THE UNSECURED CREDITOR'S BARGAIN

THE UNSECURED CREDITOR'S BARGAIN Lynn M. LoPucki* [D Joes it make any sense to award everything to a secured party who stands idly by while a doomed enterprise goes down the slippery slope into bankruptcy? -Grant Gilmore 1 INTRODUcrION..... 1888 1. THE SECURED CREDITOR'S BARGAIN. 1892 A. Involuntary Creditors... 1896 1. Leaving Involuntary Creditors Subordinate to Secured Creditors... 1903 2. Elevating Involuntary Creditors Through Universal Insurance... 1906 3. Elevating Involuntary Creditors to Priority over Secured Creditors... 1907 B. Uninformed Creditors... 1916 C. Can Security Be Proven Efficient?... 1920 II. THE UNSECURED CREDITOR'S BARGAIN. 1924 A. Asset-Based Unsecured Lending... 1924 B. Cash-Flow-Based Unsecured Lending... 1931 1. LoPucki's Formulation of Bowers' Law: Security Tends To Expand to the Liquidation Value of the Collateral... 1931 * William R. Orthwein Professor of Law, Washington University in St. Louis. I express my appreciation to Barry Adler, Susan Block-Lieb, Jim Bowers, David Carlson, Kate Heidt, Dan Keating, Steve Knippenberg, Ronald Mann, Bob Rasmussen, Paul Shupack, Harry Sigman, Barbara Jo Smith, Bob Thompson, Jay Westbrook, Bill Whitford, Jim White, and participants in the University of Virginia School of Law's Conference on "Revision of Article 9 of the Uniform Commercial Code" for their comments on earlier drafts of this manuscript, to Bob Thompson for supplying unpublished data from his empirical study of corporate veil piercing, to Steven L. Schwarcz for his insights into unsecured lending by large financial institutions, to Bob Wirengard for his insights into unsecured lending by sophisticated trade creditors, and to Barbara Jo Smith for assistance with research. 1 Grant Gilmore, The Good Faith Purchase Idea and the Uniform Commercial Code: Confessions of a Repentant Draftsman, 15 Ga. L. Rev. 605, 627 (1981). 1887 HeinOnline --- 80 Va. L. Rev. 1887 (1994)

1888 Virginia Law Review [Vol. 80:1887 2. Cash-Flow Surfing in a Fully Encumbered World... 1938 3. The Legal-Theoretical Implications of Cash- Flow Surfing... 1941 C. Justifying the Subordination of Unsecured Creditors: Three Bad Theories and One Not So Bad... 1947 1. The Presumption That Everyone Knows the Law... 1949 2. The Property Theory... 1952 3. The Economic Theory... 1954 4. The Implied Contract Theory... 1958 III. CONCLUSION... 1963 INTRODUCfION ECONOMICS is called the dismal science 2 for good reason. For most of its inhabitants, this world is a cruel place. 3 A principal role of economists seems to be to explain why things cannot be better. Most appear to enjoy this work and to regard harsh economic realities much as personal injury lawyers regard severe injuries. The institution of security has a similarly bad reputation. Its most persistent image i,s that of families forced from home or farm through forec1osure. 4 Most noneconomists wish that things could 2 The term "dismal science" was coined by Thomas Carlyle. Thomas Carlyle, The Nigger Question, in 6 Critical and Miscellaneous Essays, 169, 177 (London, Chapman & Hall 1869). The context is worth repeating: And the Social Science,-not a "gay science," but a rueful,-which finds the secret of this Universe in "supply and demand," and reduces the duty of human governors to that of letting men alone, is also wonderful. Not a "gay science," I should say, like some we have heard of; no, a dreary, desolate, and indeed quite abject and distressing one; what we might call, by way of eminence, the dismal science. Id. 3 See generally the New York Post. 4 For example, John Steinbeck wrote: A man can hold land if he can just eat and pay taxes; he can do that. Yes, he can do that until his crops fail one day and he has to borrow money from the bank. But-you see, a bank or a company can't do that, because those creatures don't breathe air, don't eat side-meat. They breathe profits; they eat the interest on money. John Steinbeck, The Grapes of Wrath 43 (1939). HeinOnline --- 80 Va. L. Rev. 1888 (1994)

