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Publication Title

Washington University Law Quarterly

Abstract

Most bankruptcy scholars who have considered the residual owner approach have come away with a healthy skepticism. But despite its theoretical difficulties, the residual owner approach persists. I attribute this persistence to an empirical assumption that usually remains implicit. In spite of the theoretical difficulties in identifying the single residual owners of bankrupt firms, the scholars who employ residual owner approaches believe that in reality, residual owners exist and can be easily identified inmost cases. Parties may bluster about the uncertainty of firm value and other parties may be compelled to compromise with them in order to avoid an expensive, burdensome valuation process. But at bottom, those scholars assume that the parties all know who is in the money, who is out of it, and who—the residual owner—is in between.

This Article reports the results of an empirical study designed to test that implicit assumption. The study concludes that no identifiable, single residual owner class exists in most reorganizing large public companies. Even by the end of the case, the parties have not been able to identify such a class. Part I describes the theoretical debate over the existence and utility of single residual owner classes in big bankruptcy cases. Part II presents the empirical study, beginning with a description of the universe of cases studied, the sources of the data, and the limitations of those sources. Subpart A reports and discusses the study’s findings with respect to the numbers of investors having different levels of priority in the reorganizing firm. The typical reorganizing firm has about four investor priority levels that are subordinate to secured and bankruptcy priority creditors. The existence of so many investor priority levels makes it likely that investors at more than one level will share residual owner status. Subpart B reports and discusses the study’s findings with respect to the numbers of residual owners actually identified by the reorganization process. The principal finding is that in 62% of the firms studied, the reorganization plan recognized that investors at more than one priority level shared residual owner status in a manner that left them with a substantial conflict with respect to investment policy. (That figure is a demonstrated minimum level of sharing; the actual level may be much higher.) Part III concludes that theories depending upon the existence of a single residual owner are unworkable. The problem is not merely that single residual owners are difficult to identify. The problem is that they rarely exist.

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