An Essay on Optimal Bankruptcy Rules and Social Justice

The economic approach to bankruptcy envisions bankruptcy law as a set of rules approximating the contractual terms to which, at the time credit is extended, a creditor and debtor would agree should govern in the event of the debtor's insolvency. Some traditional bankruptcy scholars criticize the economic approach for what they see as its failure to advance goals and values which they deem necessary for social justice, and contend that viewing bankruptcy law as a set of contractual terms ignores the impact of insol-vency upon various groups affected by a firm which experiences financial difficulties. In this article, Professor Robert K. Rasmussen challenges those critics, arguing that the economic approach to bankruptcy law is fully compatible with social justice as defined by philosopher John Rawls. Rawls's theory of justice requires that those in the original position must adequately advance the needs of society's least advantaged members in order to create a just political and legal system. In accordance with this requirement, Professor Ras-mussen demonstrates that regardless of which class of creditors is found to be the least advantaged, the economic approach to bankruptcy law protects that class's interests better than more traditional theories. Thus, from a Rawlsian perspective, adopting a bankruptcy regime designed to promote efficiency would promote social justice. What to do about Chapter 11? This question has become one of the more vigorously debated issues in corporate law. The debate itself has proceeded at two levels. At one level, discussion has focused on whether Chapter 11 should be abolished, amended, or retained. Proposals range from the most conservative-retaining Chapter 11 in its present form'-to the most extreme-abolishing Chapter 11 in its entirety. 2 Some scholars advocate modest amendments to cure what they perceive as the most pernicious problems with current law. 3 Other, more expansive proposals for reworking extant law include an auction regime under which firms that file for bankruptcy are sold to the highest bidder, 4 and a menu of optional bankruptcy regimes from which a firm can select when it is incorporated. 5 At another level, however, the debate over Chapter 11 reflects a division over which policies bankruptcy law should embrace. Arrayed on one side of the debate are those who view bankruptcy law in solely economic terms. For these scholars, the goal of bankruptcy law is wealth maximization. To implement this goal, these scholars attempt to devise a bankruptcy system which mirrors the …