expected to compensate for employment insecurities by demanding that these be reflected in higher wage packets. Inequalities of employer/employee bargaining positions and information levels are factors, inter alia, however that make such expectations unrealistic: see e.g. A. I. Ogus, Regulation: Legal Form and Economic Theory (Oxford University Press, Oxford, 1994) pp. 38–41; S. Breyer, Regulation and Its Reform (Harvard University Press, Cambridge, Mass., 1982); K. Van Wezel Stone, ‘Policing Employment Contracts Within the Nexus-of- Contracts Firm’ (1993) 43 U Toronto LJ 353.

36See Warren, ‘Bankruptcy Policy’, esp. pp. 790, 802, 808.

the respective bodies of law. Whereas pre-insolvency state entitlements are designed with an eye to ongoing contractual relationships, it is arguably the very purpose of a (federal) insolvency system to apportion the losses of a debtor’s default in a new and different situation when a variety of factors impinge on decisions as to where losses should fall.

If, indeed, it is proper for insolvency law to look beyond preinsolvency rights, this again strikes at the heart of the creditors’ bargain thesis. It can be said, in the first instance, that insolvency does and should recognise the interests of parties who lack formal legal rights in the preinsolvency scenario,37 not least because parties with formal legal rights never bear the complete costs of a business failure. Thus, creditors may suffer in an insolvency but those without formal legal rights may also be prejudiced: not only, as already noted, employees who will lose jobs and suppliers who will lose customers, but also tax authorities whose prospective entitlements may be diminished and neighbouring traders whose business environments may be devalued. A danger of the creditor wealth maximisation vision is that it fails adequately to value the continuation of business relationships that have not been formalised in contracts and may, indeed, omit from consideration those who suffer the greatest hardships in the context of financial distress.38

A second point concerns those parties with various pre-insolvency legal rights. The argument that insolvency law should only give effect to these pre-insolvency rights can be countered by asserting that a core and proper function of insolvency law is to pursue different distributional objectives than are implied in the body of pre-insolvency rights; that insolvency law does so by adopting a base-line rule on equality – pari passu – and by then making considered exceptions to that rule. It is insolvency law’s application to the turbulence of financial crisis, as distinct from the calm waters that mark pre-insolvency contracts, that can be said to justify the intrusion of a number of value judgements concerning relative priorities of various liabilities and the order in which groups of liabilities should be discharged.39

37See E. Warren, ‘Bankruptcy Policymaking in an Imperfect World’ (1993) 92 Mich. L Rev. 336 at 356.

38See Korobkin, ‘Contractarianism and the Normative Foundations’, p. 581.

39See Warren, ‘Bankruptcy Policy’, p. 778; Warren, ‘Bankruptcy Policymaking’, pp. 353–4. On preferential status generally see Cork Report, chs. 32, 33; D. Milman, ‘Priority Rights on Corporate Insolvency’ in A. Clarke (ed.), Current Issues in Insolvency Law (Stevens & Sons, London, 1991) p. 57; S. S. Cantlie, ‘Preferred Priority in Bankruptcy’ in J. Ziegel (ed.), Current Developments in International and Comparative Corporate Insolvency Law (Clarendon Press, Oxford, 1994) p. 413.