Whoa, Congress, courts can do it

The recent tanking, or near-tanking, of several of America’s large corporations—first the airlines, then Enron and Kmart—has sent Congress scurrying to clean up the mess, a move which Professor of Law David Skeel believes is not entirely necessary.

Skeel, who penned a book on bankruptcy titled “Debt’s Dominion” (Princeton, 2001), said America’s bankruptcy system is well suited to preserving firms that are worth saving.

“The airline bailouts were premised on the assumption that the only way to save the airlines was through federal intervention,” said Skeel. “That’s not right. Our bankruptcy system is well designed to reorganize any firm that is a truly viable enterprise.”

Unlike in many other nations, bankruptcy in America is friendly to debtors, allowing them various options in how they discharge and reorganize their debts.

Given this flexibility, Skeel said federal intervention becomes problematic on several levels.

“It tends to be indiscriminate,” said Skeel. “It tries to save every firm in the industry in a situation where that might not be the right solution.”

Federal intervention also creates big incentive problems.

“If the firms in an industry know that Congress is going to bail them out if they run into trouble, they aren’t going to do as much to protect against the possibility of trouble arising,” said Skeel. “They’re not going to insure as much as they might. They’re not going to take precautions against risks that they could possibly take.”

According to Skeel, 90 percent of large corporations that fail successfully reorganize.

Still, Skeel concedes that federal intervention does hold some advantages. In times of a sudden money crunch, such as when a disaster hits, the federal government can intervene more quickly and in a more cost-effective way.

Yet even in cases of managerial misbehavior, such as the Enron scandal, America’s bankruptcy law is prepared, Skeel said.

“It provides wide-ranging investigatory powers so if there is a concern against mismanagement, the bankruptcy court is well positioned to allow an extensive investigation,” he said. “Bankruptcy cases don’t proceed in the darkness. They produce a lot of information.”

This past year, a record was set with more than 1.5 million bankruptcy filings, both from individuals and corporations. While there was a slight push to make bankruptcy filings harder before Sept. 11, Skeel said such sentiments have died down. The U.S. bankruptcy system will likely remain unchanged and continue to give debtors second chances, he said.

“We’re going to have changes in our security laws, changes in our accounting oversight. But nobody’s really talking much about changes in bankruptcy, and I think there won’t be,” he said. “Our bankruptcy system is well-designed to handle specifically these kinds of problems and there’s no reason to think it’s broken.”

Originally published on March 7, 2002