Forum shopping is one of the most controversial features of American corporate bankruptcy law. The controversy dates back to Congress’ decision in 1978 to create a unified court system for both consumers and businesses in local Federal Bankruptcy Courts. However, Congress acknowledged that this geographically-focused system is a clumsy fit for large firms with operations in many different jurisdictions. Accordingly, Congress provided large companies with discretion and implemented a venue statute that is so broad that most distressed companies have their choice of several jurisdictions. Over the past thirty years, the corporate bankruptcy bar has embarked on an ambitious experiment in forum shopping, effectively rewriting the statute to create two de facto specialized national business bankruptcy courts: the District of Delaware and the Southern District of New York. In my new working paper, I ask a simple question: why is it that more than 60% of large firms in recent years have chosen to file for bankruptcy in those two venues.
The paper joins a large literature that has sought to answer this question, chiefly through case studies and interviews with lawyers. One group of scholars believes that these two experienced courts attract firms because they have expert judges and stores of legal precedent that make bankruptcy more predictable. A rival camp disputes this explanation, arguing instead that “predictability” is a cloak for the true, self-interested motivation of the managers, lawyers and senior creditors that influence the debtor’s venue decision.
My approach is to look to a new source of insight on bankruptcy forum shopping: market data. The advantage of this approach is that the market price of the claims of bankrupt firms impounds a vast amount of information that reflects the market’s best guess as to what the claim will be worth at the end of the bankruptcy process. Unlike interview studies, the data should be unbiased. This allows me to test hypotheses about the predictability of the bankruptcy process using a research design that measures the accuracy of petition date market pricing.
In my paper, I study a new hand-collected sample of 1,484 claims of 352 bankrupt firms between 2001 and 2012. I find that the market appears to be better at predicting the outcomes of bankruptcy cases in the two destination venues, suggesting that New York and Delaware’s expert judges and store of precedent might improve the predictability of the bankruptcy process. This statistically significant relationship is robust to controls for firm size, the lawyers and investment bankers advising the debtor, the industries of the sample firms, the duration of the bankruptcy case, changes in market conditions over the bankruptcy period, pre-packaged or pre-negotiated filings and other potential confounding variables.
Of course, firms are not randomly assigned to venues and it is possible that I am simply observing the selection of more experienced bankruptcy courts by either more predictable firms or firms that the market knows more about. I do not find any evidence that this is true after examining proxies for firm-specific certainty and market informedness such as pre-bankruptcy stock price volatility and Wall Street analyst coverage. However, I cannot eliminate the possibility that it is true and thus cannot make strong causal claims using my data.
I can, however, look at other parts of the data to see if the market’s observed pricing advantage in Delaware and New York behaves in the way we might predict if we thought it was driven by predictable law and not a spurious correlation. I find evidence consistent with the notion that it might be. For example, the observed pricing advantage appears to persist through the early part of the bankruptcy process but disappears in the data as the firm moves closer to emergence from bankruptcy. This makes sense if you think that the usefulness of predictable judges and precedent will decline as a firm moves through bankruptcy and the judge issues intermediate orders that resolve legal uncertainty.
Further, contrary to the views of forum shopping critics, I do not find evidence suggesting that the destination courts are biased in favor of senior creditors or managers. However, I do not observe all possible channels for bias to manifest itself and I cannot dismiss the possibility forum shopping could be driven by firms seeking judges that are both predictable and biased.
Jared A. Ellias is an Associate Professor of Law at the University of California, Hastings.