Small business reorganizations, Business bankruptcy reorganizations, Empirical legal studies, Chapter 11, Chapter 7, Japanese business reorganization proceedings, Composition proceedings
Applied Statistics | Bankruptcy Law | Corporation and Enterprise Law
Optimizing reorganization proceedings for small and midsized businesses is an important issue in every industrial country. But little information exists about the actual operation of such proceedings. Recent U.S. bankruptcy studies focus either on consumer bankruptcies or on large Chapter 11 cases involving publicly listed firms. This article presents the results of a comprehensive empirical study of Japan's most frequently used business bankruptcy reorganization provision. Small and midsized reorganizations have become important for several reasons. First, unlike large firms, the vast majority of small businesses fail to obtain confirmation of a Chapter 11 plan and end up in liquidation, thus suggesting the possible need for reform. Second, while failure dominates small Chapter 11 cases, small cases make up the bulk of Chapter 11 filings. Third, empirical data suggest that violations of absolute priority occur in small business reorganizations and that unsecured creditors are in a weak negotiating position with the debtor. These findings raise the question whether most small or midsized businesses should be routed to Chapter 7, without a wasteful pause in Chapter 11. Even in the case of large firms, academics propose abolishing Chapter 11.
Before proposing reforms, it is important to understand how reorganizations function for small and midsized firms. Analysis of the Japanese data yields several important results. The data allow the first quantitative estimate of the rate of successful reorganizations necessary to yield a gain to creditors in filed cases. The obvious alternative, advocated by abolition proposals, is to have some form of forced liquidation be the exclusive business bankruptcy mechanism. Based on the Japanese data, a surprisingly low reorganization success rate, under 30 percent, can yield a gain to creditors over liquidation in filed cases
The surprisingly low reorganization success rate needed to yield a gain in filed cases has direct implications for reorganization of larger firms and for proposals to modify or eliminate Chapter 11. Our data show that the reorganization of small firms, even in the face of a substantial failure rate, yields a net surplus over liquidation. For larger firms, administrative costs are likely to be a smaller percentage of assets, and the surplus from reorganizing over liquidating should, in general, be larger than for smaller firms. In addition, larger firms successfully reorganize at a higher rate than smaller firms. Therefore, the surplus we detect for small and mid-sized firms is likely to be higher for larger firms. Proposals to abolish or reform Chapter 11 ought to be rethought in light of these data.
This article also presents the first detailed empirical study of several important features of any reorganization law. First, it examines the best-interests-of-creditors test (creditors in reorganization proceedings must receive at least what they would receive in liquidation), the fundamental protection afforded creditors in any nonliquidating bankruptcy proceeding in both Japan and the United States. Some violations of the requirement exist. Second, we analyze the factors that influence liquidation value estimates and proposed repayment percentages. Third, we explore the factors that influence whether a proposed plan will be confirmed or rejected.
Eisenberg, Theodore and Tagashira, Shoichi, "Should We Abolish Chapter 11? The Evidence from Japan" (1994). Cornell Law Faculty Publications. Paper 381.
Published in: Journal of Legal Studies, vol. 23, no. 1, part 1 (January 1994).