Bargaining around Bankruptcy: Small Business Workouts and State Law

Federal bankruptcy law is rarely used by distressed small businesses. For every 100 that suspend operations, at most 20 file for bankruptcy. The rest use state law procedures to liquidate or reorganize. This paper documents the importance of these procedures and the conditions under which they are c...

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Bibliographic Details
Published in:The Journal of legal studies 2009-06, Vol.38 (2), p.255-307
Main Author: Morrison, Edward R.
Format: Article
Language:English
Subjects:
Bankruptcy
Bankruptcy Code
Bankruptcy petitions
Bankruptcy procedures
Bargaining
Creditors
Debtors
Federal law
Law
Legal Procedure
Lenders
Negotiation
Small and medium sized enterprises
Small Businesses
State
State law
States (Political Subdivisions)
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Summary:Federal bankruptcy law is rarely used by distressed small businesses. For every 100 that suspend operations, at most 20 file for bankruptcy. The rest use state law procedures to liquidate or reorganize. This paper documents the importance of these procedures and the conditions under which they are chosen using firm‐level data on Chicago‐area small businesses. I show that business owners bargain with senior lenders over the resolution of financial distress. Federal bankruptcy law is invoked only when bargaining fails. This tends to occur when there is more than one senior lender or when the debtor has defaulted on senior debt (harming trust‐based relationships with lenders). These findings raise questions about the design of and need for federal bankruptcy law.
ISSN:0047-2530
1537-5366
DOI:10.1086/597982