1127
Revitalizing Involuntary Bankruptcy
Richard M. Hynes* & Steven D. Walt**
ABSTRACT: For the first centuries of bankruptcy’s existence, only creditors
could initiate a proceeding. “Voluntary” bankruptcy—initiated by the debtor
rather than creditors—began in the nineteenth century, but well into the early
twentieth century, involuntary bankruptcy accounted for about two-thirds of
the money distributed to general creditors. Today, involuntary bankruptcy is
a mere vestige. Just 0.05 percent of petitions are involuntary, and most of
those are summarily dismissed without any court order formally commencing
a bankruptcy case.
Evidence from both theory and practice suggests that the demise of involuntary
bankruptcy has had significant social costs, with businesses delaying
voluntary bankruptcy too long. To address that problem, other scholars have
considered whether incentives should be offered to induce earlier voluntary
bankruptcy, but the literature has largely overlooked involuntary bankruptcy.
This Article fills that gap in the literature by providing a comprehensive study
of the previously vibrant practice of involuntary bankruptcy. Crucially, we
find that early twentieth century bankruptcy practice provided de facto
incentives for involuntary petitions by rewarding filing attorneys with
lucrative post-petition work. Such rewards helped overcome the collective
action problems that otherwise discourage creditors from filing. The law of
involuntary bankruptcy should look back to that past to find its future. We
propose a number of reforms, including instituting a system of de jure
“bankruptcy bounties” to encourage involuntary petitions that will revitalize
involuntary bankruptcy and restore its rightful place in the law and theory of
bankruptcy.
I.INTRODUCTION ........................................................................... 1128
II. INVOLUNTARY PETITIONS AND THEIR ROLE IN HISTORY ............ 1134
*
John Allan Love Professor of Law, University of Virginia School of Law.
** Percy Brown, Jr., Professor of Law & Class of 1948 Professor of Scholarly Research in
Law, University of Virginia School of Law. We thank Quinn Curtis, John Duffy, Michael Gilbert,
Melissa Jacoby, Anne Lawton, and participants at and the 2018 Canadian Law and Economics
Association Annual Meeting for valuable comment. We thank Pol Minguet, Nathan Mardis, and
Trevor Quick for valuable research assistance. All errors remain our own.
1128 IOWA LAW REVIEW [Vol. 105:1127
A.INVOLUNTARY BANKRUPTCY IN THE EARLY TWENTIETH
CENTURY .............................................................................. 1136
B.THE DECLINE IN INVOLUNTARY FILINGS ................................. 1141
III.INVOLUNTARY BANKRUPTCY IN CURRENT PRACTICE .................. 1150
A.AGGREGATE DATA ................................................................. 1150
B.RANDOM SAMPLE .................................................................. 1153
IV. REFORM AND THE FUTURE OF INVOLUNTARY BANKRUPTCY ........ 1161
A.DISCOURAGING PRO SE PETITIONS ......................................... 1162
B.BANKRUPTCY BOUNTIES ........................................................ 1165
1.Delay and the Creditors’ Collective Action
Problem ........................................................................ 1165
2.Encouraging Petitions with Bankruptcy Bounties .... 1168
V.CONCLUSION .............................................................................. 1180
APPENDIX .................................................................................... 1182
A.AGGREGATE FJC STATISTICS .................................................. 1182
B.RANDOM SAMPLE .................................................................. 1184
I. INTRODUCTION
Bankruptcy began in sixteenth century England as a remedy for
creditors.1 Creditors initiated a bankruptcy proceeding by filing a complaint
against their debtor.2 Debtors could not file for bankruptcy voluntarily in
England or the United States until the middle of the nineteenth century,3 and
American corporations could not file voluntarily until 1910.4 Yet, despite the
late emergence of voluntary bankruptcy, it has come to utterly dominate
modern American bankruptcy practice. Involuntary petitions filed by
creditors now account for less than 0.05 percent of all petitions.5 Even that
meager number overstates involuntary bankruptcy’s modern role because
most involuntary petitions are dismissed without a court even issuing an order
for relief to formally begin a bankruptcy case.6
1. See, e.g., Max Radin, The Nature o f Bankruptcy, 89 U. PA. L. REV. 1, 3–4 (1940); Louis
Edward Levinthal, The Early History of English Bankruptcy, 67 U. PA. L. REV. 1, 14–15 (1919).
