TITLE:
On Deviating from Absolute Priority: The Case of Tort Claims and Active Creditors
AUTHORS:
Joshua O. Anyangah
KEYWORDS:
Absolute Priority Rule, Bankruptcy, Tort Claims
JOURNAL NAME:
Theoretical Economics Letters,
Vol.7 No.3,
April
14,
2017
ABSTRACT: The impact of deviating from absolute priority
rule, a basic tenet of bankruptcy law that accords secured creditors a
privileged position in bankruptcy distribution, has long been at the centre of
research on bankruptcy. This paper develops a model of a firm that can cause an
accident and then claim bankruptcy to investigate the ex ante effects of elevating
tort claims a head of creditors. In the model, the firm (or its manager)
controls an unobservable care (or effort) decision. The creditor not only
provides the requisite capital, but also exercises control over the firm by
virtue of its significant cash flow rights. Together managerial care and
creditor control determine the distribution of the tortious harm. We find that
according tort claims a privileged position relative to creditors leads to a
shift away from managerial care and towards more creditor control. As a consequence,
subordinating secured creditor has an ambiguous effect on the expected social
welfare.