Draft: not for citation or quotation

Fairness and Flexibility:

Understanding Corporate Bankruptcy’s Arc
Stephen J. Lubben+

The century and a half story of American corporate reorganization law exhibits a distinctive pattern:
a long, slow wave, drifting between flexibility and fairness, and back again.1 Flexibility in the
corporate bankruptcy process means that it can adapt to changing times and changing corporate
structures. Fairness means that the process fully respects the privileges of all stakeholders, without
preferences for insiders or repeat players in a process that turns on key questions of who should get
paid when there are limited resources.

The two coexist uneasily in corporate bankruptcy: flexibility is enhanced by reducing the number of
voices that matter in a corporate restructuring. But reducing voice rather obviously reduces fairness.
Flexibility is also a tool that favors large, repeat players, who can learn to use flexibility. Along the
way, there is also a temptation to utilize that knowledge in understandably self-interested ways that
maximize repeat player recoveries at the expense of the less sophisticated. Indeed, it can be said that
repeat players will seek out flexibility precisely because it is less fair. On some level, flexibility and
fairness will always represent inherent tradeoffs in this context.

That said, and as I develop throughout the paper, there is real risk that fairness considerations are
used mostly by other repeat players who have lost in the earlier flexibility competition. Specifically,
the small player gets held up as a poster-child for more fairness, when in practice many of the
reforms end up being used to the benefit of larger or repeat players.

Restructuring law developed in flexibility, only to have that taken away, first slowly by courts and
then abruptly by New Dealers determined to improve corporate reorganization’s fairness. Then
flexibility returned, somewhat gradually, with the enactment of the 1978 Bankruptcy Code.2 After
more than four decades under the Code, that flexibility has been expanded to the point where, at
least in big chapter 11 cases, it seems that a reorganization can take any form. Whatever key
constituencies agree to ex ante can now be packaged in a “Restructuring Support Agreement” and
made binding by the court.3

Flexibility now reigns supreme. The Code is situated in the extreme; the forces of fairness are
primed for a counterattack. Any move to an extreme pole in this regard is inherently incompatible

+ Harvey Washington Wiley Chair in Corporate Governance & Business Ethics, Seton Hall
University School of Law. I am grateful for the comments of Abbye Atkinson, Rich Levin, Virginia
Torrie, and the participants in the Brooklyn Law School Advanced Bankruptcy Colloquium.
1 Cf. RICHARD OVERY, THE MORBID AGE: BRITAIN BETWEEN THE WARS 29-49 (2009) (reviewing
cyclical theories of history).
2 N.L.R.B. v. Bildisco & Bildisco, 465 U.S. 513, 525 (1984) (noting “the policies of flexibility and
equity built into Chapter 11 of the Bankruptcy Code”).
3 See David A. Skeel, The Empty Idea of “Equality Among Creditors,” 166 U. Pa. L. Rev. 699, 701 (2017)
(“[I]f we look at current bankruptcy practice, creditor equality seems to be rapidly disappearing.
Bankruptcy courts often bless arrangements that give one group of general creditors starkly different
treatment than other groups.”).

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

with the opposite; thus, extreme flexibility also means increased deviations from fairness, which
makes such a backlash almost inevitable.

***

Almost seventy years ago, Walter Blum observed that while corporate finance documents are drafted
as if they will be enforced in state court, at a sheriff’s sale, the reality has long been that large
corporations are never liquidated, but instead reorganized.4 One key motivation behind this
inclination to reorganize

is that the assets of a distressed business are not to be disposed of until there has been a
reasonable opportunity to determine what disposition will be most advantageous. This
principle is so clearly sound that elaboration is unnecessary.5

American corporate insolvency law developed hand-in-hand with corporations. From the days
before the Civil War, to recent times, the ever-increasing sophistication of corporate operations and
capital structures have called for corresponding changes in the techniques for addressing financial
distress. Until Congress could be persuaded to use its powers under the Bankruptcy Clause to
address corporations, development of these techniques often involved reshaping existing non-
bankruptcy tools to meet new challenges.6 This was the story throughout the Nineteenth and early
Twentieth Centuries.

Thus, in the very early days before the Civil War and immediately after, large corporations – mostly
railroads – were reorganized within the context of a mortgage foreclosure sale. When the
foreclosure process was found wanting, receiverships were adapted as a reorganization tool. 7 In
both cases the reorganization techniques became increasingly flexible, so that by the turn of the
twentieth century, large American corporations could restructure their multi-million-dollar capital
structures with relative ease.8

But soon thereafter, the pushback began. Cries of “collusion” and claims that the court system was
being used to reward insiders and cut off small investors soon lead courts to impose increasingly
stringent limitations on reorganizations done through equity receiverships. At the same time, these
new rules were used by sophisticated holdout creditors to extract more value for their claims. The
receiverships perhaps became “fairer” as a result of the newly imposed rules, but they also were
becoming less useful.

4 Walter J. Blum, The Law and Language of Corporate Reorganization, 17 U. Chi. L. Rev. 565, 566 (1950).
5 Id.
6 Sidney Post Simpson, Fifty Years of American Equity, 50 Harv. L. Rev. 171, 190-92 (1936).
7 Joseph C. Simpson, Comments on the Railroad Reorganization Provisions of the Bankruptcy Act of 1973, 30
Bus. Law. 1207, 1209 (1975) (“This procedure, developed largely through ingenuity in federal court
practice, in effect converted old equity forms originally intended to transform the debtor's property
into cash for distribution among creditors into a procedure which achieved the opposite result,
namely, preserving the properties intact while adjusting the debts.”).
8 See Douglas G. Baird & Robert K. Rasmussen, Boyd's Legacy and Blackstone's Ghost, 1999 Sup. Ct.
Rev. 393, 405 (1999).

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

Proponents of the receiverships thought they had saved them when the process was codified in the
early 1930s as sections 77 and 77B of the 1898 federal Bankruptcy Act. The codification did away
with the need for an inefficient ancillary receivership system,9 and section 77 even did away with the
need for receivers, pioneering the “debtor in possession” system that we use today. 10

Both sections made clear that holdouts could be bound to a reorganization plan supported by a
majority.11 Moreover, sections 77 and 77B overcame the steady narrowing of the equity receivership
architecture by the Supreme Court.12

But soon thereafter railroad receiverships were taken over the by Interstate Commerce Commission
in a completely revamped version of section 77 and the Chandler Act replaced section 77B – the
general corporate reorganization provision – with chapter X.13 Under that new chapter, the
reorganization of large companies would be overseen by not only bankruptcy courts, but also the
Securities and Exchange Commission, which was specially entrusted to look after the interests of
small investors.14 Insiders were kept far away from the process, and corporate management replaced
with a court-appointed trustee. 15

9 Whereby ancillary receivers had to be appointed in every district where the debtor had operations.
See infra note 112.
10 8 SECURITIES AND EXCHANGE COMMISSION, STUDY AND INVESTIGATION OF THE WORK,
ACTIVITIES, PERSONNEL AND FUNCTIONS OF PROTECTIVE AND REORGANIZATION COMMITTEES
104 (1940). See also 11 U.S.C. §§ 1101(1), 1107.
11 8 SECURITIES AND EXCHANGE COMMISSION, STUDY AND INVESTIGATION OF THE WORK,
ACTIVITIES, PERSONNEL AND FUNCTIONS OF PROTECTIVE AND REORGANIZATION COMMITTEES
83-84 (1940).
12 Discussed infra notes 101 to 110 and text.
13 Congress codified the railroad receivership process in 1933 – Act of March 3, 1933, chap. 204, 47
Stat. 1474 (1933) (“section 77”) – and the receiverships of other, non-rail corporations in 1934. Act
of June 7, 1934, chap. 424, 48 Stat. 211 (1934) (“section 77B”). Leslie Craven & Warner Fuller, The
1935 Amendments of the Railroad Bankruptcy Law, 49 Harv. L. Rev. 1254, 1258-60 (1936). In 1938 the
Chandler Act (52 Stat. 840) was adopted. Section 77, relating to railroads, was retained, and Chapter
X, Corporate Reorganizations, replaced former section 77B. William O. Douglas, Improvement in Federal
Procedure for Corporate Reorganizations, 24 A.B.A. J. 875 (1938). Section 77 essentially put an end to
railroad receiverships. Note, Bankruptcy - Railroad Reorganization - Reorganization Under Consent
Receivership Held Improper Where Statutory Reorganization Provisions Are Applicable, 57 Harv. L. Rev. 1114
(1944) (“Since the enactment of § 77 … the railroads and their creditors have practically abandoned
the use of equity receiverships in favor of the statutory system”).
14 Frederick J. R. Heebe, Corporate Reorganization under Chapter X of the Bankruptcy Act, 16 Loy. L. Rev.
27, 28 (1969).
15 Troy A. McKenzie, Bankruptcy and the Future of Aggregate Litigation: The Past As Prologue?, 90 Wash.
U.L. Rev. 839, 872 (2013).

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

The process was exceedingly fair, but rarely used.16 Indeed, whenever possible, debtor-firms
attempted to use chapter XI, which had been designed for small businesses.17 Somewhat ironically,
an era founded on extreme fairness was increasingly utilizing covert flexibility.

With the 1978 Bankruptcy Code, the law we still use today, chapter 11 was revised to allow
corporate reorganization of all sorts to proceed under an openly flexible scheme.18 At first the
process was dominated by debtors and their management, but by the 1990s creditors learned how to
play too.19 Soon a statute drafted to deal with 1970s businesses was doing a good job reorganizing
tech companies and capital structures far more complex than any the drafters could have imagined.20

But recently worries have resurfaced about the fairness of the process. Cases are increasingly filed in
jurisdictions far away from the bulk of creditors and employees, and shareholders are increasingly
viewed as more of a nuisance than a legitimate stakeholder in the process. Insiders (including
controlling creditors) structure deals before cases are filed, and courts have shown a willingness to
adopt these deals within the chapter 11 process, despite concerns that the deals might not strictly
comply with the Code.

And thus we see the early signs of backlash.

In its recent opinion in Czyzewski v. Jevic Holding Corporation,21 the Supreme Court rejected the idea
that a “structured settlement” could be used to end a chapter 11 case on a broadly consensual basis,
when doing so would avoid the holdup power granted to a narrow group of objecting creditors.
While the Third Circuit had suggested a “rare case” exception that could be applied sparingly for
sufficient reasons, the Supreme Court baulked, noting that “it is difficult to give precise content to
the concept ‘sufficient reasons.’ That fact threatens to turn a ‘rare case’ exception into a more
general rule.” Instead, the Court held that the absolute priority rule “has long been considered
fundamental to the Bankruptcy Code’s operation,” and that the “priority system constitutes a basic
underpinning of business bankruptcy law.” In short, follow the rules.

16 Richard W. Jennings, Mr. Justice Douglas: His Influence on Corporate and Securities Regulation, 73 Yale L.J.
920, 940 (1964) (“Over the years, Chapter X has more and more faded into the background…”).
17 Walter J. Blum & Stanley A. Kaplan, The Absolute Priority Doctrine in Corporate Reorganizations, 41 U.
Chi. L. Rev. 651, 659 (1974).
18 See In re AG Consultants Grain Div., Inc., 77 B.R. 665, 675 (Bankr. N.D. Ind. 1987) (“The idea
behind Chapter 11 of the Code was to combine the speed and flexibility of Chapter XI with some of
the protection and remedial tools of Chapter X.”). See also Michelle M. Harner, The Search for an
Unbiased Fiduciary in Corporate Reorganizations, 86 Notre Dame L. Rev. 469, 484 (2011); William C.
Whitford, What's Right About Chapter 11, 72 Wash. U. L.Q. 1379, 1399 (1994).
19 Although academics perhaps overstated the lessons that could be learned from the specific market
conditions present in the late 1990s and early 2000s. Stephanie Ben-Ishai & Stephen J. Lubben,
Involuntary Creditors and Corporate Bankruptcy, 45 U. British Columbia L. Rev. 253, 265-66 (2012).
20 Hon. Leif M. Clark, Chapter 11-Does One Size Fit All?, 4 Am. Bankr. Inst. L. Rev. 167, 183 (1996)
(noting that “the extraordinary flexibility of chapter 11 has proven itself in handling a wide panoply
of business enterprises—and business problems.”).
21 580 U. S. ____ (2017).

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

Other cases have rejected the “gifting” of senior creditor recoveries to junior players22 or the use of
the old “doctrine of necessity” to pay important trade creditors in full during a chapter 11 case. 23
The flexibility of modern chapter 11 risks being slowly rolled back.24

In many respects, chapter 11 today is much like corporate reorganization in the early 1930s, when
after a brief “wobble” in the 1920s, due to some unhelpful Supreme Court decisions, it looked like
the basic reorganization structure had stabilized around sections 77 and 77B. The widespread use of
aggressive restructuring support agreements that set forth deals with only an incidental connection
to the actual structure of the 1978 Bankruptcy Code looks very much like the very same smugness
that pervaded section 77 and 77B cases right up until the New Dealers announced “enough.” 25

Are we fated to travel back to the other extreme, “reforming” chapter 11 so much that it ceases to
be useful?

The key insight of this paper is that neither extreme fairness nor extreme flexibility are stable states
for our system of corporate reorganization. In particular, because moves to extreme fairness tend to
render reorganization systems unusable, the need for a functional reorganization system will
inherently force a move back from fairness and toward flexibility. Moreover, claims of “fairness”
are too easily coopted by repeat players seeking an edge on their rivals. But extreme flexibility is also
unstable, in that it invites the kind of backlash this introduction has outlined.

Deeper understanding is needed before true (and lasting) reform can be achieved.

***

This paper begins by tracing the history of the cycle of American corporate bankruptcy law between
fairness and flexibility.26 Part 1 recounts the early journey from mortgage foreclosures to equity
receiverships, a story that largely turns on the growth of railroads as multi-state businesses. Here we
see the growing flexibility of corporate reorganization procedures, as they use old forms in new and
creative ways.

Part 2 picks up the story in the New Deal, and carries it up to the Jimmy Carter years. Here we see
the move back toward fairness, but with a corporate reorganization process that was of declining
utility, particularly for larger businesses. In many respects it is remarkable that the nation persisted
as long as it did – about forty years – with such a deficient reorganization system.

