![]() Our goal is not to doubt the ‘richness and elasticity’ of corporate bankruptcy, particularly in the United States, but to find the essential elements. Both these elements drive much of the rules that are necessary to resolve distress but also show that parts of Chapter 11 are ‘unessential’ – for example, rules regarding reorganisation plans. Asset separation ensures that the assets underlying these options can be separated from liabilities that are attached to them by law or contract. Stabilisation ensures that the firm’s options are maintained. We argue that two elements are essential because they cannot be achieved by contracting alone: asset stabilisation and asset separation. This observation begs the question what parts of a bankruptcy system are ‘essential’. This article begins from a simple observation: Chapter 11 of the United States Bankruptcy Code is the global standard for corporate restructuring, but at the same time it is a far more complex procedure than most jurisdictions seem to require. By allowing a limited number of investors to opt out of bankruptcy in a particular, discrete, and visible way, investors as a group may be able to both limit the risk of bargaining failure and at the same time enjoy the disciplining effect that a withdrawal right brings with it. This regime of tailored bankruptcy has been unrecognized and underappreciated and may be preferable to both mandatory and free design regimes. In this way, legal entities serve as building blocks that can be combined to create specific and varied but transparent investor withdrawal rights. Thus, by partitioning assets of one economic enterprise into different legal entities, investors can create a tailored bankruptcy regime. There is nothing mandatory about rules like the automatic stay when assets can be partitioned off into legal entities that are beyond the reach of the bankruptcy judge. The ability of investors to place assets in separate entities gives them the ability to create specific withdrawal rights in the event the firm encounters financial distress. For this reason, sophisticated investors do not face a mandatory regime at all. Bankruptcy operates on legal entities, not on firms in the economic sense. In this paper, we suggest that the academic debate has missed a fundamental feature of the law. In particular, investors cannot design their rights to achieve optimal monitoring as they could in a system of bankruptcy by free design. But there are costs to a mandatory regime. These rules solve collective action problems and reduce the risk of bargaining failure. ![]() Various rules that cannot be avoided ensure that investors’ actions are limited and they do not exercise their rights against specialized assets in a way that destroys the value of a business as a whole. By the standard account, the current law of corporate reorganization is mandatory. ![]() Bankruptcy scholarship is largely a debate about the comparative merits of a mandatory regime on one hand and bankruptcy by free design on the other.
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