Finding Nemo: Rediscovering the Virtues of Negotiability in the Wake of Enron

Abstract

Creditors have long understood that any claims they submit for repayment in a bankruptcy might be valid, but subject to subordination in the order of payment of the bankruptcy estate’s limited funds if the creditor behaved inequitably as the debtor failed. A groundbreaking opinion in Enron’s bankruptcy has expanded the practice of equitable subordination far beyond its traditional reach and subjected buyers of bankruptcy claims to subordination, not just for their own conduct, but also for the conduct of previous owners of the claims, regardless of whether the conduct related to the claims. Enron provides a striking example of what happens when markets outrun the law. Bankruptcy claims trading is a new market that has emerged since the enactment of the Bankruptcy Code of 1978. Claims trading undermines many of the Code’s assumptions about risks and relationships. Although the net costs and benefits of claims trading to the reorganization process are not clear, Enron illustrates how the courts are struggling to bring the law and markets in sync and the problems that arise when courts attempt to saddle new markets with outdated legal structures. In a world of active bankruptcy claims trading, Enron raises powerful policy questions about the legal rules governing property transfers that affect the doctrinal development of bankruptcy law and the survival of a secondary market that provides important liquidity to other capital markets. This article shows how Enron was erroneous from both doctrinal and policy perspectives and examines the problems Enron has created for several distinct markets. The solution to the disconnect between markets and law is to look to the essential underpinnings of core legal concepts and consider how they might be used to bring order to new transactional situations, rather than shoehorn markets into old paradigms. This article argues that hoary commercial law concepts like negotiability can and should be revitalized, revised, and expanded to account for new types of markets. Indeed, Enron is a reminder of the continuing value of negotiability in commercial contexts, for if the claims involved had been negotiable, they could not have been subordinated. Thus, this article considers what factors have traditionally determined when the law adopts a negotiability regime for property transfers and whether these factors make sense in today’s financial markets. The article argues that in the bankruptcy claims context, the liquidity benefits of negotiability outweigh its costs. Accordingly, the article proposes a federal law of negotiability for bankruptcy claims to protect the liquidity of this vital market.