Part 3 then looks at the adoption of the current Bankruptcy Code in 1978. The story becomes a
move once again toward flexibility, as the several reorganization provisions of the old Bankruptcy

22 In re DBSD N. Am., Inc., 634 F.3d 79, 98 (2d Cir. 2011).

23 In re Kmart Corp., 359 F.3d 866, 871 (7th Cir. 2004).
24 In re Lehman Bros. Holdings Inc., 508 B.R. 283, 294 (S.D.N.Y. 2014) (“Although flexibility is
necessary… the federal scheme cannot remain comprehensive if interested parties and bankruptcy
courts in each case are free to tweak the law to fit their preferences…”)(citation omitted).
25 See generally Edward J. Janger & Adam J. Levitin, Badges of Opportunism: Principles for Policing
Restructuring Support Agreements, 13 Brook. J. Corp. Fin. & Com. L. 169 (2018).
26 Cf. Mark J. Roe, Three Ages of Bankruptcy, 7 Harv. Bus. L. Rev. 187 (2017) (telling a substantially
different story of bankruptcy law’s cycles).

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

Act were folded into a single reorganization chapter: today’s chapter 11.27 Prepacks, 363 sales, first
day motions, and then restructuring support agreements have all molded chapter 11 into a tool that
could support nearly any form of corporate reorganization.

Part 4 then examines the growing move to reign in the flexibility of chapter 11. The Supreme
Court’s opinion in Jevic, the backlash against the 2009 automotive chapter 11 cases, and the
widespread disdain for permitting bankruptcy judges to exercise discretion,28 and the preference for
fixed rules, all point toward a new move toward fairness.

In Part 5, I then argue caution in making this move, not so much because I believe that concerns
expressed about current chapter 11 practice are misguided, so much as I fear the proffered remedies
are worse than the underlying problem. In short, I fear that in remedying the problems with chapter
11 in its current guise, we are enabling a new era where the holdout creditor will reign supreme.
Moreover, many attempts to set fixed, inflexible rules into the corporate reorganization process
simply reflect one group’s triumph over another. And in a fight among large, sophisticated investors
– hedge fund A vs. distressed debt fund B – I see no reason to take sides.

Thus, I conclude by arguing that changes to help the legitimate interests of small players getting
crushed in the current system are worthwhile, but “reforms” that ultimately help distressed debt
investors or other asset managers extract greater returns from bankrupt corporations are misguided
at best. Moreover, as shown by an analysis of the prior reign of tremendous fairness – from about
1938 to 1978 – such a system is inherently unstable because the corporate reorganization system
becomes unworkable. Rigidity increases the pressure for change and the likelihood of stealth
evasion. The best solution then is to scale back the extremes of the present ultra-flexible chapter
system, without going so far as to thwart its very utility.

Indeed, only by appreciating the inherent contradiction between political discourse that emphasizes
the small player, on the one hand, and the actual practice of so many restructuring law reforms
(which tend to benefit big players) will we understand why attempts to bring fairness to corporate
bankruptcy have so often proven unstable.

1. The Early Years: Developing Flexibility

Until the Bankruptcy Act was signed into law by President McKinley on July 1, 1898, federal
bankruptcy law consisted of three laws, each of limited duration.29 Moreover, even the 1898 Act

27 Frederick Tung, Confirmation and Claims Trading, 90 Nw. U. L. Rev. 1684, 1713 (1996).
28 Reflected in the business context in things like section 560, which prohibits any sort of injunction
in connection with a swap (derivative), even when the alleged “swap” might be little more than an
ordinary supply contract. See also 11 U.S.C. §101(53B) (defining “swap agreement” to include most
every sort of derivative, including “any agreement or transaction that is similar to any other
agreement or transaction referred to in this paragraph and that … is a … swap”). See Stephen J.
Lubben, Subsidizing Liquidity or Subsidizing Markets? Safe Harbors, Derivatives, and Finance, 91 Am. Bankr.
L.J. 463, 471-72 (2017) (providing an overview of the derivative safe harbors in the Code, including
section 560).
29 This history is discussed in finer detail in Stephen J. Lubben, A New Understanding of the Bankruptcy
Clause, 64 Case W. Res. L. Rev. 319 (2013). See also 3 JOSEPH STORY, COMMENTARIES ON THE

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

excluded railroads, which had long been seen as vital public utilities that could not be permitted to
liquidate in bankruptcy or otherwise.30 As one latter commentator noted, railroad developed the
earliest forms of corporate reorganization, because

To an even greater extent than in the case of private corporations, the solution to the
financial difficulties of a railroad lies in reorganization, for regardless of what may be the
best interest of its creditors or of its owners, a definite public policy demands that the
operation of the business be continued to avert a failure of railroad service and that
dismantling of the road be avoided. It is clear that liquidation in bankruptcy can not satisfy
this demand.31

As a result of their exclusion from the bankruptcy, all railroad reorganizations took place outside the
federal bankruptcy system, until such reorganizations were codified during the New Deal. 32 In the
early days – particularly the 1850s and 60s – foreclosure sales were commonly used to address over-
indebted railroads. The railroads of this period tended to be smaller, single-state operations.

But as railroads grew in scope, different mortgages typically covered different assets. The original
line would be covered by one mortgage, the new extension to Boston or Los Angeles funded by a
new issue of secured bonds, and the branch line to Miami by yet another. 33

As one learned commentator summarized:

The chief difference between railroad mortgages and other mortgages is based upon the fact
that other mortgages merely hypothecate certain specific articles, which remain constant in
kind and quality, while a railroad mortgage is the pledge of a venture, the assignment of “a
going concern”—a changing and growing security.34

A single foreclosure would not keep the railroad together as a going concern, and the use of equity
receiverships eventually took the place of earlier foreclosure techniques.35

CONSTITUTION OF THE UNITED STATES § 1108 (1833) (“It is well known, that the power has lain
dormant, except for a short period, ever since the constitution was adopted; and the excellent
system, then put into operation, was repealed, before it had any fair trial, upon grounds generally
believed to be wholly beside its merits, and from causes more easily understood, than deliberately
vindicated.”).
30 Barton v. Barbour, 104 U.S. 126, 135 (1881). My focus is on large corporations generally, but until
the late 19th century, we can largely assume that all large corporations were railroads.
31 1 JOHN GERDES, CORPORATE REORGANIZATIONS § 10 (3rd ed. 1936).
32 Corporations in general initially were excluded from filing voluntary petitions under the 1898 Act,
and “[b]y 1910, when amendments finally broadened the scope of bankruptcy, the pattern of equity
reorganization had already been definitely fixed.” 8 SECURITIES AND EXCHANGE COMMISSION,
STUDY AND INVESTIGATION OF THE WORK, ACTIVITIES, PERSONNEL AND FUNCTIONS OF
PROTECTIVE AND REORGANIZATION COMMITTEES 62 (1940).
33 See D.H. Chamberlain, New-Fashioned Receiverships, 10 HARV. L. REV. 139, 140 (1896).
34 Henry H. Ingersoll, Rights and Remedies of General Creditors of Mortgaged Railways, 19 Yale L.J. 622, 624
(1910) (emphasis in original).
35 Cf. HARRY G. GUTHMANN & HERBERT E. DOUGALL, CORPORATE FINANCIAL POLICY 329 (4th ed.
1962):

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

a. Foreclosure and Execution Sales

In the early Nineteenth Century, it was well settled that, absent legislative authorization, a
corporation could not mortgage its “franchise” or special rights given by the legislature. 36 While the
concepts of the charter, franchise or privileges were sometimes run together, the first two were
distinguishable from the latter:

What is called the franchise of forming a corporation is really but an exemption from a
general rule of the common law prohibiting the formation of corporations. In former times,
this exemption was granted only in exceptional cases, by a special charter in each instance. It
was, therefore, looked upon as something valuable, -as a gift of a special privilege to the
grantees of the charter, - and was called a “franchise.”37

As the New Hampshire Supreme Court said in 1856, a “corporation, being itself a franchise, consists
and is made up of its rights and franchises.”38 Or as the Texas Supreme Court explained shortly
thereafter, “the charter is a grant of franchises by the state.”39

Thus, the power to use the franchise as collateral had to be expressly given by the state, either in the
charter itself or in a separate statute. For example, in Texas state law provided that

Because separate properties are separately mortgaged, the status of different bond issues is
often obscure until reorganization takes place. Foreclosure and acquisition of the mortgaged
property seldom occur because the separate units usually cannot be operated to the greatest
advantage except as parts of a unified going concern. The right of foreclosure therefore
serves mainly to give the holders of a specific lien bargaining power in any reorganization in
proportion to the profitableness and importance of the property pledged to them.
36 Pullan v. Cincinnati & C. Air-Line R. Co., 20 F. Cas. 32, 35 (C.C.D. Ind. 1865); Coe v. Columbus,
P. & I.R. Co., 10 Ohio St. 372, 394 (1859).
37 2 VICTOR MORAWETZ, A TREATISE ON THE LAW OF PRIVATE CORPORATIONS 884 (2d ed. 1886).
See also R. Mason Lisle, Foreclosure of Railway Mortgages, 20 Am. L. Rev. 867, 868 (1886)
(“Incorporation is the creation of an artificial person, which can only exist by the grant of the
sovereign power; hence when the latter creates a corporation, it grants a liberty or a franchise for it
to exist.”).
38 Pierce v. Emery, 32 N.H. 484, 507 (1856).
39 State v. S. Pac. R. Co., 24 Tex. 80, 122 (1859). In full, the Court explains:

The correct view of the subject is, that the charter is a grant of franchises by the state, and
the rights granted to the company, are limited by the charter. They have a right to be a
corporate body--that is, a franchise; they have a right to construct a public railroad, and
charge for its use (incidental powers are conferred to accomplish these objects); these
constitute a franchise. These franchises are the private property of the company....

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

no company shall have the power to make any trust deed or mortgage on the franchise or
property of the company, unless the power is expressly given by the by-laws of the
company.40

Here the State grants the power, but requires a further step: the adoption of a relevant bylaw.

But once the power to mortgage was established, a natural question arose: What remedies did the
creditors have under such a mortgage? In particular, as railroads in this era were created by
legislative act,41 did the purchasers of the railroad at a foreclosure sale need to go back to the
legislature to get a new corporate charter, to hold the assets obtained at the sale?

The courts soon developed a rule that the power to foreclose on the franchise included the power to
operate under a charter, a holding that was soon confirmed by statutes in several jurisdictions.42 An
1863 New York treatise summarized the law at that time as follows:

The sale by virtue of a decree granted on a mortgage foreclosure of the franchises and
corporate property vests in the purchaser the right to use and enjoy both, as the same were
used and enjoyed when the mortgage was given; without any liability for debts or obligations
created subsequent to the mortgage. This is a legitimate inference from the power to
mortgage the franchise and corporate property. The corporation still subsists
notwithstanding the foreclosure, and its business can be carried on under the original
charter, by the purchasers or their assigns.43

This is also reflected in the statutes enacted in this era. For example, the Texas act of December 19,
1857, section 5 (article 4912) provided:

The road-bed, track, franchise, and chartered rights and privileges of any railroad company
in this State shall be subject to the payment of the debts and legal liabilities of said company,
and may be sold in satisfaction of the same . . . the purchaser or purchasers at such sale, and
their associates, shall be entitled to have and exercise all the powers, privileges, and franchises granted to
said company by its charter, or by virtue of the general laws of this State; and the said purchaser
or purchasers and their associates shall be deemed and taken to be the true owners of said charter and
corporators under the same, and vested with all the powers, rights, privileges, and benefits

40 Act of December, 1857, section 4. GEORGE W. PASCHAL, A DIGEST OF THE LAWS OF TEXAS 820
(article 4911) (1870)
41 Joseph A. Ranney, A Fool's Errand? Legal Legacies of Reconstruction in Two Southern States, 9 Tex.
Wesleyan L. Rev. 1, 39 (2002) (“Texas placed some limits on private incorporation laws before the
Civil War; the 1845 constitution allowed the legislature to create private corporations only by a two-
thirds vote of each chamber.”).
42 SIMEON E. BALDWIN AMERICAN RAILROAD LAW 466 (1904) (“Power given to a railroad company
to mortgage its railroad implies power to mortgage the franchise to operate it, for otherwise the
property, in case of foreclosure, would fail to serve its proper purposes and the public interest might
be prejudiced.”). See also Rights Acquired by Purchasers of Public Utilities at A Judicial Sale, 50 Harv. L.
Rev. 1303, 1307 (1937).
43 JOHN WILLARD, TREATISE ON EQUITY JURISPRUDENCE 744 (1863).

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

thereof, in the same manner and to the same extent as if they were the original corporators
of said company.44

And under section 9 (article 4916) of the same Texas act, “the directors or managers of the sold-out
company at the time of the sale, by whatever name they may be known at law, shall be the trustees
of the creditors and stockholders of the sold-out company, and shall have full powers to settle the
affairs of the sold-out company.”45

The net effect of such a foreclosure sale was to create a new company – operating the very same
railroad, yet entirely free from claims and equity interests associated with the old railroad.46 The old
company – now stripped of its railroad assets – continued as a trust to pay off its remaining
creditors and, if possible, the shareholders.47 As one commentator explained, “the franchises pass
with the mortgaged property as they were meant to, all that is vital is thus transferred, and there is
neither injustice nor incongruity in holding that the legislature may treat the substance instead of the
shadow as representing the corporate body.”48

And the law was “well settled that stockholders are not entitled to any share of the capital stock nor
to any dividend of the profits until all the debts of the corporation are paid.”49 That is, the
shareholders of the old railroad had no entitlement in the new railroad, and they also had no
entitlements in the estate of the old railroad until all creditors were paid in full.50

As one knowledgeable author, writing at the turn of the century, wryly summarized:

… the procedure was simplicity itself. The trustee of the mortgage went into court, or
resorted to the ordinary summary power of sale, and foreclosed the equity of redemption of
the mortgagor. The stock, to use an expression more forcible and familiar than elegant, was
“wiped out.” That was the end of it. The unsecured creditor retired to his place of business,
charged the debt to profit and loss account, and endeavored to make up his loss by over-

44 PASCHAL, supra note 40, at 820 (emphasis added).

45 Id. at 820-21.
46 Morgan Cty. v. Thomas, 76 Ill. 120, 147 (1875); Commonwealth v. Cent. Pass. Ry. Co., 52 Pa. 506,
512 (1866); Vilas v. Milwaukee & P. du C. Ry. Co., 17 Wis. 497, 502 (1863). See also Houston &
T.C.R. Co. v. Shirley, 54 Tex. 125, 137–38 (1880) (“But clearly the purchaser of property at a sale
under an execution or deed of trust assumes no personal liability for the debts of the former owner;
and if by such a purchase the chartered rights and corporate existence and privileges of a
corporation pass under the control of the purchaser, it still does not follow that its liabilities also
attach to him.”).
47 Witherspoon & Lane v. Texas Pac. R. Co., 48 Tex. 309, 319 (1877).
48 Lisle, Foreclosure of Railway Mortgages, supra note 37, at 873. The author goes on to state:

In the absence of legislation, there might be some awkwardness in giving a precise legal
definition to the new arrangement, but there could be none concerning its substantial rights.
There could be no diminution of the privileges mortgaged without impairing the value of the
mortgage as a security.
49 Chicago, R.I. & P.R. Co. v. Howard, 74 U.S. 392, 409–10 (1868).
50 LEONARD A. JONES, A TREATISE ON THE LAW OF RAILROAD AND OTHER CORPORATE
SECURITIES INCLUDING MUNICIPAL AID §640 (1879).

