UC Berkeley

During reorganization, a firm must make two distinct types of decisions: operational and distributional. Operational decisions focus on asset deployment, such as selling assets and securing financing. Distributional decisions address creditor seniority and payoffs under the plan of reorganization. The timing, goals, and decision-making authority for these decisions differ markedly. Operational decisions occur early in the case with the goal of maximizing asset value, governed by the debtor’s management business judgment. Conversely, distributional decisions aim to respect priority rules later in the case, governed by procedural protections and multilateral creditor negotiations.

However, many recent corporate reorganization cases have shown a complex interplay between operational and distributional decisions. This dissertation will use doctrinal analysis, computational methods, and formal modeling to explore these new developments in bankruptcy law practice.

Chapter I offers a new analytical framework to examine the interplay between operational and distributional decisions. Bankruptcy transactions are categorized into crossover and non-crossover transactions. Crossover transactions uniquely affect both operational aspects and distributional aspects, leading to circumvention of procedural safeguards tailored for distributional decisions. Crossover transactions are further divided into inherent and strategic crossovers.

Using J.C. Penney as a case study, Chapter I argues that judges should adopt two strategies: standardization and unbundling. Specifically, judges should standardize the distributional effects of inherent crossovers to protect the interests of other creditors and unbundle the distributional effects that are strategically bundled into purely operational transactions.

Drawing on empirical evidence, Chapter II examines bundling further, whereas Chapter III, employing formal models, explains standardization. Chapter I introduces the theory of bundling. Additionally, some case studies demonstrate how distributional effects are bundled into a transaction. However, anecdotal evidence cannot answer whether this bundling is merely incidental or a broader trend, nor does it pinpoint when the shift occurred. Therefore, this chapter employs network analysis to systematically examine this significant paradigm shift from unbundling to bundling.

Judges, when deciding cases, only cite statutes together that are doctrinally connected, similarly to how they co-cite related precedents. A shift from a section being rarely co-cited to frequently co-cited with another, can thus signal a doctrinal evolution. Based on 6,439 opinions, this article constructs the first co-citation network of U.S. bankruptcy law. Through co-citation analysis and community detection, it reveals that prior to 2005, only sections of similar nature were frequently co-cited and thus located within the same community. Conversely, post-2005, operational sections such as Sections 363 and 364 began to be frequently co-cited with the distributional section like Section 1129. This resulted in their merging into the distributional section community. The transition of diverse sections from separate to unified communities verified the shift from unbundling to bundling. This chapter provides the first empirical examination of a significant shift in bankruptcy jurisprudence. Furthermore, this chapter introduces community detection to legal studies for the first time, with potential applications to other statutory fields.

Chapter III models how judges select standard and non-standard Debtor-in-Possession (DIP) loans for payments to analyze standardization. DIP loans provide the necessary liquidity for the reorganization process of a cash constrained firm. In many recent reorganization cases, the DIP loan is not a traditional, standard debt claim paid through cash. Instead, the DIP loan is compensated with non-standard, equity-linked securities, tied to the uncertain future of the reorganized firm.

Chapter III models this recent DIP financing development to show the trade-offs of different payments. Although standard DIP loans are more conducive to ensuring fair treatment among creditors, they require the firm to spend more cash ex post. Cash compensation may lead to the erosion of firm-specific assets, thereby lowering the firm value. On the other hand, non-standard DIP loans are more favorable for preserving firm-specific assets but might result in an excess payment for the DIP lender. The excess payment enjoyed exclusively by the DIP lender violates the priority rule of bankruptcy law, as it results in unfair treatment among creditors.

The model shows how a bankruptcy judge balances maximizing firm value and defending priority rules when approving DIP loans. The judge will approve a non-standard DIP loan under two circumstances. First, when the DIP lender possesses private information about a high future firm value. A judge, lacking such private information, may approve the non-standard DIP loan, as he does not perceive that the DIP lender receives excess payment. Second, even if the judge is aware that the DIP lender obtains an excess payment in violation of the priority rule, he might still approve the non-standard DIP loan for the sake of firm value. This shows that excess payment is based on the private information or the legal monopoly over the provision of DIP loans, permitted by bankruptcy law.