1994] Unsecured Creditor's Bargain 1889 be different. We are rooting for the underdog, which means we are rooting against security. But even as we dislike that harsh institution, we respect it. The debtor agreed to it expressly and the unsecured creditors did so implicitly. How could it be unfair? When the newly minted discipline of Law and Economics met the institution of secured credit in the late 1970s, they fell in love. Law and Economics needed cruelty to explain, and secured credit had something of a gold mine. The seminal article, written by Professors Thomas Jackson and Anthony Kronman and published in the Yale Law Journal in 1979, purports to justify security as an institution by proving it to be economically efficient.s When an institution is "efficient," any change in it will reduce aggregate wealth, something that nobody with any sense wants to do. 6 As bad as an efficient institution might seem to the layperson, tinkering with it, the economist has opined, can only make things worse. Ah, to be exquisitely cruel but at the same time efficient-what more could an economist ask of an institution? Popular discussions of security quickly deteriorate into melodrama. For example, Amy Wallace reported on one woman's plight as follows: The men lifted the ailing, 56-year-old grandmother onto a tarp and carried herkicking and screaming-out to an alley... And that's where she sat, a bottle of oxygen at her side, as... the president of Otwin Investments... took a quick look around the house that is now his and then padlocked the door. Amy Wallace, In Debt and Out of a Home, L.A. Times, Mar. 19, 1993, at B3. So, sometimes, do scholarly discussions of security, as when Professors Harris and Mooney argue that the "good name" of secured transactions "should be cleared." Steven L. Harris & Charles W. Mooney, Jr., A Property-Based Theory of Security Interests: Taking Debtors' Choices Seriously, 80 Va. L. Rev. 2021, 2037 (1994). 5 Thomas H. Jackson & Anthony T. Kronman, Secured Financing and Priorities Among Creditors, 88 Yale L.J. 1143 (1979) (suggesting that monitoring savings justify secured finance). Jackson and Kronman do not use the word "efficient," but their proof is essentially that and others have so described it. See, e.g., Homer Kripke, Law and Economics: Measuring the Economic Efficiency of Commercial Law in a Vacuum of Fact, 133 U. Pa. L. Rev. 929, 930 (1985) (stating that Jackson and Kronman "conclude that taking security is economically efficient"). 6 Nicholas Kaldor and J.R: Hicks are credited with the idea that when maximizing wealth necessitates the goring of somebody's ox, society can, if it wants to, replace the ox with the newly created wealth and stili have some left over. J.R. Hicks, The Foundations of Welfare Economics, 49 Econ. J. 696, 706 (1939); Nicholas Kaldor, Welfare Propositions of Economics and Interpersonal Comparisons of Utility, 49 Econ. J. 549,550-51 (1939). Here I must admit that I agree with the economists. More is better. For a contrary view, see Less is More: The Art of Voluntary Poverty (Goldian VandenBroeck ed., 1978). HeinOnline --- 80 Va. L. Rev. 1889 (1994)

1890 Virginia Law Review [Vol. 80:1887 The Jackson and Kronman article became the foundation for a debate that has become known as the "puzzle of secured debt." The debate has smoldered in the academic literature like a coal mine fire for fifteen years 7 and gives no indication of burning out any time soon. Its persistence is all the more remarkable in that none of the debaters has yet questioned whether the institution of security is justified, good, or even in need of significant change. 8 In the early years of the debate, two leading "Law and Law"9 scholars argued in separate articles that the Law and Economics scholars had come to the right result-that security was good-but for the wrong reasons. 10 Among themselves, the Law and Economics scholars debated not whether security was efficient, but 7 See Barry E. Adler, An Equity-Agency Solution to the Bankruptcy-Priority Puzzle, 22 J. Legal Stud. 73 (1993); Richard L. Barnes, The Efficiency Justification for Secured Transactions: Foxes with Soxes and Other Fanciful Stuff, 42 Kan. L. Rev. 13 (1993); James w. Bowers, Whither What Hits the Fan?: Murphy's Law, Bankruptcy Theory, and the Elementary Economics of Loss Distribution, 26 Ga. L. Rev. 27, 57-68 (1991); F.H. Buckley, The Bankruptcy Priority Puzzle, 72 Va. L. Rev. 1393 (1986); Saul Levmore, Monitors and Freeriders in Commercial and Corporate Settings, 92 Yale L.J. 49 (1982); Randal C. Picker, Security Interests, Misbehavior, and Common Pools, 59 U. Chi. L. Rev. 645 (1992); Alan Schwartz, The Continuing Puzzle of Secured Debt, 37 Vand. L. Rev. 1051 (1984) [hereinafter Schwartz, The Continuing Puzzle]; Alan Schwartz, Security Interests and Bankruptcy Priorities: A Review of Current Theories, 10 J. Legal Stud. 1 (1981) [hereinafter Schwartz, Security Interests]; Robert E. Scott, A Relational Theory of Secured Financing, 86 Colum. L. Rev. 901 (1986); Paul M. Shupack, Solving the Puzzle of Secured Transactions, 41 Rutgers L. Rev. 1067, 1118 (1989); George G. Triantis, Secured Debt Under Conditions of Imperfect Information, 21 J. Legal Stud. 225 (1992); James J. White, Efficiency Justifications for Personal Property Security, 37 Vand. L. Rev. 473 (1984). 8 I considered whether Alan Schwartz had questioned the inherent goodness of security and concluded that he had not. Although Schwartz explored many of the arguments against security and attached arguments for it, he did not subscribe to any of them. He did recommend giving priority over secured creditors to a financial institution that makes the first loan to a debtor. His proposal in that regard amounts to little more than excusing the financial institution-a secured creditor in sheep's clothing-from filing a financing statement. See Alan Schwartz, A Theory of Loan Priorities, 18 J. Legal Stud. 209, 218-22 (1989). 9 As Law and Economics theorists came to dominate the field of debtor-creditor relations, their natural predators, the empiricists, began to multiply. Traditional scholars, always known for their good sense of humor, began referring to themselves as "Law and Law." I first heard the term in a conversation with Peter Alces, Charles Tabb, and Margaret Howard in San Antonio in 1992. All seemed fully accustomed to it, indicating additional history with which I am not familiar. 10 Kripke, supra note 5, at 930; White, supra note 7, at 508. HeinOnline --- 80 Va. L. Rev. 1890 (1994)