10

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

charging the successor company. The stockholder went into the market to find some more
bargains, hoping by a lucky stroke to “average.”51

Likewise, in 1880, the Texas Supreme Court explained that the “plain intent of the [1857] statute is
to transfer the roadbed, track, franchise and chartered rights entire to the purchaser and associates,
upon their adopting the form of organization prescribed in the charter and complying with its other
requirements; and to remit creditors unsecured by lien to their remedy against such assets as pass to
the trustees of the sold-out company.”52

In short, upon sale, a new railroad was created in the buyer, and the rights of the creditors and
shareholders in the old company remained with the old company.53 The “franchises would not be
forfeited to the State, but transferred to the purchasers; and the State could not revive the old
corporation by a regrant of the franchises, which had become vested in the purchasers.” 54 Thus, one
commentator concluded that

both upon principle and by the decisions of the courts of the country, that under a legislative
authority to mortgage “all the rights, privileges and franchises” of a railroad company with an
unalterable charter, the company executing such a mortgage will, at a foreclosure sale, pass
to the purchasers the corporate existence.55

Frequently this was done as part of an overall plan of reorganization. As the U.S. Supreme Court
explained in 1883,

it rarely happens in the United States that foreclosures of railway mortgages are anything else
than the machinery by which arrangements between the creditors and other parties in
interest are carried into effect, and a reorganization of the affairs of the corporation under a
new name brought about. It is in entire harmony with the spirit of bankrupt laws, the
binding force of which, upon those who are subject to the jurisdiction, is recognized by all
civilized nations.56

51 Adrian H. Joline, Railway Reorganizations, 8 Am. Law. 507, 508 (1900). Joline was a well-known
reorganization lawyer of his day, who also often served as a receiver. E.g., United States v.
Whitridge, 231 U.S. 144, 146 (1913).
52 Houston & T.C.R. Co. v. Shirley, 54 Tex. 125, 139 (1880).
53 Id. at 139 (“Under this statute it is believed that a number of railroads in this state have been sold
out and purchased by individuals, who have proceeded to organize and manage the corporation
under the original charter. Not only the road-bed and other mortgaged property, but the franchise
to operate a road and the very corporate existence of the sold-out railroad passes to the new
organization by virtue of the statute. Ordinarily such purchaser and associates need no further
legislation.” (citation omitted)); see also Thayer v. Wathem, 17 Tex. Civ. App. 382, 392, 44 S.W. 906,
910 (1897), writ refused (“The effect of these decisions, as we understand them, is that when a
railway and franchises are sold the corporation is not dissolved thereby, but ‘the corporation
continues, and the purchasers become in effect new stockholders.’”).
54 Pierce v. Emery, 32 N.H. 484, 512–13 (1856).
55 Lisle, Foreclosure of Railway Mortgages, supra note 37, at 888.
56 Canada S. Ry. Co. v. Gebhard, 109 U.S. 527, 539 (1883).

11

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

Thus a mechanism with a long history, mortgage foreclosure, was readapted to become a corporate
reorganization tool. Mortgage foreclosure ultimately proved inadequate to reorganization of a large,
multi-state business.57 But in these early cases we see the foundation of the more sophisticated
practice that developed in the late Nineteenth Century: sale of the operating railroad to a new
corporation that would maintain those operations.58

b. Receiverships

While receiverships in their traditional form have a very long history,59 during the nineteenth century
they were transformed into a unique and flexible tool for reorganizing insolvent railroads.60 While
the precise point at which receiverships began to be used as a reorganization device is unclear,61 by
the 1880s receiverships had clearly surpassed foreclosures as the favored means of addressing
financial distress:

The new and changed condition of things which is presented by the insolvency of such a
corporation as a railroad company has rendered necessary the exercise of large and modified
forms of control over its property by the courts charged with the settlement of its affairs and
the disposition of its assets. Two very different courses of proceeding are presented for
adoption. One is the old method, usually applied to banking, insurance, and manufacturing
companies, of shutting down and stopping by injunction all operations and proceedings,
taking possession of the property in the condition it is found at the instant of stoppage, and
selling it for what it will bring at auction. The other is to give the receiver power to continue
the ordinary operations of the corporation, to run trains of cars, to keep the tracks, bridges,

57 See Hand v. Savannah & C.R. Co., 12 S.C. 314, 329 (1879) (“It is to be presumed that the
necessary proceedings will be instituted in the court of the State of Georgia for the adjudication of
the rights of parties in the portion of the road lying in that state; and that by the comity of the
respective courts, or by the agreement of parties, a time of sale, assented to in each jurisdiction, will
be eventually fixed upon.”). Accord Midland Valley Ry. Co. v. Moran Nut & Bolt Mfg. Co., 97 S.W.
679, 680 (Ark. 1906) (“The judgment in this case was correct in form in fixing a lien on all the
property of appellant railroad in the state of Arkansas, but it was erroneous in allowing that lien to
be made up of material furnished and used in the construction of appellant's road in the Indian
Territory.”). New York had (indeed, still has) a helpful statute to cover this problem, but many
other states did not. LEONARD A. JONES. TREATISE ON THE LAW OF RAILROAD AND OTHER
CORPORATE SECURITIES, INCLUDING MUNICIPAL AID BONDS §659 (1879).
58 De Forest Billyou, Priority Rights of Security Holders in Bankruptcy Reorganization: New Directions, 67
Harv. L. Rev. 553, 557 (1954) (“Corporate reorganization through an equity receivership developed,
not as a substitute for the liquidation of an insolvent corporation, but rather from the limitations of
a simple mortgage foreclosure.”).
59 HENRY G. TARDY. TREATISE ON THE LAW AND PROCEDURE OF RECEIVERS at §1 (2d ed. 1920).
See also FRED F. LAWRENCE, A TREATISE ON THE SUBSTANTIVE LAW OF EQUITY JURISPRUDENCE at
§ 1108 (1929).
60 Gross v. Missouri & A. Ry. Co., 74 F. Supp. 242, 244 (W.D. Ark. 1947).
61 Charles Warren argued that federal courts were reluctant to appoint receivers before 1880.
Charles Warren, Federal and State Court Interference, 43 Harv. L. Rev. 345, 364 (1930). In Vermont, one
such receivership reportedly was commenced “prior to 1861” and remained pending in the early
1880s. M.M. Cohn, Railroad Receiverships – Questions of Practice Concerning Them, 19 Am. L. Rev. 400,
410 (1885).

12

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

and other property in repair, so as to save them from destruction, and as soon as the interest
of all parties having any title to or claim upon the corpus of the estate will allow, to dispose
of it to the best advantage for all, having due regard to the rights of those who have priority
of claim.62

Receiverships in the early days were sometimes commenced in response to suits by unpaid secured
bondholders. In later years, they were most often instituted in response to a suit by an unsecured
creditor (a “creditor’s bill”), coupled with the debtor’s admission that the debt was due and the
railroad was unable to pay.63 This was the “friendly” or consent receivership that New Dealers
would bemoan as “collusive” and the source of much insider dealing.64

As one commentator noted

From the standpoint of the corporation involved, such a method of securing a receivership
is to be commended for several reasons. It is simple, as almost any large corporation can
secure the co-operation of a non-resident creditor with a claim of $3,000 or more. It is
expeditious, for the bill praying for a receiver and the answer consenting can be filed within
a few minutes of each other. It allows the corporation in financial difficulties to have the
protection of the United States court.65

Normally an unsecured creditor cannot obtain a receiver until the creditor has received a final
judgment on its debt, a receiver being more in the nature of a remedy than an end in itself. But if

62 Barton v. Barbour, 104 U.S. 126, 134–35 (1881).

63 E.g., Louisville Trust Co. v. Louisville & C. Ry. Co., 174 U.S. 674, 676-77, 687-88 (1899); Brassey
v. N.Y. & N.E.R. Co., 19 F. 663, 669 (C.C.D. Conn. 1884). See James Byrne, The Foreclosure of
Railroad Mortgages in the United States Courts, in SOME LEGAL PHASES OF CORPORATE FINANCING,
REORGANIZATION AND REGULATION 77, 79–81 (1917) (explaining that unsecured creditors were
used to reach all property and assets controlled by the railroad, and not just the property subject to
any specific mortgage).
64 Modern scholars, beginning with Albro Martin, have lavished much attention on the Wabash case,
where Jay Gould somehow convinced a federal court to approve the railroad’s own petition for a
receivership. Wabash, St. L. & P. Ry. Co. v. Cent. Tr. Co., 22 F. 272, 273 (C.C.E.D. Mo. 1884)
(“True, the proceeding is peculiar in this aspect: that the application was made by the corporation
itself, instead of being made by the mortgagee on default of payment of interest.”); Albro Martin,
Railroads and the Equity Receivership: An Essay on Institutional Change, 34 J. Econ. Hist. 685 (1974); see also
Lubben, supra note 113, at n. 106. But the consent receivership was far more important, because it
not only launched the reorganization process, but it provided federal courts with diversity
jurisdiction, since the friendly petitioning creditor was always from outside the home state of the
railroad. Warner Fuller, The Background and Techniques of Equity and Bankruptcy Railroad Reorganizations--
A Survey, 7 Law & Contemp. Probs. 377, 378-80 (1940). Accord 8 SECURITIES AND EXCHANGE
COMMISSION, STUDY AND INVESTIGATION OF THE WORK, ACTIVITIES, PERSONNEL AND
FUNCTIONS OF PROTECTIVE AND REORGANIZATION COMMITTEES 24 (1940) (“The procedure failed
to crystallize along these lines [i.e., the Wabash approach]; instead, there was increasing resort to
another, and less novel, form of legal action. This was the general creditor's bill, out of which the
standard procedure was even then being fashioned in other cases.”).
65 Thomas A. Thacher, Some Tendencies of Modern Receiverships, 4 Calif. L. Rev. 32, 34-35 (1916).

13

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

the defendant railroad were to file an answer admitting the validity of the debt, and its inability to
quickly pay the same, the courts felt comfortable moving quickly to the remedy stage.66

Early receiverships were first conducted in state courts. Later, receiverships moved to federal court,
as the federal judges had somewhat broader jurisdiction, and developed clear procedures for
recognition of the receivership in all districts where the railroad might have property.67 Moreover, a
nineteenth century federal circuit judge could enter an order appointing the receiver in all districts
within the circuit, something no state court judge could do.68 Likewise, after 1911 (and the abolition
of the old circuit courts), federal district courts had the power to appoint a single receiver for all
fixed property within the circuit.69

In state courts, or when reorganizing larger businesses in federal court, ancillary receivers would be
appointed in all jurisdictions outside the circuit or state where the main case was pending. 70 In some
instances, these would be the same receivers as in the main proceeding. But in many cases local
receivers, with local counsel, would be appointed. In the main cases the receiver was frequently an
officer of the debtor, providing a kind of precursor to the “debtor in possession” concept.

In all cases, the goal was to place the railroad’s assets under court control, and out of the reach of
individual creditors.71 Foreclosure and other collection activity was halted while the creditors

66 For a good overview of the procedure, see 3 CLARK ON RECEIVERS § 855 (3d ed. 1959), at page
1339. Eventually this process of “consent receivers” was adopted by the state courts too. See New
England Theatres, Inc. v. Olympic Theatres, Inc., 287 Mass. 485 (1934).
67 Warren, Federal and State Court Interference, 43 Harv. L. Rev. at 364–65 (“it became customary for a
corporation to apply in the federal courts itself, or (if it could not sue) through some “friendly”
creditor with requisite diverse citizenship; and frequently races arose between an adverse creditor
seeking a receivership in a state court, and a “friendly” creditor petitioning in a federal court.”).
68 Kingsport Press v. Brief English Sys., 54 F.2d 497 (2d Cir. 1931) contains a good description of
the process, including the debtor’s communication with its petitioning creditors and the ultimate
appointment of the debtor’s president as receiver.
69 Judicial Code of 1911 § 56, Pub.L. 61–475, 36 Stat. 1087. The circuit courts had lost their
appellate jurisdiction back in the 1890s, but were not phased out as trial courts until the passage of
this law, nearly 20 years later.
70 8 SECURITIES AND EXCHANGE COMMISSION, STUDY AND INVESTIGATION OF THE WORK,
ACTIVITIES, PERSONNEL AND FUNCTIONS OF PROTECTIVE AND REORGANIZATION COMMITTEES
30-33 (1940) (“In the case of other than railroad corporations, this necessity created problems of
administration which appreciably retarded the speed of reorganization. In every type of case it
involved the additional preparation of many sets of legal papers. the employment of ancillary
receivers and of counsel for each of them, and, in general, a needless duplication of much effort and
expense.”).
71 Taylor v. the Philadelphia & Reading R Co., 7 F. 381, 384 (C.C.E.D. Pa. 1881) (“The custody of
the property of this railroad devolves upon the receivers appointed by the court. They are custodians
of it for the benefit of the creditors. As the object of the whole proceeding is the preservation of the
property for the benefit of the creditors…”). See also In re Higgins, 27 F. 443, 444 (C.C.N.D. Tex.
1886).

