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Abstract

On the eve of the financial crisis, a series of Delaware court decisions resulted in a radical change in law: creditors would no longer have the kind of common law protections from opportunism that helped protect their bargains for the better part of two centuries. In this Article, we argue that Delaware’s shift materially altered the way large firms approach financial distress, which is now characterized by a level of chaos and rent-seeking unchecked by norms that formerly restrained managerial opportunism. We refer to the new status quo as “bankruptcy hardball.” It is now routine for distressed firms to engage in tactics that harm some creditors for the benefit of other stakeholders, often in violation of contractual promises and basic principles of corporate finance. The fundamental problem is that Delaware’s change in law was predicated on the faulty assumption that creditors are fully capable of protecting their bargains during periods of distress with contracts and bankruptcy law. Through a series of case studies, we show how the creditor’s bargain is often, contrary to that undergirding assumption, an easy target for opportunistic repudiation and, in turn, dashed expectations once distress sets in. We further argue that the Delaware courts paved the way for scorched earth corporate governance. Fortunately, judges can help fix the problem with more rigorous application of existing legal doctrines.

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