Hidden Wealth Transfers in Bankruptcy Asset Sales: A Real Option Analysis

Under the US Bankruptcy Code, company-debtors can sell assets, out of the ordinary course of business, if there is a" good business reason," before creditors, shareholders, and other claimants have agreed to a plan (§ 363). Such asset sales are frequently contested among claimants. This paper focuses on the conflicts that arise during such asset sales between creditors of different rank priorities and between creditors and shareholders. We use option theory to describe the payoffs and incentives of the two parties and show, under a limited set of assumptions, how permitting these sales affects the value of parties' interests. We show large wealth-redistributive effects from early sale that can dwarf the value losses that courts use to justify early asset sales. This suggests recent court decisions misplace their focus on issues such as declining asset values rather than the larger redistributive effect of early sale.