14

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

negotiated a reorganized capital structure for the railroad. Creditors, and sometimes even
shareholders, were represented in this process by committees.72

While the committees negotiated, the receivers would often spruce up the railroad. 73 These
improvements were funded by “receivers’ certificates,” essentially a form of priority debt instrument
issued by the receiver and paid off by the receivership estate.74

Once a plan was agreed upon, foreclosure suits resumed. The railroad was purchased in exchange
for the various defaulted bonds under a joint committee’s control, and the assets placed in a new
corporate shell.75 Often the new company would adopt a similar, although subtlety different name.
For example, the Reading Railroad might become the Reading Railway, or vice versa.76

Shareholders typically retained their interests in the reorganized railroad only if they paid an
assessment, which helped fund the new road’s operating cash requirements.77 In some cases the
shareholders also received subordinated debt upon payment of the assessment, which protected
them in the case of a future receivership.78 As one commentator in 1900 wrote:

72 Fuller, supra note 64, at 380-81 (“Protective committees were self-constituted groups, formed to
represent the various creditor and stock interests of the insolvent carrier. Usually each creditor or
equity class had its separate committee.”).
73 Importantly, it was the shareholders and creditors who reorganized the railroad, the receiver
simply kept it in good operating condition. See James William Moore, Reorganizations under Chapter X,
35 J. Nat'l Ass'n Ref. Bankr. 105, 109 (1961).
74 Thacher, supra note 65, at 37-42, 45-48. There was some doubt about whether priority “new
money” financing was appropriate in cases not involving quasi-utilities, like railroads. 1 JOHN
GERDES, CORPORATE REORGANIZATIONS § 15 (3rd ed. 1936).
75 Sage v. Cent. R.R. Co., 99 U.S. 334, 339 (1878) (“The amount required is so large usually, that it is
beyond the reach of ordinary purchasers . . . the first-mortgage bondholders are the only party that
can become the purchasers, and they only, because they need not pay their bid in cash.”).
76 Hon. Henry Clay Caldwell, Railroad Receiverships in the Federal Courts, 30 Am. L. Rev. 161, 169
(1896).
77 E.g., Boyd v. N. Pac. Ry. Co., 170 F. 779, 801 (C.C.D. Wash. 1909), aff'd, 177 F. 804 (9th Cir.
1910), aff'd 228 U.S. 482 (1913). See Kan. City Terminal Ry. Co. v. Cent. Union Trust Co., 28 F.2d
177, 188 (8th Cir. 1928) (“[Because] the [common] stockholders, in order to obtain any participation,
were compelled to further invest to the extent of . . . 25 per cent . . . of the par value of the
participating stock, we conclude that there is no doubt as to the fairness of this offer to the
unsecured creditor.”).
78 See Guar. Trust Co. of N.Y. v. Missouri Pac. Ry. Co., 238 F. 812, 818 (E.D. Mo. 1916) (“In this
case the old stockholders are required to pay in cash 50 per cent. of the par of their holdings. They
will receive for their cash payments new 4 per cent. bonds at par. In order, these bonds will come
just ahead of the preferred stock. They will be inferior to all the other bonded indebtedness, and
their subordinate position in that respect, and their rate of interest, taken together, make it doubtful
that they will soon, if ever, be worth par. This will operate as an assessment upon the common stock
to the amount of the discount. That the stockholders will be given such bonds for their cash
payments is not inequitable to general creditors. They will pay more than they will get in value; but if
they paid nothing, and received no bonds, still the relation between them and general creditors
would not be disturbed. Besides, the raising of money from some source is imperative, and that
raised from the stockholders will be for the benefit of the enterprise as a whole.”).

15

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

The right to participate in the benefit of the reorganization comes to stockholders not by
virtue of their right as holders of stock, but purely from the grace of the prior lien creditors,
who have, in the absence of fraud, the power to give to whom they please an interest in the
purchased property.79

Shareholders (and unsecured creditors) who did not participate in the reorganization were left with
claims against the old corporation, now without operating assets. At most they might have a
proportionate claim to the upset price – essentially the liquidation value – paid to the old railroad as
part of the foreclosure process.80

This is how the receivership process operated in general. In a few, rare cases there was no
foreclosure sale, and the receiver simply returned the assets to the railroad.81 This happened when
the parties were able to work out a fully consensual plan, and thus there was no need to bind
dissenters to the plan.82 If dissenters were small in number, sometimes the plan proponents would
buy out the dissenters to facilitate such a consensual plan. Alternatively, the old securities might be
left outstanding. In all cases, “the reorganizers must determine whether the expense and practical
injustice involved in thus preferring the non-assenting securities is more than counterbalanced” by
the benefits of moving forward with the plan.83

In modern terms, we would call this latter sort of reorganization a “workout.” The parties became
bound to the plan by contract, rather than by judicial action.84 As with traditional receiverships,
shareholders would agree to pay an assessment to keep their interests in the corporation after the
reorganization.85 And the railroad got to keep its original charter, which might be of some value if
the legislature hand granted special privileges.86

As Paul Cravath explained:

79 Joline, supra note 51, at 513.

80 Samuel Spring, Upset Prices in Corporate Reorganization, 32 Harv. L. Rev. 489, 494-95 (1919).
81 STUART DAGGETT, RAILROAD REORGANIZATION 28-29 (1908) (discussing the reorganization of
the Baltimore & Ohio, an example of a consensual reorganization, and noting “It will be
remembered that, while provision had early been made for foreclosure, it had been hoped to avoid
such a drastic step. Hopes in this respect were fulfilled, and while a number of branch lines were
sold, the main stem escaped.”).
82 In his March 1916 lectures to the New York City bar, Paul Cravath (partner in the law firm today
known as Cravath, Swaine & Moore LLP) explained that such consensual restructurings were more
common in commercial corporations, than railroads. Paul D. Cravath, The Reorganization of
Corporations, in SOME LEGAL PHASES OF CORPORATE FINANCING, REORGANIZATION AND
REGULATION 153, 211-12 (1917).
83 Cravath, supra note 82, at 212-13.
84 Joline, supra note 51, at 508.
85 DAGGETT, supra note 81, at 30 (explaining that in the Baltimore & Ohio reorganization, “The
common stockholders, instead of being wiped out, have received their common stock in the new
company upon paying an assessment, the net amount of which (because of the value of the
securities received for such assessment) would not exceed $5 or $6.”).
86 DAGGETT, supra note 81, at 30 (noting such a consideration in the 1899 Baltimore & Ohio
reorganization).

16

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

A voluntary readjustment may be preceded by a receivership, or even by the institution of

foreclosure proceedings, for in case the necessary support of security holders eventually is
forthcoming, the receivership can be dismissed, or the foreclosure suit abandoned …

The same result was accomplished in the reorganization of the Texas and Pacific Company
in 1887, where the foreclosure sale actually took place but was never confirmed. The consent
of the security holders finally made it possible to cancel the old mortgages, dismiss the
foreclosure proceedings, create new mortgages and issue additional stock, thereby preserving
the corporation's Federal charter.87

The railroad kept its name, and was indeed the same corporation. The effects of the reorganization
are thus solely the result of the agreement between the creditors and the shareholders, and the
subsequent vote by the shareholders to implement the revised reorganization plan.88 The
receivership in these consensual cases gave the parties sufficient time to come to a deal.

In either the traditional or consensual versions of receiverships, the goal was to implement a deal
agreed to by most creditors. The precise contours of that deal was largely left to the parties,

receivership courts exercised very little supervision over this process. They did not typically
concern themselves with either the fairness or the feasibility of the reorganization plan.89

At the turn of the century the use of receiverships as a flexible reorganization tool was widespread.
And when the Supreme Court blessed the use of consent receiverships in 1908, and rejected the
argument that their highly choreographed nature was “collusive,” the receivership’s future as the
reorganization tool of choice for larger corporations seemed quite stable.90

But there were already signs of discord.91 As early as 1881, Justice Samuel F. Miller, in dissent,
expressed strong cynicism toward the receivership process that was then just hitting its stride.92 In a
lengthy 1895 speech, then circuit judge William Howard Taft argued that it would be better if
receiverships were replaced by federal bankruptcy legislation.93 And a 1905 critic suggested that
receivers were routinely flouting the law that governed solvent businesses.94

87 Cravath, supra note 82, at 210-11.

88 Texas and Pacific. The Commercial and Financial Chronical, vol. XLVI at p. 321 (noting that a
special shareholders meeting had been held the prior week to approve the new mortgages granted
under the plan).
89 Vern Countryman, Justice Douglas: Expositor of the Bankruptcy Law, 16 UCLA L. Rev. 773, 804 (1969).
90 In re Reisenberg (aka In re Metropolitan Railway Receivership), 208 U. S. 90, 109 (1908). See also
Hollins v. Brierfield Coal & Iron Co., 150 U.S. 371 (1893).
91 JAMES W. ELY, JR., RAILROADS AND AMERICAN LAW 178-79 (2001).
92 Barton v. Barbour, 104 U.S. 126, 137-38 (1881) (Miller, J. dissenting).
93 William H. Taft, Recent Criticism of the Federal Judiciary, 18 Annu. Rep. A.B.A. 237, 264 (1895).
94 W. A. Coutts, The Act of Congress Permitting Suits against Federal Receivers - Injunctions from State Courts,
39 Am. L. Rev. 59, 75 (1905).

17

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

In 1908, one editorialist proclaimed that the “undue prolongation of the receivership in order that
the receiver may fatten upon rich fees is a scandalous abuse of trust.”95 A few years later, the
governor of Kansas was less restrained, complaining that

The attorneys and receivers who participate in this graft seem to have no sense of decency,
no feeling of shame when it comes to appropriating money to their own use, which they are
presumed to hold as a sacred trust.96

And in a 1916 speech before the Commercial Law League, Samuel Untermyer97 argued that many
receivership cases were commenced by corporate officers without the knowledge of their boards,
with rampant insider trading on the eve of filing.98 Professional fees, he complained, were “easily
ten times as large as in any other country and necessarily so because of the complications of the
procedure.” He ultimately concluded that the entire process should be reformed, with railroad
reorganizations under the control of the Interstate Commerce Commission, using a process like that
used for insolvent banks.99

Initially these commentators had limited effect. Indeed, “friendly” consent receiverships were quite
common throughout the first three decades of the Twentieth Century.100

95 Receivers, 13 Va. L. Reg. 995, 995-96 (1908) (“At the present time in this state there is one large
railroad corporation in the hands of receivers, and it is not amiss to impress upon these officers of
the court a lively sense of their duty.”).
96 Arthur Kapper [Capper], Law Enforcement, 5 Women Law. J. 40 (1916).
97 For background, see Untermyer Dead In His 82d Year, N.Y. Times (March 17, 1940), at p. 1.
98 At the annual meeting of the Commercial Law League, July 27, 1916. The speech is reprinted in
Samuel Untermyer, The Lawyer-Citizen-His Enlarging Responsibilities, Chicago Legal News (Oct. 26,
1916), at p. 98 (available at https://heinonline.org/HOL/P?h=hein.journals/chiclene49&i=156)
and The Bulletin of the Commercial Law League of America, Volume 21, at page 591.
99 Beginning in 1920, the Interstate Commerce Commission was given a role in receiverships,
approving the capital structures of the reorganized railroads. 41 Stat. 494 (1920) (The Transportation
Act of 1920). As Professors Armour and Cheffins explain:

This legislation expanded the I.C.C.’s jurisdiction over railways to include the power to veto
acquisitions that failed to conform to national transportation policy. Correspondingly, an
acquirer who successfully bought up the desired percentage of stock could still lose out due
to an I.C.C. veto. This likely was a serious deterrent to attempts to gain control by the
unsolicited open market buying of shares.

I.C.C. intervention was by no means merely a theoretical possibility. There were at least two
instances during the 1920s where the Commission exercised its veto power to block railroad
acquisitions after voting control was successfully obtained on the open market.

John Armour & Brian Cheffins, The Origins of the Market for Corporate Control, 2014 U. Ill. L. Rev.
1835, 1847 (2014) (footnotes omitted).
100 Nathan L. Jacobs, Problems in Federal Receivership Jurisdiction, 1 Mercer Beasley L. Rev. 29, 44-45
(1932) (citing cases, and noting that “Although the decision in the Metropolitan Railway case met with
adverse criticism, the lower federal courts displayed no hesitancy in adopting it to its outermost
implications; and abuses of its authority, which will be dealt with later, became prevalent.”).

18

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

But slowly the Supreme Court was chipping away at the flexibility of the receivership process,
imposing newly discovered rules to defeat previously unnoticed abuses, and in the process slowly
decreasing the utility of the process. As early as 1894, the Supreme Court criticized courts who
attempted to create something like a bar date and full discharge in consensual – that is, non-
foreclosure – reorganizations.101

In 1928, the Court attempted to narrow the use of consent receivers, with limited success.102
Nonetheless, commentators began to worry:

There can be no doubt that the Supreme Court intended to call a halt to the unlimited use of
the friendly receivership; but with occasional exceptions the district judges have continued as
before. The continued failure of the district judges to exercise their unquestioned discretion
to limit the friendly receivership to proper situations and to eliminate prevalent abuses is
indeed unfortunate for it may well lead to a reversal by the Supreme Court of its decision in
Re Metropolitan Railway Receivership.103

Henry Friendly would write that while “earlier reorganizers had regarded the Boyd case as ‘a veritable
demon incarnate’, reorganizers of the 1920's had far greater justification for considering the dictum
in Harkin v. Brundage in a similar light.”104

A line of cases followed, all suggesting that the consent receivership was living on borrowed time. 105

Boyd itself can be seen as part of the slow drip of caselaw that undermined receiverships, even if
today it is known mostly for its purported role in establishing the absolute priority rule.106 While
Justice Douglas managed to twist the understanding of the case for all time,107 its actual holding was

101 Texas & P. Ry. Co. v. Johnson, 151 U.S. 81, 103 (1894) (“Certainly the preservation of general
equity jurisdiction over suits instituted against receivers without leave does not, in promotion of the
ends of justice, make it competent for the appointing court to determine the rights of persons who
are not before it, or subject to its jurisdiction; and the right to sue without resorting to the
appointing court, which involves the right to obtain judgment, cannot be assumed to have been
rendered practically valueless by this further provision in the same section of the statute which
granted it.”).
102 Harkin v. Brundage, 276 U.S. 36, 52-53 (1928).
103 Jacobs, supra note 100, at 46.
104 Henry J. Friendly, Some Comments on the Corporate Reorganizations Act, 48 Harv. L. Rev. 39, 43 (1934)
(quoting Paul Cravath with respect to Boyd).
105 E.g., Shapiro v. Wilgus, 287 U. S. 348, 355 (1932); First Nat. Bank v. Flershem, 290 U. S. 504, 515
(1934).
106 Lawrence M. Bell, Valuation and the Probability of Bankruptcy in Chapter X, 52 Am. Bankr. L.J. 1, 2
(1978); see also Stephen J. Lubben, The Overstated Absolute Priority Rule, 21 Fordham J. Corp. & Fin. L.
581, 591 (2016).
107 In Case v. Los Angeles Lumber Prod. Co., 308 U.S. 106, 116 (1939), Justice Douglas tied Boyd to
the so-called “absolute priority rule,” as discussed in the text. Interestingly, just a few years earlier
the SEC, of which Douglas was then a member, suggested that payment according the strict
liquidation priority (i.e., the absolute priority rule) was not practical in reorganization cases:

19

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

understood in the receivership era to be something like “non-participating creditors will not be
‘discharged’ in a reorganization plan that saves old shareholders.”108 That is only indirectly
concerned with priority, but the holding did inject another aspect of doubt into the receivership
process. 109

Thus, the receivership’s usefulness was well undermined by the Court by the early 1930s.110 That, of
course, was precisely when the need for corporate reorganization was at its highest.111

In the give and take of negotiation nice legal priorities of various classes of claims will not be
strictly observed. Rather the positions of these various claimants will be traded out in
conference, so that only a gross approximation of their strictly legal status will be reached.

