Are big banks using bankruptcy as a bullying tactic? A recent report by the American Bankruptcy Institute suggested that a longtime—and increasingly popular—mechanism in the US code that allows for expedited, less-democratic asset sales (known as Section 363 sales) is unfairly benefiting secured lenders and liquidating otherwise viable companies. As the theory goes, the deep-pocketed secured lenders at the front of the line have a bias toward shutting down viable operations, selling off the assets, and collecting the cash they’re owed without regard for other creditors. The less sophisticated creditors at the back of the line, meanwhile, lose out on the value that could have been produced had the company kept operating.

A new working paper coauthored by Professor Stuart Gilson challenges that assertion. Gilson and his colleagues studied 350 public companies that filed for Chapter 11 between 2002 and 2011, and found that just over half undertook Section 363 sales. But of those, a full 21 percent sold the entire company as an ongoing enterprise, instead of simply breaking up the company and liquidating it. That approach indicates that the use of the mechanism was more nuanced than some have suggested. “For one out of five of these sales, the process is really just about transferring ownership of an ongoing, operating enterprise to another owner,” says Gilson. “That’s exactly what happens in the market for mergers and acquisitions.”

Furthermore, overall credit recoveries and long-term survival rates of companies that are sold under these Section 363 sales are no different than those that have traditional reorganizations—with new debt or equity provided to all creditors through a slower, more democratic process.

Gilson and his colleagues say that their research supports the idea that Section 363 sales are both versatile and valuable for struggling companies. “The findings suggest that the US system still works exceptionally well for what it is intended to do: protect assets and businesses while companies are under financial stress, provide a variety of ways for the businesses to restructure, and ultimately restore the companies to financial health. That leaves everybody better off.”

“Cashing Out: The Rise of M&A in Bankruptcy,” by Stuart Gilson, Edith Hotchkiss, and Matthew Osborn, HBS Working Paper.

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