Corporate reorganization rules is to be judged and the fundamental problem of valuation:THE BARGAINING-BASED APPROACH OF EXISTING RULES

Corporate reorganization rules is to be judged and the fundamental problem of valuation:THE BARGAINING-BASED APPROACH OF EXISTING RULESThis essay surveys the literature on Chapter 11. I start by discussing the objectives by which the performance of corporate reorganization rules is to be judged and then consider the fundamental problem of valuation that arises in corporate reorganization. I next turn to examine the performance of the prevailing bargaining-based approach to reorganization, both in terms of its effect on total reorganization value and in terms of its effect on the division of this value. Finally, I examine the two alternative approaches that have been put forward to the approach of existing rules — that of auctioning the reorganized company’s asset (put forward by Baird and Jensen ) and that of using options to reorganize the company’s ownership (put forward by Bebchuk ).

The way in which the law has dealt with this problem of valuation is by leaving the division of reorganization value to a process of bargaining among the participants. The law has sought only to provide a set-up for this bargaining and to establish constraints within which the division must take place.
Under the existing rules, a plan of reorganization will generally be confirmed if all the classes of participants approve it. The rules governing this approval process prescribe how participants may be grouped into classes, how their votes are to be solicited, and what majority counts as class approval.

The law also includes a procedure, often referred to as a “cramdown,” that enables approving a plan over the objection of a class if it shown that this class is treated in a way that is “fair and equitable.” However, because of the difficulties involved in getting a cramdown approved, the designers of reorganization plans commonly seek to get the approval of all classes. Consequently, the consent of each class is regarded as valuable to obtain.