1 SECURITIES AND EXCHANGE COMMISSION, STUDY AND INVESTIGATION OF THE WORK,

ACTIVITIES, PERSONNEL AND FUNCTIONS OF PROTECTIVE AND REORGANIZATION COMMITTEES 3
(1937).
108 De Forest Billyou, Railroad Reorganization Since Enactment of Section 77, 96 U. Pa. L. Rev. 793, 809
(1948) (“Long prior to the federal reorganization statutes it was held that a reorganization that did
not allow junior creditors to participate in the reorganized company was unfair and inequitable to
these creditors if old stockholders were allowed to participate to an extent greater than justified by a
new contribution to the reorganized company. It was held also that such a plan, even though
consummated, did not preclude these creditors from asserting a debt claim against the reorganized
company.”); Fuller, supra note 64, at 383 (“The rationale of the decision was that bondholders, who
might have purchased the property for themselves alone, could not permit stockholders to obtain an
interest in the new company pursuant to an arrangement made before the sale, without also giving
every creditor of the old the privilege of participating in the reorganization on a fair and equitable
basis.”); see also HENRY WINTHROP BALLANTINE. BALLANTINE'S MANUAL OF CORPORATION LAW
AND PRACTICE - A TREATISE ON THE PRINCIPLES OF CORPORATION LAW PRACTICAL DIRECTIONS
ON ORGANIZATION CORPORATE FORMS 767 (1930) (“In Northern Pac. Ry. Co. v. Boyd the principle
was established that stockholders may not combine with bondholders in a friendly foreclosure sale
to freeze out general creditors and obtain an interest in the new corporation which is derived in
whole or in part from their interest in the old, free and clear of the claims of its creditors.”); Railroad
Reorganization in the Federal Courts: The Unsecured Creditor, 36 Harv. L. Rev. 1007, 1008 (1923) (“But in
1913 the famous Boyd case decided that if the stockholders derive any advantage from the
reorganization, the unsecured creditors must be given an opportunity to participate on terms at least
as favorable as those offered to the stockholders, or their claims against the property will not be
extinguished by the decree.”).
109 James N. Rosenberg, New Scheme of Reorganization, 17 Colum. L. Rev. 523, 526 (1917) (“This
important case, followed by another decision along the same lines, has subjected reorganizations by
foreclosure sale to serious danger of subsequent destructive attack, and indeed is a very nightmare to
counsel who have to do with modern reorganizations.”); Corporations: Participation of old stockholders in
reorganized corporation after consent decree of foreclosure, 9 Cornell L. Q. 192 (1924) (“The difficulty is that
there is apparently no way by which non-assenting creditors may be compelled to accept a fair and
equitable reorganization scheme.”); contra Fuller, supra note 64, at 383 (“In the words of one writer,
the doctrine of the Boyd case became reasonably domesticated.”).
110 This was not uniformly viewed as a bad thing. Felix Frankfurter, Distribution of Judicial Power
Between United States and State Courts, 13 Cornell L. Q. 499, 526 (1928).
111 Sidney Post Simpson, Fifty Years of American Equity, 50 Harv. L. Rev. 171, 191 (1936).

20

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

And receiverships clearly were not without their faults. The ancillary receivership process was
extremely cumbersome for industrial companies, who, unlike railroads, did not tend to have their
property in contiguous jurisdictions.112 Professional fees remained quite high, especially when
viewed from a modern (chapter 11) perspective.113 In a speech just before the market crash, then
professor William O. Douglas broadly argued that “businesses in receiverships are frequently - far
too frequently- operated at a loss, thus depleting the estate which otherwise would be available to
creditors.”114

Looking back, is it now possible to see that flexibility had a kind of double peak: first in 1908, with
the Court’s blessing of consent receiverships, and then, after two-decade wobble, again with the
enactment of a codified railroad receivership process in 1933 (“section 77”)115 – and the
receiverships of other, non-rail corporations in 1934 (“section 77B”).116

It seemed that Congress had killed the receiverships to save them.117 But the preservation of the
receivership’s flexibility, now in the form of a statutory bankruptcy process, was short-lived. And
none of these initial reforms addressed the complaint – dating back to the early years of the
Twentieth Century – that the receivership process was inherently corrupt.118

Perhaps unsurprisingly, these complaints reached fever-pitch with the Great Depression.119 For
example, New York attorney C.C. Daniels wrote that

112 Friendly, supra note 104, at 46.

113 Stephen J. Lubben, Railroad Receiverships and Modern Bankruptcy Theory, 89 Cornell L. Rev. 1420,
1452 (2004).
114 Professor Douglas’ Address, 3 J. Nat'l Ass'n Ref. Bankr. 48, 49 (1929).
115 Act of March 3, 1933, chap. 204, 47 Stat. 1474 (1933).
116 Act of June 7, 1934, chap. 424, 48 Stat. 211 (1934).
117 STEPHEN J. LUBBEN, THE LAW OF FAILURE 45 (2018). See also Provisions for Non-Assenting Classes of
Creditors in Bankruptcy Reorganizations, 46 Yale L. J. 116 (1936).
118 Supra note 96. As one commentator summarized:

The reorganization of corporations has been the stepping-stone for and graveyard of
professional and judicial reputations and the battleground of conflicting interests and
philosophies for many years. This was due in part to the fact that until 1934 there was no
statute charting the course for the unwary, but use had to be made of the cumbersome
equity or consent receivership. Briefly stated, the objections to that method of
reorganization were to the collusive nature of the proceedings, the cumbersome ancillary
receiverships, the necessity for sale at an upset price because non-depositors could not be
bound, the failure by some courts to exercise adequate control over the plan causing the
Supreme Court to cast doubt on the validity of these proceedings, and the reputedly large
fees for which courts were criticized, in many instances unjustly because the parties and their
representatives would for tactical reasons present a solid front before the Court without
objection.

Benjamin Wham, Chapter X, Corporate Reorganizations Chapter X of the Bankruptcy Act, 1939 Sec. Comm.
L. 12 (1939).
119 The SEC’s multi-volume report on the receivership process, largely overseen by William O.
Douglas, was the most prominent example of this literature.

21

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

The “receivership racket” has taken so much from the stockholders of corporations that the
“graft” of the lower courts looks like “chicken feed” by comparison.

Receivership allowances, attorneys', auditors' and accountants' fees aggregate huge sums-to
say nothing of the sale of assets under conditions that “foreordain” both the purchaser and
the price.120

This was the atmosphere as corporate reorganization law took a sharp move away from its flexible
early days, and toward a fairer approach, that was less beholden to insiders.121

2. The New Deal and the Move Toward Fairness

Section 77, a product of the late Hoover administration, and section 77B, the general corporate
reorganization provision that built off of the railroad-specific section 77, were never warmly
embraced by the New Dealers.122 And thus both were revised again before the decade was out. The
broad theme of both revisions was to move away from loose, business friendly rules toward a more
formal, less discretionary approach, overseen in each case by independent experts.

a. Railroad Reorganizations – the 1935 Revamp of Section 77 and Chapter XV

Section 77 was the first reorganization provision to be revised in the New Deal. While in its original
1933 form it was something of a codified railroad receivership, Congress revamped the process in
1935 to provide for a greater role for the ICC. Moving along the lines that Samuel Untermyer had
proposed a couple of decades before, Congress transformed section 77 into a special reorganization
proceeding for a regulated industry.123

120 C. C. Daniels, Receivership Racketeering of Corporation Assets, 3 Corp. Prac. Rev. 9 (1931).
121 See Ferdinand Fairfax Stone, The Case of the Ladies' Handbags: A Study in Receivership Procedure, 24 Va.
L. Rev. 831, 835 (1938) (“Valeria Coriell, claiming that she had no adequate recovery at law, then
sued on this note for the appointment of a receiver with the usual allegation of multiplicity of suits
and dissipation of assets. It is not pretended that she was more than a convenient non-resident
‘dummy,’ who lent name and diverse citizenship to a suit planned and negotiated by the bank
creditors and the debtor himself.”).
122 See Roger S. Foster, Conflicting Ideals for Reorganization, 44 Yale L. J. 923, 924 (1935) (“It is not
altogether clear how sweeping has been the reformer's victory in the recent changes in
reorganization practice.”).
123 Other railroad restructuring provisions, often neglected by modern commentators, were also
available in this era:

In 1939 Congress added Chapter XV, a temporary measure for Railroad Adjustments to
supplement §77, and provide a simpler and less drastic means of adjusting the temporary
financial difficulties of railroads which were not necessarily insolvent. By its own terms the
period within which a petition might be filed under Chapter XV expired July 31, 1940. But a
slightly revised Chapter XV was passed in 1942 with, however, a terminating date of Nov. 1.
1945 for the filing of a petition. And in 1948 Congress put railroad adjustments on a more
permanent basis by adding §20b to the Interstate Commerce Act.

22

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

In many respects, the quick move to alter section 77 was not unexpected, inasmuch as the “original
Section 77 was drafted and rushed through Congress in the closing days of the Hoover
administration.”124 But by the time the revision was complete, there was such a change in tone –
represented by a strong shift from emergency measures to substantial reform – that the law was
almost entirely altered.125

In its original form, section 77 innovated the notion of the “debtor in possession,” central to today’s
chapter 11.126 The goal was to replace the duplicative receivership process of appointing multiple
receivers – often one insider, plus one “independent” party to satisfy receivership tradition – and
move straight to the plan negotiation. In the context of the early 1930s, it was easy to imagine that
the railroad might have failed without any culpability on the part of management, and thus the need
to replace them with an outsider seemed less urgent.127

The court obtained jurisdiction over the entire railroad, eliminating the need for ancillary
receiverships.128 The debtor proposed a plan and presented it at a hearing before the ICC.129 If
approved by two-thirds of creditors and the ICC, and confirmed by the court, the plan would
become binding on all.130 Nascent cram-down provisions allowed for the imposition of plans on
holdout groups.131

After revision in 1935, the debtor-in-possession was gone, and trustees were required in all cases.132
The ICC obtained strong powers over the composition of committees, and the right to veto any
plan before it went to the court or creditors for consideration. In true New Deal style, the problem
of railroad in financial distress was handed over to the technocrats, and thus became a question of
administrative law.133

James William Moore, Reorganizations under Chapter X, 35 J. Nat'l Ass'n Ref. Bankr. 105, 106 (1961).
124 Charles S. Rhyne, Work of the Interstate Commerce Commission in Railroad Reorganization Proceedings under
Section 77 of the Bankruptcy Act, 5 Geo. Wash. L. Rev. 749, 751 (1937).
125 Id. at 752.
126 47 Stat. 1474 (1933), at §77c.
127 See Fuller, supra note 64, at 385.
128 §77a.
129 §77c(9).
130 §77e, g, h. Interestingly, the court classified creditors. §77c(5). Contra 11 U.S.C. § 1122 (modern
chapter 11, where the plan proponent, often the debtor, classifies claims).
131 §77e.
132 49 Stat. 911 (1935), at §77c.
133 See generally Leslie Craven & Warner Fuller, The 1935 Amendments of the Railroad Bankruptcy Law, 49
Harv. L. Rev. 1254 (1936).

23

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

The court’s continued involvement in the process was somewhat awkward, to say the least.134 But
the general trend was clear, flexibility had been supplanted by an orderly, fair process, in which all
stakeholders would have a chance to participate.135

b. Section 77B and the Chandler Act

Then came the Chandler Act in 1938, which repealed section 77B in its entirety, and replaced it with
chapter X.136 The changes here were dramatic.137

For the New Dealers, section 77B was too much like what had come before. As E. Merrick Dodd
Jr. explained:

Section 77B is… a series of ad hoc concessions to the views of the different groups than a
carefully worked out compromise between them. To the reorganizers it gives the main
reforms for which they have asked, coercive power over minorities and abolition of the sale
and of the necessity for ancillary receiverships. These gifts are, indeed, coupled with
concessions to the individual creditor or investor which reorganizers are likely to regard as
undesirable obstacles to their own control and inconvenient clogs to the smooth and speedy
working of the reorganization machinery; but the amendment, taken as a whole, seems more
nearly to embody the views of reorganizers than those of any other group.138

Like its track-bound predecessor, section 77B promoted the use of a “debtor in possession” model
of reorganization, obviating the need to find a trustee or receiver who was both “pure” and able to
ably run the distressed business. Section 77B also contained provision for what we would today call
a prepackaged reorganization plan: “the plan may be accepted not only before the hearing as to its
fairness, but even before the institution of proceedings under Section 77B.”139 Committees were
regulated, but still played a strong role in these proceedings.140

134 See In Re New York, New Haven, and Hartford Railroad Co., 16 F. Supp. 504, 507 (D. Conn.
1936).
135 The Passing of the Consent Receivership, 31 Va. L. Rev. 184, 185 (1944) (“Today not only does a
standard of the ‘fair and equitable’ in reorganization remain unaltered, but it is put into effect in the
course of the reorganization proceeding itself, where every interest has a chance to be heard; and by
the like token, a plan which is confirmed binds everybody.”).
136 Chapter X, 52 Stat. 883-905.
137 As one commentator lamented, “[i]t must be conceded that 77B was not given a fair trial.”
Benjamin Wham, Chapter X, Corporate Reorganizations Chapter X of the Bankruptcy Act, 1939 ABA Sec.
Comm. L. 12, 13 (1939).
138 E. Merrick Jr. Dodd, Reorganization Through Bankruptcy: A Remedy for What?, 48 Harv. L. Rev. 1100,
1135 (1935).
139 Joseph L. Weiner, Corporate Reorganization: Section 77B of the Bankruptcy Act, 34 Colum. L. Rev. 1173,
1184 (1934). The author notes that the provision was based on the National Radiator case, where a
form of “prepack” was attempted in a receivership, only to be quashed by the Supreme Court (after
the enactment of section 77B), which “used rather unflattering language concerning the plan and its
protagonists.” Id. at 1184-85.
140 Id. at 1185, 1188-89. Some sources indicate that the SEC’s power over certificates of deposit
under the ’33 Act provided an even greater source of committee regulation. Carl B. Spaeth & J.
Frank Friedberg, Early Developments under Section 77B, 30 Ill. L. Rev. 137, 146-47 (1935)

24

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

Not only could section 77B plans bind dissenting minorities within a class, but the section also
included full-throated cramdown provisions that could bind dissenting classes, provided that secured
creditors were provided with “adequate protection.”141 Under section 77B(f), the court was directed
to confirm the plan if satisfied, that “it is fair and equitable and does not discriminate unfairly in
favor of any class of creditors or stockholders, and is feasible. .. .”

