A Positive And Normative Analysis Of Lender Control In Reorganizations And Its Liability Implications
Lenders have taken over reorganizations. This fact, largely accepted and celebrated by legal and finance scholars, is defended using the framework of the explicit nexus of contracts theory of the firm. This dissertation begins by arguing against the nonexistent costs of lender control of reorganization, claiming that the explicit nexus of contracts uses unrealistic assumptions which serve to hide some of the costs of lender control. Specifically, this dissertation shows that lender control costs can arise even in the e xtreme scenario of having only one class of legal claimants. In addition, this dissertation uncovers that lender control may constrain debtor's investment opportunity set, leading to preclude adaptation possibilities. This dissertation further shows that lender control liability theories have been largely abandoned by United States courts due to an implicit understanding of the firm within the framework of the explicit nexus of contracts theory. As a result, lender control liability currently is a non-deterrent to opportunistic behavior by controlling creditors, as it merely mimics the absolute priority rule. Additionally, this dissertation shows that fraudulent conveyance law is a poor substitute for lender control liability due to the former's transaction by transaction focus. Cognitive errors may produce systematic distortions on lender control liability adjudications. This dissertation shows that if hindsight bias was the only cognitive error affecting adjudications those worries would be unsupported as a strict liability rule would take care of them. Unfortunately, hindsight bias and anchoring working together distort adjudications, making the strict liability rule solution ineffective. Additionally, this dissertation shows that arguments in favor of a no- liability rule for breach of fiduciary duties, a la BJR, do not translate into the lender control liability realm as : a) a no-liability rule wouldn't improve the controlling lender's risk aversion; and b) other opportunistic behavior constraints supportive of the BJR seem e mpirically irrelevant in lender control liability cases. Finally, this dissertation proposes to limit opportunistic behavior y controlling lenders. With that aim, it suggests dropping the negative control safe harbor from Agency Law in lender control liability cases within the reorganization context.
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