A broad-based contractarian approach

A vision of insolvency law that attempts to overcome the restrictions of creditor wealth maximisation is a broader contractarianism. The version discussed here is the Rawlsian scheme of Donald Korobkin.40 Whereas Jackson seeks to justify insolvency law with reference to the rules that contract creditors would agree to from behind the veil of ignorance, Korobkin places behind the veil not merely contract creditors but representatives of all those persons who are potentially affected by a company’s decline, including employees, managers, owners, tort claimants, members of the community, etc. These people choose the principles of insolvency law from behind a strict veil, ignorant of their legal status, position within the company or other factors that might lead them to advance personal interests. They would, however, foresee that the financial distress of companies would affect a wide variety of individuals and groups occupying various positions and differing in their ability to affect the actions and decisions of the companies in distress.

Korobkin argues that the parties in such a position of choice would opt for two principles to govern insolvencies.41 First, a ‘principle of inclusion’ would provide that all parties affected by financial distress would be eligible to press their demands. Second, a principle of ‘rational planning’ would determine whether and to what extent persons would be able to enforce legal rights and exert leverage. It would seek to promote the greatest part of the most important aims (the ‘maximisation of aims’) and would involve formulating the most rational, long-term plan as a means of realising the ‘good’ for the business enterprise. It would require an outcome that would ‘maximumly satisfy the aims’ but, in reflection of Rawls’ difference principle, would mandate that persons in the worst-off positions in the context of financial distress should be protected over those occupying better-off positions. For such purposes persons in worst-off positions would be those relatively powerless to promote their aims, yet with the most to lose on the frustration of those aims.

40See Korobkin, ‘Contractarianism and the Normative Foundations’. See also Rawls, A Theory of Justice. For an argument that the economic approach is compatible with Rawlsian social justice see R. Rasmussen, ‘An Essay on Optimal Bankruptcy Rules and Social Justice’ (1994) U Illinois L Rev. 1 (an approach perhaps throwing light on the distributional limitations of Rawls’ theory of justice). See also R. Mokal, ‘The Authentic Consent Model: Contractarianism, Creditors’ Bargain and Corporate Liquidation’ (2001) 21 Legal Studies 400; Mokal, Corporate Insolvency Law: Theory and Application

(Oxford University Press, Oxford, 2005) ch. 3.

41Korobkin, ‘Contractarianism and the Normative Foundations’, pp. 575–89.

Korobkin argues that application of his contractarian approach would produce laws corresponding in fundamental ways to the kind of insolvency system encountered in the USA.42 His approach, like that of Rawls,43 however, is open to question on a number of fronts. First, the particular choices of principle made from behind the veil of ignorance depend on a particular concept of the person: it is not possible to strip the individual completely yet conclude that he or she would choose, for instance, the difference principle.44 Risk-averse and risk-neutral individuals might produce very different principles of justice. It is not clear why an individual behind the veil might not prefer a regime marked by low-cost credit and low protection for vulnerable parties to one with high costs of credit and high levels of protection.

This introduces a second difficulty as encountered in Rawls: the extent to which diminutions in justice may be traded off against gains on other fronts, such as in wealth. Advocates of creditor wealth maximisation might object to Korobkin’s scheme on the grounds that principles of insolvency law designed by a veiled and highly inclusive group are liable to be so protective of so many interests, and as a result so uncertain, that the effects on the cost of credit would be catastrophic. Korobkin’s answer would be that such effects would be anticipated by those behind the veil.45 The device of the veil, however, does not in itself explain, in a convincing fashion, important distributional issues, such as how to judge

42In this, the approach differs markedly from other proposed regime designs that have been called ‘contractualist’ and which suggest that businesses might elect ex ante for a system in which they are free to bargain in advance for a set of rules to govern their rights in the event of bankruptcy and in which such bargains would override the federal rules of bankruptcy: see e.g. B. E. Adler, ‘Financial and Political Theories of American Corporate Bankruptcy’ (1993) 45 Stanford L Rev. 311; L. A. Bebchuk, ‘A New Approach to Corporate Reorganisations’ (1988) 101 Harv. L Rev. 775; R. Rasmussen, ‘Debtor’s Choice: A Menu Approach to Corporate Bankruptcy’ (1992) 71 Texas L Rev. 51; and for a critique of these (questioning their economic efficiency contentions) see E. Warren and J. Westbrook, ‘Contracting Out of Bankruptcy: An Empirical Intervention’ (2005) 118 Harv. L Rev 1197.

43On Rawls see e.g. N. Daniels (ed.), Reading Rawls: Critical Studies on Rawls’ ‘A Theory of Justice’ (Stanford University Press, Stanford, 1989); R. Nozick, Anarchy, State and Utopia (Blackwell, Oxford, 1974) pp. 183–231; R. Wolff, Understanding Rawls (Princeton University Press, Princeton, N. J., 1977).