But the Securities Exchange Act of 1934 directed the Securities and Exchange Commission to
conduct a study of corporate reorganizations and to report thereon to Congress.142 This began a
multi-year process that leading to the ultimate repeal of section 77B and its replacement with chapter
X under the Chandler Act.143

Section 77B’s flexibility was central to is ultimate downfall. Indeed, the debtor-in-possession and
prepack provisions provided the basis for an argument that the insiders were still in charge of
restructuring under section 77B.144 And thus the SEC produced a report that tarred the section with
a parade of horror stories from the “old days” of the receiverships.145

In the final installment of the report, issued shortly after the Chandler Act had repealed section 77B,
the Commission fired one more broadside at the old section:

Under Section 77B, the management usually remained dominant in the situation during and
after reorganization, as was the case in equity reorganizations. It was not held to an account
for its stewardship. At the most, its personnel and activities met only casual scrutiny. Good,
bad, or in- different management continued in the saddle….And it is equally beyond
question that the 77B method often promoted and induced superficial reorganizations which
left the corporate body with uncured dangerous diseases…. So long as the management is in
uncontrovertible control, it is futile to expect that a genuine accounting for its past activities
can be had, or that its record can be thoroughly analyzed and appraised.

141 Reorganization under Section 77B of the Bankruptcy Act--1934-1936, 49 Harv. L. Rev. 1111, 1185-88
(1936). The Murel Holding Corp. case, which developed the concept of “indubitable equivalence,”
found in today’s Bankruptcy Code, is discussed in the foregoing pages, mostly as a leading case
rejecting cramdown of a secured class.
142 Act of June 6, 1934, ch. 404, §211. The story behind the report is told in John W. Hopkirk,
William O. Douglas--His Work in Policing Bankruptcy Proceedings, 18 Vand. L. Rev. 663, 666-76 (1965).
143 An initial revision of section 77B was drafted by the newly formed National Bankruptcy
Conference. When the SEC’s report came along, the NBC draft was revised to reflect most of the
SEC’s proposed changes. John Gerdes, Corporate Reorganizations: Changes Effected by Chapter X of the
Bankruptcy Act, 52 Harv. L. Rev. 1, 2 (1938).
144 Wham, supra note 137, at 13.
145 E. Merrick Dodd Jr., The Securities and Exchange Commission's Reform Program for Bankruptcy
Reorganizations, 38 Colum. L. Rev. 223, 225 (1938) (“Both Part I and Part II of the [SEC] report are
essentially briefs – fair-minded and well documented briefs to be sure – in support of the
Commission's recommendations for reform.”). Contra Robert T. Swaine, Democratization of Corporate
Reorganizations, 38 Colum. L. Rev. 256, 258 (1938) (“It is unfortunate… that the SEC Reports lack
the objectivity which was to be expected in the light of the scholarly qualities of those primarily
responsible for their preparation.”).

25

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

It is absurd to suppose, if the debtor or one of its officers is made the appointee of
the court to do these things, that they will be well and thoroughly done…
The important function of formulation and negotiation of a plan of reorganization
was left to the inside few under the system embodied in Section 77B…
This serious deficiency under Section 77B has been corrected in Chapter X of the
Chandler Act…146

The first step of the new regime was to completely remove management from control of the
debtor.147 Gone was the debtor-in-possession model, and an independent trustee would now be
appointed in every large reorganization case.148 The trustee was given “most of the power and
control formerly exercised both within and without the proceedings by the debtor, its underwriters,
and its largest creditors, in the hope of causing a larger part of the fruits of reorganization to accrue
to the benefit of investors.”149

Buttressing the trustee’s new role, and an enhanced role for the judge, was an express role for the
SEC. That is, the agency played a key role in drafting and promoting a new corporate bankruptcy
law that placed itself at the center of American corporate restructuring.150 In particular, the
Commission was required to opine on the reorganization plan in large cases, and permitted to do so
in smaller cases.151 It is interesting to note that the SEC’s role was advisory, while the ICC’s role in
post-amendment section 77 cases was more that of a gatekeeper.152

146 8 SECURITIES AND EXCHANGE COMMISSION, STUDY AND INVESTIGATION OF THE WORK,
ACTIVITIES, PERSONNEL AND FUNCTIONS OF PROTECTIVE AND REORGANIZATION COMMITTEES
108-111 (1940).
147 Gerdes, supra note 143, at 10.
148 Chapter X §§156, 158. Subsection (4) of § 158 declared that a person was not disinterested if, for
any reason, it appears they had an interest materially adverse to any creditors or stockholders.
Debtors were allowed to remain in possession in cases with less than $250,000 in debt.
149 Gerdes, supra note 143, at 12.
150 Alfred B. Teton, Reorganization Revised, 48 Yale L. J. 573, 583 (1939). See also Jonathan C. Lipson,
The Shadow Bankruptcy System, 89 B.U. L. Rev. 1609, 1683 (2009) (“Douglas had a uniquely broad
understanding of how reorganizations fit into the larger financial system of his time. It is thus not
surprising that he believed the SEC should be the administrator of choice for bankruptcy
reorganization, and that disclosure rules should mimic those of the federal securities laws.”).
151 Chapter X §172.
152 But under section 173 of Chapter X, the Court could not proceed to confirm a plan until the SEC
had either reported or indicated that it did not intend to report, thus giving the SEC a strong say on
the pace of the case.

26

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

Nevertheless, it was clear that the SEC had been given a key role in the process.153 In essence,
insiders were replaced with three experts: the judge, the trustee, and the Securities and Exchange
Commission.154 In chapter X,

the debtor plays a minor role, creditors and stockholders are furnished ample information
and are given many safeguards, and all major steps in the reorganization are subject to
supervision and decisions are to be made by the [district] judge, and not by the [bankruptcy
court]. Why the elaborate safeguards?

Largely because it was felt that these were needed to cure the deficiencies of the equity
receivership.155

Of course, founding a reorganization provision solely on avoiding the sins of the past was probably
never the recipe for a lasting process.

At the same time, Congress enacted chapter XI, which was aimed at smaller companies.156 Under
this chapter, the debtor had control over both its own bankruptcy estate and the plan process. 157 In
theory secured creditors and shareholders could not have their rights altered by the plan, but they
could consent to a modification of their treatment. From 1952 onward, a chapter XI plan was also
not subject to the requirement that it be “fair and equitable,” a term the Supreme Court had
interpreted to encompass the “absolute priority rule” from liquidations.158

In Los Angeles Lumber, Justice Douglas had written that the “fair and equitable,”

153 Jerome Frank, Epithetical Jurisprudence and the Work of the Securities and Exchange Commission in the
Administration of Chapter X of the Bankruptcy Act, 18 N.Y.U. L. Q. Rev. 317, 322-23, 334 (1941) (“We
think we can say that the injection of the Securities and Exchange Commission into the
reorganization cases has not substantially delayed the consummation of these proceedings; that in
some cases it has demonstrably accelerated it; that in others any delay has been insignificant in
amount compared to the benefits derived from the Commission's participation; and that there is
generally no feeling on the part of the Bar that the Commission's participation has unnecessarily
protracted reorganizations.”) See also David A. Skeel, Jr., An Evolutionary Theory of Corporate Law and
Corporate Bankruptcy, 51 Vand. L. Rev. 1325, 1371 (1998).
154 Eugene V. Rostow & Lloyd N. Cutler, Competing Systems of Corporate Reorganization: Chapters X and
XI of the Bankruptcy Act, 48 Yale L. J. 1334 (1939).
155 James William Moore, Reorganizations under Chapter X, 35 J. Nat'l Ass'n Ref. Bankr. 105, 108
(1961).
156 Chapter XI was modeled after the common-law composition of creditors. It was sponsored by
the National Association of Credit Men and other groups of creditors' representatives who had
experience in representing trade creditors in small and medium sized commercial failures. Hearings
on H.R. 6439 before the House Committee on the Judiciary (reintroduced as H.R. 8046 and enacted
in 1938), 75th Cong., 1st Sess. 31, 35 (1938).
157 Peter van Zandt Cobb, Initial Financing Restrictions in Chapter XI Bankruptcy Proceedings, 78 Colum. L.
Rev. 1683 (1978).
158 Allocation of Corporate Reorganizations Between Chapters X and XI of the Bankruptcy Act, 69 HARV. L.
REV. 352 (1955).

27

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

phrase became a term of art used to indicate that a plan of reorganization fulfilled the
necessary standards of fairness. Thus throughout the cases in this earlier chapter of
reorganization law, we find the words ‘equitable and fair’, ‘fair and equitable’, fairly and
equitably treated', ‘adequate and equitable’, ‘just, ‘fair, and equitable’ and like phrases used to
include the ‘fixed principle’ of the Boyd case, its antecedents and its successors. Hence we
conclude, as have other courts, that that doctrine is firmly imbedded in s 77B.159

Suggesting that “fair and equitable” had acquired “term of art” status in the railroad receivership
community probably exaggerated things more than a bit.160 Nonetheless, Los Angeles Lumber
indicated that the Supreme Court agreed with the SEC’s inclination to read the term “fair and
equitable” to include something like the absolute priority concept.161 In emphasizing the “fixed
principles” of thing, the Court underlined the degree to which fairness came from strict application
of the “rules.”

But under chapter XI, shareholders could retain stakes in bankrupt companies under chapter XI,
even when creditors were not paid in full.

While “although it seems clear that the simplified procedures of Chapter XI were designed for small,
privately owned debtors,” the chapter was used by many public companies that managed to
shoehorn themselves in.162 Eventually this convoluted system of three business reorganization
provisions (one for railroads and two for other corporations), operating in conjunction with the
traditional liquidation bankruptcy provisions, would need to be rehabilitated.163 And with the
enactment of the 1978 Bankruptcy Code, it was.

But for about forty years, fairness triumphed over the extreme flexibility of the receivership era.
That the fairness era lasted as long as it did was undoubtedly largely due to the healthy state of the
American economy in the decades immediately after the Second World War.164 In a less vibrant
economy, the need for a workable corporate insolvency system would have been more apparent,
much sooner.

159 Case v. Los Angeles Lumber Products Co., 308 U.S. 106, 118-19, (1939) (footnotes omitted).
160 In the words of Jack Ayer: “Strictly speaking, this is poppycock, and Justice Douglas knew it.”
John D. Ayer, Rethinking Absolute Priority After Ahlers, 87 MICH. L. REV. 963, 975 (1989); see also De
Forest Billyou, "New Directions'" A Further Comment, 67 HARV. L. REV. 1379, 1380-81 (1954).
161 See Eugene V. Rostow & Lloyd N. Cutler, Competing Systems of Corporate Reorganization: Chapters X
and Xi of the Bankruptcy Act, 48 YALE L.J. 1334, 1346 n.55 (1939) (“The S. E. C. is committed to a
“ strict priority” view of reorganization draftsmanship.”). As noted, the SEC apparently did not
always hold that view. See supra note 107.
162 Discretion Properly Exercised in Relying on Business Prospects to Allow Chapter XI Arrangement of Large
Public Corporate Debtor, 64 COLUM. L. REV. 155, 157 (1964). See also Melvin Robert Katskee, The
Calculus of Corporate Reorganization Chapter X v. XI and the Role of the SEC Assessed, 45 Am. Bankr. L.J.
171 (1971).
163 Cf. In re Herold Radio & Elecs. Corp., 191 F. Supp. 780, 786-87 (S.D.N.Y. 1961).
164 See ROBERT SKIDELSY, MONEY AND GOVERNMENT: THE PAST AND FUTURE OF ECONOMICS
154-62 (2018) (discussing the post-war to 1970 boom in developed economies).

28

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

3. 1978 and the Return of Flexibility

Although chapter X was largely considered to have died of its own complexity, with chapter XI used
whenever possible, it is remarkable how many leading commentators continued to praise the basic
concept of chapter X even as an effort to reform the Bankruptcy Act began to take shape.165 In the
early Sixties, James William Moore remarked that chapter X, while not perfect, was still much better
than the old equity receivership system.166 And Benjamin Weintraub and Harris Levin thought that
the revision of the Bankruptcy Rules in the early 1970s had taken care of most of the problems.167
That the Rules constituted almost a complete rewriting of chapter X might give us some pause
about the true state of chapter X.168

And there were other hints that all was not quite right. A 1961 speech by the SEC’s Chicago
restructuring chief defended chapter X by reference to the recently completed reorganization of
Inland Gas Corporation, which took more than 30 years.169 In the same remarks, he also lamented that
“creditors and stockholders who have large sums of money at stake display almost complete lack of
interest in the reorganization proceedings,”170 and implored the attorneys in the audience to become
“reorganization minded.171

In 1972, two leading restructuring attorneys, while generally sympathetic to chapter X, conceded that

Most complaints about corporate reorganization center around time and money. It takes too
long and it costs too much.

165 As explained by one attorney,

I think that the predilection for Chapter XI is based upon the experience of the creditor
community which has come to the recognition that Chapter X is cumbersome, bureaucratic,
time consuming and expensive. On the other hand, creditors recognize that Chapter XI
affords a quicker, more intelligent and less expensive way to solve an economic problem.

