Contracting About Bankruptcy

Creditors and the insolvent firm are required to use the state supplied bankruptcy procedure if they cannot agree on a private resolution after financial distress has occurred. While these ex post workouts are legal, parties cannot agree in the lending contracts to use a bankruptcy procedure alternative to the one the state supplies. This paper considers this legal prohibition. The paper makes three principal claims: the prohibition on contracting for preferred bankruptcy procedures exacerbates underinvestment; the prohibition should be lifted for this reason and because parties could coordinate on quot;bankruptcy contractsquot; although firms tend to have numerous creditors, who lend at different times and may have different preferences over procedures; and methodologically, that regulators should take the ability of parties to contract about bankruptcy issues into account when devising legal rules