Section 365, Mandatory Bankruptcy Rules and Inefficient Continuance

Yeon-Koo Che and Alan Schwartz

The Journal of Law, Economics, and Organization, 1999, vol. 15, issue 2, 441-67

Abstract: Section 365 of the Bankruptcy Code prohibits enforcement of the once common 'ipso facto clause.' The clause excuses the solvent party from performance of the contract when the other party becomes insolvent. We show that the ability of insolvent firms to continue bad projects is enhanced by the absence of ipso facto clauses. Without such a clause, the firm can exploit the inability of courts always to assess expectation damages accurately to compel a solvent party to stay in a bad deal. An ipso facto clause would preclude this outcome because the clause permits the solvent party to exist costlessly. Further, an ipso factor clause improves the managers' incentive to exert effort to avoid financial distress. These results have two broader implications. First, that the important mandatory rule regulating the ability of solvent parties to exit is inefficient suggests that the justifications for the Bankruptcy Code's other mandatory rules should be rethought. Second, our analysis suggests that stakeholders such as contract partners of bankrupt firms may have important roles to play in inducing efficient bankruptcy decisions through their abilities to stop unproductive projects that bankrupt firms may otherwise continue. Copyright 1999 by Oxford University Press.

Date: 1999
References: Add references at CitEc
Citations: View citations in EconPapers (7)

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

Related works:
Working Paper: Section 365, Mandatory Bankruptcy Rules and Inefficient Continuance (1998)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:oup:jleorg:v:15:y:1999:i:2:p:441-67

Ordering information: This journal article can be ordered from
https://academic.oup.com/journals

Access Statistics for this article

The Journal of Law, Economics, and Organization is currently edited by Andrea Prat

More articles in The Journal of Law, Economics, and Organization from Oxford University Press Oxford University Press, Great Clarendon Street, Oxford OX2 6DP, UK.
Bibliographic data for series maintained by Oxford University Press ().