Peter F. Coogan, George W. Bermant, & Herman L. Glatt, Panel Discussion: The Problems of the Sinking
Ship, 31 Bus. Law. 1371, 1378 (1976).
166 James William Moore, Reorganizations under Chapter X, 35 J. Nat'l Ass'n Ref. Bankr. 105, 112
(1961).
167 Benjamin Weintraub & Harris Levin, Chapter VII (Reorganizations) as Proposed by the Bankruptcy
Commission: The Widening Gap between Theory and Reality, 47 Am. Bankr. L.J. 323, 323-24 (1973). 28
U.S.C. § 2075 (1964) (since revised) provided that the "Supreme Court shall have the power to
prescribe by general rules, the forms of process, writs, pleadings, and motions, and the practice and
procedure under the Bankruptcy Act ...provided the rules do not abridge, enlarge, or modify any
substantive right.... All laws in conflict with such rules shall be of no further force or effect after
such rules have taken effect."
168 William H. Lake, The Chapter X Bankruptcy Rules: Procedural Reform for the Reorganization of a
Corporation, 51 L.A. B.J. 493 (1976) (“The Act is largely replaced by the Rules since many of the
provisions of Chapter X are procedural in nature.”).
169 J. Kirk Windle, Obstacles to Successful Reorganization, 36 J. Nat'l Ass'n Ref. Bankr. 12, 12-13 (1962).
170 Id. at 17.
171 Id.

29

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

It is true that the elapsed time between the filing of the petition and the closing of the case is
measured in years rather than months. This results from three basic causes. First, the
Chapter is structured with many safeguards designed to protect the public, the investors and
the creditors. The court, the stockholders, and the creditors must be informed before they
can act or vote intelligently. They are informed by the Section 167 Report which is
disseminated only after the most careful investigation by the trustee, aided by the Securities
and Exchange Commission. This takes time. The plan takes time to prepare. Creditors must
be classified, and hearings on this facet alone may require many months. Valuation is,
perhaps, the court's most critical function, and this valuation is time-consuming. After all,
the debtor may have taken several years or even several decades to arrive at the trouble it is
in. It can hardly be expected that the accumulated problems resulting from years of inept
management or misfortune can be quickly solved. The second reason for delay is that many
complex and conflicting rights are involved. A not untypical case may involve priorities as
between tax liens, consensual liens, mechanic's and materialmen's liens, overlapping security
interests with consequent marshalling problems, outstanding debentures which are sub-
ordinated to one class of creditors and not to another, and problems of equitable
subordination. This tangled skein requires time to unravel. Third, plan acceptance is based
on plan approval by a two-thirds majority in amount of the creditors in each affected class,
and there may be many such classes. The hard bargaining between the various classes and
the trustee which necessarily goes into the formulation of an acceptable plan makes delay
inevitable. But no one suggests that the democratic process should be abandoned and
"cram-down" provisions substituted.172

By the end of the decade, a return to cramdown was indeed deemed the apt solution.173

As early as 1940, Florence De Haas Dembitz, then an attorney with the Reconstruction Finance
Corporation’s railroad division (and who had previously practiced before the ICC), noted that
railroad reorganizations under section 77 were painfully slow, a result she traced to both an
overworked ICC staff and a process that was overly focused on litigation, in place of negotiation.174
In a similar vein, in 1943 Robert Swaine complained that section 77 turned business problems into
bureaucratic tasks and formal litigation, and consequently delayed resolution of financial distress.175
Somewhat later, Edwin S. Sunderland echoed these complaints, placing most of the blame on the
ICC and its laborious procedures.176 By the time the Penn Central sank into a section 77 proceeding
in 1970, it was well-recognized that section 77 was not really a workable solution for failure outside
the context of the Great Depression.177

172 William J. Rochelle Jr. & Jack H. Balzersen, Recommendations for Amendments to Chapter X, 46 Am.
Bankr. L.J. 93, 94-95 (1972).
173 11 U.S.C. § 1129(b).
174 See generally Florence De Haas Dembitz, Progress and Delay in Railroad Reorganizations Since 1933, 7
Law & Contemp. Probs. 393 (1940).
175 Robert T. Swaine, A Decade of Railroad Reorganization under Section 77 of the Federal Bankruptcy Act, 56
Harv. L. Rev. 1037, 1056-58 (1943). See Joseph C. Simpson, Comments on the Railroad Reorganization
Provisions of the Bankruptcy Act of 1973, 30 Bus. Law. 1207, 1216 (1975).
176 Edwin S. S. Sunderland, Suggestions for Improvement in Section 77 of the Bankruptcy Act, 14 Bus. Law.
487, 495, 498-99 (1959).
177 Steven S. Elbaum, Division of Jurisdiction between Section 77 Reorganization Courts, 39 Brook. L. Rev.
839, 857 (1973).

30

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

As summarized by one commentator:

section 77 is inadequate to deal with the present situation. It neither provides the tools nor
creates the circumstances necessary for the successful reorganization of railroads under
today's conditions. This is not to criticize those who drafted section 77 and the 1935
amendments… However, as things stand today section 77 is too limited in its scope, too
formal in its approach, and too circumscribed in its procedures to permit the formulation of
a sound plan of reorganization under contemporary circumstances.178

Indeed, ultimately Congress adopted a special “one off” bankruptcy procedure for the Northeastern
railroads.179 In doing so, the legislators at least implicitly indicated their agreement with the critics.180

In a similar vein, the 1973 Commission on Bankruptcy Laws of the United States argued that “the
defects in section 77 stem from divided responsibility and an elaborate procedure which assumes
that the time available in which to effect a cure is infinite.”181 But the proposed solution was to
make section 77 more like chapter X, with the ICC supporting the court, instead of operating in
parallel with it.182

On the general business reorganization side, the Commission proposed a new reorganization
chapter (chapter VII) in which the “flexibility of present Chapter XI is retained to the extent
compatible with the interests of creditors, but the protective features of present Chapter X are
generally made applicable, with the exception of the ‘absolute priority rule,’ which is substantially
modified.”183 This never enacted chapter would have also retained many features of the Chandler
Act as well: including a presumption of trustees in larger cases, and government oversight in cases
involving public securities (albeit by a new bankruptcy administrator, instead of the SEC).

Even the need for this seemingly modest set of reforms was questioned. Two leading practitioners
argued that

178 Richard J. Barber, Railroad Reorganization, Section 77, and the Need for Legislative Reform, 21 UCLA L.
Rev. 553, 554 (1973).
179 In re Penn Cent. Transp. Co., 384 F. Supp. 895, 902-904 (Reg'l Rail Reorg. Ct. 1974) (“While the
Act is titled a reorganization statute, its drafters acknowledged that the northeastern railroad
problem cannot be solved simply by resort to the traditional procedures available under § 77 of the
Bankruptcy Act and the Interstate Commerce Act.”). See Stephen J. Lubben, PROMESA and the
Bankruptcy Clause: A Reminder About Uniformity, 12 Brook. J. Corp. Fin. & Com. L. 53, 57 (2017).
180 See Oscar Couwenberg & Stephen J. Lubben, Not A Bank, Not A SIFI; Still Too Big to Fail, 35
Emory Bankr. Dev. J. 53, 79 (2019). One critic argued that section 77 was no longer fit for modern
railroad problems, and suggested that “the whole question of railroad reorganization be separated
from the consideration of reform of the Bankruptcy Act and spotlighted as a transportation problem
that calls for immediate congressional examination aimed at producing specifically tailored
legislation,” as Congress ultimately did. Barber, supra note 178, at 554 (1973).
181 1 REPORT OF COMMISSION ON BANKRUPTCY LAWS OF UNITED STATES 29 (1973).
182 Id. at 30.
183 Id. at 237.

31

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

Amendments beneficial to Chapters X and XI can be effected within the confines of those
chapters without the necessity of destroying a thirty-five year old system which has
responded well to the needs of the parties whose interests are at stake. Indeed, the present
problems are not such as require total restructuring.184

In short, as late as 1973, outside the specific issue of railroad insolvency, there was no clear
consensus that business bankruptcy was in need of reform. Indeed, the so-called “Judge’s bill,” a
proposed revision to the Commission’s bankruptcy reform bill, expressly retained chapters X and
XI.185

But the American economy looked increasingly wobbly in the mid 1970s, and the Bankruptcy Act
was tested and found wanting. As summarized by Professor Minsky:

Not only was income declining rapidly and the unemployment rate exploding, but virtually
each day saw another bank, financial organization, municipality, business corporation, or
country admit to financial difficulties. For example, in October 1974 the multi-billion-dollar
Franklin National Bank of New York failed (at the time it was the largest American bank
ever to fail), and in early 1975 the billion-dollar Security National Bank of New York was
merged to prevent over failure. During 1974-75 more banks failed, and more assets were
affected than in any period since World War II. Moreover, the Real Estate Invest Trust
(REIT) industry, with some $20 billion in assets, experienced a severe run that led to many
bankruptcies and work-outs…

In addition, 1975 was marked by New York City’s financial crisis, the failure of W.T. Grant
and Company, the need for Consolidated Edison to sell assets to New York state to meet
payments commitments and the walking bankruptcy of Pan Am.186

And perhaps as a result, between the failure of both the Commission and Judge’s bills, and the
enactment of the 1978 Bankruptcy Code, there developed a consensus that the two general
reorganization chapters187 should be combined into a single chapter.188 The primary argument
seemed to be that creditors and debtors would benefit from being able to “mix and match” aspects
of both chapters X and XI: for example, allowing the debtor to stay in possession, while also
imposing the absolute priority rule.189

From these relatively tenuous beginnings began the process which returned corporate bankruptcy,
and corporate reorganization in particular, to a state of flexibility. The 1978 Bankruptcy Code not

184 Weintraub & Levin, supra note 167, at 323.

185 J. Ronald Trost & Lawrence P. King, Congress and Bankruptcy Reform Circa 1977, 33 Bus. Law. 489,
493 (1978). The alternate bill was proposed by the National Conference of Bankruptcy Judges.
186 HYMAN P. MINSKY, STABILIZING AN UNSTABLE ECONOMY 15 (1986) (2008 McGraw-Hill
edition). The W.T. Grant bankruptcy was the biggest to that point, save for Penn Central’s. Pan
Am would file an actual bankruptcy in the 1980s, after the enactment of the new Bankruptcy Code.
187 Three if you counted the rarely used Chapter XII. Michelle M. Harner, Rethinking Preemption and
Constitutional Parameters in Bankruptcy, 59 Wm. & Mary L. Rev. 147, 162 (2017).
188 Indeed, the National Conference of Bankruptcy Judges and the National Bankruptcy Conference
identified this as one of a handful of points of agreement. Trost & King, supra note 185, at 494.
189 Id. at 529-30.

32

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

only consolidated reorganization chapters, but importantly removed the requirement of a trustee in
certain classes of cases, namely those involving large or widely held debtors.190 That is, the old
section 77B concept of the debtor in possession – which had been kept alive in chapter XI – was
now back in full.

The SEC was taken out of the center of reorganization and, perhaps most importantly, its role was
not taken over by any other expert body.191 Rather, the New Deal faith in administrative expertise
seemingly died, at least with regard to bankruptcy, with the 1978 Code.192

In a nutshell,

A general and basic concept of the new chapter 11 is the recognition that the parties
involved should be able to negotiate a plan even to the point that those holding senior
interests allow junior interests to realize some distribution and, if such a plan is acceptable
based on informed consent, the court should not be hamstrung by an inflexible standard in
determining whether the plan should be confirmed.193

Not all were in favor of the change,194 but the door to a more flexible approach to business
bankruptcy was open once again.

4. Modern Business Bankruptcy: Too Much Flex?

In the forty years since the enactment of the current Code, chapter 11 has moved from a debtor-
dominated system,195 to one dominated by senior lenders,196 to eventually settle, most recently, on a
system where key parties, both debtors and creditors, frequently adopt a deal well before initiating
the bankruptcy process through a “restructuring support agreement.”197 In doing so, reorganizations
are now structured with but a slight essence of the Bankruptcy Code, and the framework it sets

190 For an overview, see J. Ronald Trost, Business Reorganizations under Chapter 11 of the New Bankruptcy
Code, 34 Bus. Law. 1309 (1979).
191 Sarah Paterson, Market Organisations and Institutions in America and England: Valuation in Corporate
Bankruptcy, 93 Chi.-Kent L. Rev. 801, 815 (2018).
192 See John Wm. Butler, Jr., Chris L. Dickerson, & Stephen S. Neuman, Preserving State Corporate
Governance Law in Chapter 11: Maximizing Value Through Traditional Fiduciaries, 18 Am. Bankr. Inst. L.
Rev. 337, 340-42 (2010); see also Kelli A. Alces, Enforcing Corporate Fiduciary Duties in Bankruptcy, 56 U.
Kan. L. Rev. 83, 84-85 (2007).
193 Lawrence P. King, Chapter 11 of the 1978 Bankruptcy Code, 53 Am. Bankr. L.J. 107, 108 (1979).
194 Arthur L. Moller, Chapter 11 of the 1978 Bankruptcy Code or Whatever Happened to Good Old Chapter
XI, 11 St. Mary's L.J. 437, 438 (1979) (“One of the most drastic, and probably the least successful,
provisions of the new Bankruptcy Code is the consolidation of Chapters VIII, X, XI, and XII of the
Bankruptcy Act into a single chapter, chapter 11 of the Code.”).
195 Michelle M. Harner, The Search for an Unbiased Fiduciary in Corporate Reorganizations, 86 Notre Dame
L. Rev. 469, 485 (2011); see also Lawrence Ponoroff, Bankruptcy Preferences: Recalcitrant Passengers Aboard
the Flight from Creditor Equality, 90 Am. Bankr. L.J. 329, 331-32 (2016).
196 David A. Skeel, Jr., Creditors' Ball: The “New” New Corporate Governance in Chapter 11, 152 U. Pa. L.
Rev. 917, 931-33 (2003).
197 See generally Douglas G. Baird, Bankruptcy's Quiet Revolution, 91 Am. Bankr. L.J. 593, 593 (2017).

33

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

forth.198 But there are signs that this new, ultra-flexible approach – where any deal agreed to by large
majorities of creditors seems likely to be approved – may have gone too far.199

After an initial decade marked by strong debtor control, combined with seemingly endless
extensions of the debtor’s exclusive right to file a plan, senior creditors eventually learned how to
play the chapter 11 game too.200 Using the strong powers given to secured creditors under the Code,
combined with the ability to force asset sales under section 363 in place of chapter 7 liquidations in
situations where reorganizations were making little progress, lenders increasingly compelled asset
sales before plan formation.201 By the end of the 1990s, such 363 sales were routine, especially in
mid-cap cases.202

But powerful though secured creditors are – with control over cash, and special rights under the
Code203 – the Bankruptcy Code, even in its modern form, balances power in ways that it makes it
hard to act alone.204 As a result, in recent years it has become common for chapter 11 cases to
coalesce around a restructuring support agreement, or RSA.205

In the prototypical cases, the RSA will be negotiated at first by the debtor and one or more funds
that hold a sizable portion of the outstanding debt. Often the secured senior lenders will be largely
or entirely unharmed by the proposed reorganization, and thus the action happens in the
negotiations between the next tier of debtholders and the debtor's management. Once a deal is
reached between the initial creditor group and the debtor, the deal is frequently opened up to other
investors – or at least, other institutional investors.