2. See W.J. Jones, The Foundations of English Bankruptcy: Statutes and Commissions in the Early
Modern Period, 69 TRANSACTIONS AM. PHIL. SOC’Y, no. 3, July 1979, at 25.
3. See John C. McCoid II, The Origins of Voluntary Bankruptcy, 5 BANKR. DEV. J. 361, 361
nn.4–5 (1988).
4. See GARRARD GLENN, THE LAW GOVERNING LIQUIDATION: AS PERTAINING TO
CORPORATIONS, PARTNERSHIPS, INDIVIDUALS, DECEDENTS, BANKRUPTCY, RECEIVERSHIP,
REORGANIZATION 136–40, 310 (1935).
5. See infra Figure 2 and accompanying text.
6. See infra Table III.2 and accompanying text.
2020] REVITALIZING INVOLUNTARY BANKRUPTCY 1129
The dearth of involuntary petitions likely has significant social costs
because firm managers, representing the interests of equity shareholders,
have powerful incentives to wait too long to file voluntarily. A firm’s
“bankruptcy . . . terminates equity’s option on a firm’s assets and frequently
leads to liquidation.”7 Thus, rational shareholders have little incentive to file
for bankruptcy because they get essentially nothing from such filings. By
contrast, while delaying bankruptcy in the hope of saving a company is a risky
gamble, the rewards of the gamble asymmetrically favor shareholders. If the
company is saved and becomes profitable once again, shareholders win, and
potentially win big because shareholders get all of the upside. If conditions
deteriorate further, it is the creditors who lose.
In short, shareholders of a firm teetering on the brink of bankruptcy are
gambling with someone else’s money. They have an incentive to delay
bankruptcy past the socially optimal point where bankruptcy could increase
the aggregate value of a firm and its assets. Bankruptcy can have positive social
benefits in multiple ways—reorganizing the firm’s capital structure to allow
new investment, preventing a race among creditors to seize the firm’s assets,
or putting the assets to better use under a new business model8—but those
benefits do not help shareholders if bankruptcy terminates their interest in
the firm.
Prominent bankruptcy scholars have long recognized the problem of
excessively delayed bankruptcy filings. In 1986, Professor Thomas Jackson
observed that the shareholders of a firm have strong incentives “to delay too
long in filing a bankruptcy petition.”9 Similarly, a decade ago, then-Professor
(now Senator) Elizabeth Warren and her co-author, Professor Jay Westbrook,
noted that decisionmakers inside firms have multiple incentives to “delay
seeking bankruptcy help until long after the company can no longer be
saved.”10 More than five years ago, Professor Barry Adler and his coauthors,
summarizing the results of their study, concluded “that delay in bankruptcy
filing tends to destroy value. . . . [B]y the time firms get to bankruptcy now,
there is less to save.”11
Much of the bankruptcy literature has focused on whether voluntary
bankruptcy should be made more attractive to managers and shareholders so
that debtor firms will file for bankruptcy sooner.12 Professors Douglas Baird
7. Barry E. Adler et al., Value Destruction in the New Era of Chapter 11, 29 J.L. ECON. & ORG.
461, 465 (2013).
8. See infra notes 42–43 and accompanying text.
9. THOMAS H. JACKSON, THE LOGIC AND LIMITS OF BANKRUPTCY LAW 205 (1986).
10. Elizabeth Warren & Jay Lawrence Westbrook, The Success of Chapter 11: A Challenge to the
Critics, 107 MICH. L. REV. 603, 617 (2009).
11. See Adler et al., supra note 7, at 480.
12. See, e.g., id. at 465; David A. Skeel, Jr., The Law and Finance of Bank and Insurance Insolvency
Regulation, 76 TEX. L. REV. 723, 754–57, 759–60 (1998) (recommending bonuses to managers
for initiating bankruptcy). See generally Douglas G. Baird & Robert K. Rasmussen, Control Rights,