44In F. H. Bradley’s words, ‘a theoretical attempt to isolate what cannot be isolated’, quoted in M. Loughlin, Public Law and Political Theory (Clarendon Press, Oxford, 1992) p. 96. See also M. J. Sandel, Liberalism and the Limits of Justice (Cambridge University Press, Cambridge, 1982) pp. 93–4.

45Korobkin (‘Contractarianism and the Normative Foundations’, pp. 583–4) notes that parties in a bankruptcy choice situation (behind the veil) are aware of the ‘difficulty of

trade-offs between fairness or justice and wealth creation. Such matters are governed by the concept of human nature built into the system rather than the veil.46 If such trade-offs are ruled out it can be objected that the protection offered by a just rule is of very limited value if individuals lack the resources required to take advantage of that rule. The distinction, moreover, between principles of fairness or justice and principles governing the allocation of other goods such as wealth is also problematic.47

It might be further objected that the contractarian approach fails to explain how agreements can be reached behind the veil as to who in a potential insolvency is most vulnerable and thus should enjoy priority of protection over those occupying less threatened positions. Korobkin acknowledges the difficulties of comparing positions in terms of vulnerability, and these are indeed real.48 He suggests that vulnerability be measured in terms of the product of the potential loss to, and the degree of influence exercised by, an individual. There is no reason, however, why such an approach would be accepted by all parties behind the veil. Many may think that such benchmarking distorts the system in favour of those who already possess advantages and so have much to lose. A final difficulty is whether agreement could be expected on the relative valuations of, say, rights to secure or continued employment, as opposed to particular sums of money owed by parties to others. As a guide to the practical development of insolvency law contractarianism may indeed be considerably flawed by its indeterminacy.

The communitarian vision

In contrast with the emphasis on private rights contained within the creditor wealth maximisation approach, the communitarian countervision sees insolvency processes as weighing the interests of a broad range of different constituents. It accordingly countenances the redistribution of values so that, on insolvency, high-priority claimants may to some extent give way to others, including the community at large, in

actual decision-making’ and would be attracted to a rational plan based on Rawls’ difference principle for this reason.

46Notably the concept of human nature that is assumed to attract parties behind the veil of ignorance to Rawls’ difference principle rather than to more high-risk principles that are less protective of the most vulnerable.

47See P. P. Craig, Public Law and Democracy in the United Kingdom and the United States of America (Clarendon Press, Oxford, 1990) pp. 262–3.

48Korobkin, ‘Contractarianism and the Normative Foundations’, p. 584 and his n. 198.

protections for workers – which more properly should be dealt with by allocating pre-insolvency rights – for example, rights to employment security, fair dismissal and compensation on redundancy.55 In response, communitarians might urge, first, that there is no reason why issues arising in insolvency should be governed by rules or agreements formulated without regard to insolvency and, second, that it is perfectly proper to advert to communitarian issues in both pre-insolvency and insolvency law.56

The breadth of concerns encompassed within communitarianism gives rise in itself to problems of indeterminacy. It may be objected that corporatist visions of the company have difficulty in defining the public good and offer ‘simply a mask behind which corporate managers exercise unrestrained social and economic power’.57 Similarly, communitarianism can be said to lack the degree of focus necessary for the design of insolvency law because of the breadth of interests to which it refers. As Schermer has argued, ‘it is impossible to delineate the community … There are an infinite number of community interests at stake in each bankruptcy and their boundaries are limitless…[A]lmost anyone, from local employee to a distant supplier, can claim some remote loss to the failure of a once viable local business.’58

The problem is not so much that community interests cannot be identified but that there are so many potential interests in every insolvency and that selection of interests worthy of legal protection is liable to give rise to considerable contention. How, moreover, can selected interests be weighed? How might a court balance the community’s interest in maintaining employment against potential environmental damage? Doubts, furthermore, have been expressed about the feasibility of redistributing funds in an insolvency.59 Insolvency law might be designed in

55 B. Adler, ‘A World Without Debt’ (1994) 72 Wash. ULQ 811 at 826; compare D. G. Baird, ‘Loss Distribution, Forum Shopping and Bankruptcy: A Reply to Warren’ (1987) 54 U Chic. L Rev. 815 with Warren, ‘Bankruptcy Policy’.

56To argue that it is proper for insolvency law in some circumstances to look to communitarian issues and, if necessary, to adjust some prior rights is not, of course, to declare open season on adjusting any laws or rights that happen to arise in an insolvency, however tangentially.

57M. Stokes, ‘Company Law and Legal Theory’ in W. Twining (ed.), Legal Theory and Common Law (Blackwell, Oxford, 1986) pp. 155–83 at p. 180.

58B. S. Schermer, ‘Response to Professor Gross: Taking the Interests of the Community into Account in Bankruptcy’ (1994) 72 Wash. ULQ 1049 at 1051.

59W. Bowers, ‘Rehabilitation, Redistribution or Dissipation: The Evidence of Choosing Among Bankruptcy Hypotheses’ (1994) 72 Wash. ULQ 955 at 964.