Thus, when the chapter 11 case actually commences, the plan outlined in the RSA will often have
tremendous levels of support, far beyond those required by the Code. The real question, however,
is how much of this support comes from creditors who perceive a lack of real options. That is, the
deal reflected in the RSA might not be all the creditor is entitled to, but taking the deal still might be

198 See David A. Skeel, Jr. & George Triantis, Bankruptcy's Uneasy Shift to A Contract Paradigm, 166 U.
Pa. L. Rev. 1777, 1809 (2018).
199 Jonathan C. Lipson, The Secret Life of Priority: Corporate Reorganization After Jevic, 93 Wash. L. Rev.
631, 639 (2018).
200 See generally Kenneth M. Ayotte and Edward R. Morrison, Creditor Control and Conflict in Chapter 11,
1 J Legal Analysis 511 (2009).
201 Melissa B. Jacoby & Edward J. Janger, Ice Cube Bonds: Allocating the Price of Process in Chapter 11
Bankruptcy, 123 Yale L.J. 862, 877-78 (2014).
202 For an example which the author was involved in, see Motion for Order [A] [i] Approving Auction
Procedures with Respect to Proposed Sale of Substantially All Assets of Debtors' Business Units, [ii] Scheduling
Hearing on Approval of Sale, [iii] Approving Form and Manner of Notice of Sale, [iv] Approving Break-up Fee
and [B] [i] Approving Sale of Substantially All Assets of Debtors Business Units Free and Clear of All Liens,
Claims, Interests, and Encumbrances and [ii] Authorizing Assumption and Assignment of Certain Executory
Contracts and Unexpired Leases, and [C] Granting Related Relief, In re Brazos Sportswear, Inc., 99-142
(PJW) (Bankr. D. Del.) (docket no. 264).
203 Including the right to receive various fees, the right to adequate protection, and the right to credit
bid. 11 U.S.C. §§ 362(d)(1), 363(k), 506(b).
204 Stephen J. Lubben, The "New and Improved" Chapter 11, 93 Ky. L.J. 839, 857 (2005).
205 See Oscar Couwenberg & Stephen J. Lubben, Private Benefits Without Control? Modern Chapter 11 and
the Market for Corporate Control, 13 Brook. J. Corp. Fin. & Com. L. 145, 166 (2018).

34

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

better than an expensive and likely futile effort to disrupt the RSA.206 Creditors at the margin can be
swayed with various fees or bonuses granted to those who support the plan before a set deadline. 207

These RSAs, combined with better-known techniques like gifting plans and structured dismissals,
mean that the “fixed principles” once championed by the New Dealers,208 which importantly
provided a formal structure to reorganizations, are no longer present, and that corporate bankruptcy
has now reached a point of extreme flexibility. Indeed, chapter 11 as presently practiced is now at
least as flexible as reorganization under the old receivership regime.209

But there are also signs of a developing backlash. The automotive bankruptcy cases of 2009 present
this most clearly. Putting to one side those objections that seem to have been targeted specifically
against the Obama Administration, general objections to the use of section 363 sales to push deals
that arguably could not be achieved under section 1129 illustrate a general concern that corporate
bankruptcy has become too flexible.210

And we see this theme percolating up in a variety of contexts. Questions about the ability of
secured lenders to drive the bankruptcy process,211 challenges to the deals that big creditor groups
work out among themselves,212 and even challenges to the lack of shareholder participation in
modern chapter 11213 all suggest a growing discomfort with the new shape that corporate bankruptcy
has taken.214 While these largely academic complaints have found little traction in the bankruptcy
courts, there are growing indications that the appellate courts are more sympathetic.

206 Id.
207 Id. at 165-66.
208 Supra note 159.
209 William W. Bratton & David A. Skeel, Jr., Bankruptcy's New and Old Frontiers, 166 U. Pa. L. Rev.
1571, 1572 (2018).
210 See, e.g., Ralph Brubaker & Charles Jordan Tabb, Bankruptcy Reorganizations and the Troubling Legacy
of Chrysler and GM, 2010 U. Ill. L. Rev. 1375, 1378.
211 Melissa B. Jacoby & Edward J. Janger, Tracing Equity: Realizing and Allocating Value in Chapter 11, 96
Tex. L. Rev. 673, 706 (2018). See also Michelle M. Harner, The Value of Soft Variables in Corporate
Reorganizations, 2015 U. Ill. L. Rev. 509, 519; Melissa B. Jacoby, Corporate Bankruptcy Hybridity, 166 U.
Pa. L. Rev. 1715, 1730 (2018); Edward J. Janger, The Logic and Limits of Liens, 2015 U. Ill. L. Rev. 589,
608 (2015); Juliet M. Moringiello, When Does Some Federal Interest Require a Different Result?: An Essay on
the Use and Misuse of Butner v. United States, 2015 U. Ill. L. Rev. 657, 658-59; Jay Lawrence Westbrook,
The Control of Wealth in Bankruptcy, 82 Tex. L. Rev. 795, 826 (2004).
212 Vincent S.J. Buccola, The Janus Faces of Reorganization Law, 44 J. Corp. L. 1, 16 (2018); Sally
McDonald Henry, Chapter 11 Zombies, 50 Ind. L. Rev. 579, 580 (2017); accord Alessandra Allegretto,
Overcoming Creditor Misfortune Creatively: Structured Dismissals in Chapter 11 Bankruptcies, 36 J.L. & Com.
239, 248 (2018).
213 E.g., Diane Lourdes Dick, The Bearish Bankruptcy, 52 Ga. L. Rev. 437, 467-69 (2018).
214 Jonathan C. Lipson, Braucher's Business: Foreseeing Relational Contract Bankruptcy, 58 Ariz. L. Rev. 173,
191 (2016); see also Lynn M. LoPucki, Changes in Chapter 11 Success Levels Since 1980, 87 TEMP. L.
REV. 989, 989-92 (2015).

35

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

Thus we see opinions constraining the more extreme versions of flexibility.215 The Supreme Court’s
Jevic opinion is simply the most high-profile version of this trend.216

The door is thus open for a retrenchment toward a “fairer” corporate bankruptcy system.217 But
given that the primary past example of such a move – the Chandler Act – was somewhat less than
successful, in the next and final section I consider how the lessons of history, reviewed in this paper,
might better inform the balance between fairness and flexibility. The move toward more fairness
need not inherently mean a fairness-heavy approach.

5. The Way Forward

Modern chapter 11 rejoices in cases that are tidy. Tidiness is often measured from the debtor or
lead lender’s perspective, although quite often bankruptcy courts also appreciate this perspective as
well.

Nothing is tidier than a case that commences with large majorities of creditors supporting a plan set
forth in an RSA. Regrettably, courts have shown little willingness to consider how those remarkable
majorities were obtained. For example, did creditors feel pressured to sign onto the RSA because
the deal was going to go through in any event, and those who did not sign were relegated to a lower
return? Were creditors obliged to consider the RSA under severe time pressure, and then locked
into their support by an agreement that provides for specific performance and application of non-
US law?218

More broadly, the move toward quick 363 sales, complex DIP loan agreements that grant lenders
extensive control, and the increasing complexity of capital structures (admittedly, not strictly
speaking a bankruptcy issue), have made chapter 11 ever more an “insiders” game. 219 First day
motions, with their foundation in a host of ancient receivership law of dubious applicability, are
undoubtedly needed to achieve chapter 11’s basic goal of maintaining a going concern. But first day
motions also allow the debtor (and the DIP lender, who provides the cash) an ability to pick winners
and losers.

That is, chapter 11 is increasingly subject to the same sort of criticism once leveled at the
receiverships: namely, that insiders benefit by extracting wealth from small claimants. Some of this
is by design: the very move from the rigid chapter X to chapter 11 was inherently about making
corporate reorganization more like other corporate transactions, where the parties would negotiate

215 E.g., In re DBSD N. Am., Inc., 634 F.3d 79 (2d Cir. 2011) (rejecting “gift” plans); but see In re
Nuverra Environmental Solutions, Inc., 2018 Westlaw 3991471 (D. Del.) (disparate "gifts" from
senior secured creditors to two different classes of unsecured creditors does not unfairly
discriminate against the least-favored class and does not violate the "absolute priority" rule).
216 Controlling Creditor Control: Jevic and the end(?) of LifeCare, 27 No. 5 J. Bankr. L. & Prac. NL Art. 5
(“Although Jevic does not forbid structured dismissals, it does establish guardrails for their use.).
217 See Michelle M. Harner, Rethinking Preemption and Constitutional Parameters in Bankruptcy, 59 Wm. &
Mary L. Rev. 147, 212 (2017).
218 Couwenberg & Lubben, Private Benefits Without Control?, supra note 205, at 165-67.
219 Douglas G. Baird, Robert K. Rasmussen, Antibankruptcy, 119 Yale L.J. 648, 686 (2010).

36

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

and reach a “deal.” The real charge, at heart, is that the fear of paternalism has gone too far, and
courts have become so tolerant that they let the deal-makers run away with the show.

The easy answer to these excesses is to urge a rededication to the “rules.” Discretion should be
reduced, and in its place, a more formal structure, applicable to all creditors regardless of size of
stake, set forth in its place. Typically this involves a strong belief that the rule of liquidation – the so
called “absolute priority rule” – should make a more frequent, and more vigorous, appearance in
modern chapter 11.

One problem with this easy equation of the “rules” with the ill-named absolute priority rule is that
the current Bankruptcy Code only applies the latter rule in cases of cramdown, when a plan is being
imposed on a dissenting class, and then only in the specific case of unsecured creditors.220 In cases
were the plan is “consensual” – that is, approved by the requisite minority, there still might be a
sizable minority that does not truly consent – the absolute priority rule has no applicability. At the
point of a 363 sale or a “structured settlement,” we do not know which type of plan might arise in
the, often hypothetical, future.

Such worries did not detain the Supreme Court in Jevic, which nonetheless held that a structured
settlement must follow absolute priority. Many critics of the auto bankruptcy 363 sales also seemed
to think the absolute priority rule should apply to the terms of a 363 sale, conducted well before any
plan was on the table. In short, although many suggest the absolute priority rule, and other more
rule-based reforms of current flexible reorganization practice, come from a more formal reading of
the Code, the opposite is actually true. Nonetheless, more rules and more court oversight of
adherence to the rules is often seen as a good thing by a wide range of critics, all of whom approach
modern chapter 11 for a range of viewpoints.

The trick is that it has long been recognized that the absolute priority rule does not really work, at
least in a formal sense, with a system designed to save operating businesses. This, in large part, is
because the rule relates to liquidation, which has little to do with ongoing operations.

In some sense the absolute priority rule has become like the old Glass-Steagall Act in banking law: a
concept that encompasses all manner of reform, with regard for the actual content of the original
source law.

More broadly, as the foregoing historical analysis has shown, the embrace of rigidity in service of
greater fairness runs the risk of making the business bankruptcy unusable. That is, because fairness
is often promoted by more rules, more oversight, and more process, the reorganization system loses
its ability to be useful. Extreme fairness is thus apt to be an unstable solution, as the flaws in such a
system are apt to inspire swift revision.

The obvious solution is balance. What form might that take?

The current full-bodied flexibility is useful, but could be better restrained by some healthy judicial
skepticism. Not every trade creditor is critical,221 not every sale must be approved on the same swift

22011 U.S.C. § 1129(b).

221Keeping in mind that the caselaw undergirding such payments was never as stable as sometimes
assumed in modern contexts. Adrian H. Joline, Railway Reorganizations, 4 Brief 1, 15 (1902). (“No

37

Electronic copy available at: https://ssrn.com/abstract=3667317

Draft: not for citation or quotation

timeline as General Motors, and not every priority skipping deal is inherently better than dismissal or
chapter 7 liquidation. Somewhat ironically, judicial discretion needs to be harnessed to preserve the
flexibility of the present system.

Mechanisms to facilitate voice are also useful, so long as they do not become so broad as to foist
excessive costs on reorganizations. Nearly every modern debtor asserts that equity is “out of the
money,” and thus opposes the appointment of an equity committee. Given the proliferation of easy
lending in recent years, it is quite likely that most cases are indeed insolvent. But some are not, or at
least there might be a real question, and bankruptcy courts should not be too hasty to deny equity
committees a role.222

Likewise, several recent cases – Sears and Toys “R” Us, for example – have involved sizable
numbers of non-unionized employees. These people have essentially no say in reorganization as
presently practiced, while the shape of the reorganization will have an outsized effect on their lives.
Providing a voice in suitable proceedings – namely, those where the number of employees justifies
the cost – would help ensure greater fairness in modern chapter 11.223

Conclusion

Through a comprehensive review of history, this paper has shown that American corporate
reorganization, like other important societal trends, typically evolves in big, multi-year cycles.
Extreme flexibility is met with a sharp move back toward fairness, only to move once again to
flexibility. The turning points are recognizable, even if they are surprisingly rare and far apart.

We seem to be at the start of one such turning point: after almost two decades of increasing
flexibility in chapter 11 practice, hints of a budding backlash abound. And the appellate courts have
shown some sympathy with these critics.

But another extreme move toward fairness, like that we experienced in the New Deal, would be
both misguided and unlikely to last. Instead, I have suggested the outlines of a more retained
approach, retaining the current flexibility with more skepticism about whether flexibility is always
required. Moreover, if we crack the door open to further voices in the chapter 11 process, we can
be more certain that any flexibility that is deployed is actually warranted.

counsel may, with any confidence, advise a client whether or not his demand comes within the class
which the court will recognize as entitled to priority.”).
222 Cf. Jared A. Ellias, What Drives Bankruptcy Forum Shopping? Evidence from Market Data, 47 J. Legal
Stud. 119, 147 (2018).
223 Such voice can be justified by the cost the bankruptcy process imposes on employees over the
long term. John R. Graham, et al., Employee Costs Of Corporate Bankruptcy, NBER Working Paper
25922 (2019), available at http://www.nber.org/papers/w25922 (finding that an “employee’s annual
earnings fall by 10% the year her firm files for bankruptcy and fall by a cumulative present value of
67% over seven years.”).

38

Electronic copy available at: https://ssrn.com/abstract=3667317