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Bargaining around Bankruptcy: Small Business Workouts and State Law

Morrison, Edward R.

Federal bankruptcy law is rarely used by distressed small businesses. For every 100 that suspend operations, at most 20 file for bankruptcy. The rest use state law procedures to liquidate or reorganize. This paper documents the importance of these procedures and the conditions under which they are chosen using firm‐level data on Chicago‐area small businesses. I show that business owners bargain with senior lenders over the resolution of financial distress. Federal bankruptcy law is invoked only when bargaining fails. This tends to occur when there is more than one senior lender or when the debtor has defaulted on senior debt (harming trust‐based relationships with lenders). These findings raise questions about the design of and need for federal bankruptcy law.

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Also Published In

Title
The Journal of Legal Studies
DOI
https://doi.org/10.1086/597982

More About This Work

Academic Units
Law
Publisher
The University of Chicago Press
Published Here
October 16, 2015
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