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Open Access Publications from the University of California

Bankruptcy Control and the Theory of the Firm


Over the last five years, the idea that bankruptcy practice has trounced the scheme of the 1978 Bankruptcy Code (from now on “The Code”) has emerged. Pioneered by professors Baird and Rasmussen, a cluster of legal literature has developed around the changes in bankruptcy practice, the reasons behind those changes and possible efficiency implications of the professed novel occurrences. There are conflicting opinions over almost every aspect of the debate, but everyone seems to agree at least that actual bankruptcy practice has evolved from the depictions commonly made two decades ago. Technological changes and financial innovations3 seem to be the triggering factor for the new developments. Financial contracting design has adopted a widespread use of agreement specific increasingly detailed covenants, which allowed writing contracts that depended upon the new monitoring technology. The financial strategist is now able to employ security interests in virtually all the debtor’s property, present and future, intertwined with the credit agreement in order to reinforce the power of the lender. These innovations have helped to create new scenarios for lenders, who under the new conditions have a tighter grip to closely monitor the debtor financial health. As a result of the increased efficiency of the system, lenders willingness to advance funding seems to have grown, as evidenced by the fewer unencumbered assets that debtors have when entering bankruptcy.

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