1994] Unsecured Creditor's Bargain 1891 whether the other scholars had proven it SOl1 or had proven it so for all of the applicable reasons. 12 This Article will demonstrate that all of these scholars have been wrong. Security tends to misallocate resources by imposing on unsecured creditors a bargain to which many, if not most, of them have given no meaningful consent. It is an institution in need of basic reform. Part I of this Article briefly retraces the origins of the debate, focusing on two explanations for the widespread use of security that had been identified in earlier writings but not thoroughly explored. The first is that security enables secured creditors and debtors to extract a subsidy from those who involuntarily become unsecured creditors. I conclude that such a subsidy exists and argue that the appropriate remedy is to give involuntary creditors priority over secured creditors. The second is that the deceptive nature of security enables secured creditors and debtors to extract a similar subsidy from relatively uninformed unsecured creditors who predictably miscalculate their likelihoods of recovery. The remainder of Part I conducts a brief search for the essence of the secured creditor's bargain and concludes that none exists. Part II argues that voluntary unsecured credit is of two principal types. The first, "asset-based" unsecured lending, takes place between sophisticated lenders and borrowers, producing no systemic problems of significance. The second type of unsecured lending, which I refer to as "cash-flow surfing," occurs in the virtual absence of unencumbered assets or income. An understanding of the context in which cash-flow surfing occurs leads to a reconceptualization of the unsecured creditor's bargain. That reconceptualization demonstrates the need for basic reforms in the Article 9 filing system and the rules and procedures for determining the content of the unsecured creditor's bargain in specific cases. The Article ends with a proposal that the content of the unsecured creditor's bargain be determined not wholesale by the rigid con- 11 Schwartz, for example, has written three articles, each arguing or asserting that other scholars had not proven security efficient. Schwartz, The Continuing Puzzle, supra note 7, at 1051-52; Schwartz, Security Interests, supra note 7, at 29; Schwartz, supra note 8, at 243-47. 12 See, e.g., Picker, supra note 7, at 650 (listing several functions of security not yet acknowledged in the puzzle debate). HeinOnline --- 80 Va. L. Rev. 1891 (1994)

1892 Virginia Law Review [Vol. 80:1887 ceptions of priority in Article 9, but on a case-by-case basis, applying basic rules of contract law. I. THE SECURED CREDITOR'S BARGAIN Jackson and Kronman presented two arguments for the efficiency of secured debt, both grounded in contract. First, the unsecured creditors seemingly disadvantaged by security in fact voluntarily contracted for their roles: It is a fair assumption... that these other creditors will be aware of [the additional risk from being unsecured] and will insist on a premium for lending on an unsecured basis, will demand collateral (or some other form of protection) to secure their own claims, or will search for another borrower whose enterprise is less riskyp That they contracted for a status subordinate to other creditors, rather than paying the premium required to induce the debtor to provide security, demonstrated that the subordinate status was actually better. Second, even "if the law denied debtors the power to prefer some creditors over others through a system of security agreements, a similar network of priority relationships could be expected to emerge by consensual arrangement between creditors."14 That creditors themselves would contract for these priorities "supplement[ed] and reinforc[ed]" Jackson and Kronman's first argument and suggested "why secured credit is such a widespread phenomenon." 15 In other words, the secured credit 13 Jackson & Kronman, supra note 5, at 1147-48 (footnote omitted). Other scholars have accepted the idea that reductions in the cost of financing achieved by giving priority to some creditors will be offset by increases in the cost of the debtor's other financing. See, e.g., Schwartz, supra note 8, at 210 ("Any [proposal by an initial financer for priority] would "elevate the first financer's rank at the expense of potential later creditors, whose priority status necessarily would be lowered; actual later creditors then would exact compensation for their worsened status in the interest rate they charge."); Robert E. Scott, Error and Rationality In Individual Decisionmaking: An Essay on the Relationship Between Cognitive Illusions and the Management of Choices, 59 S. Cal. L. Rev. 329, 351 (1986) ("Viewed from a supply side perspective, secured credit is a zero-sum transaction for the debtor. Any reduction in the debtor's credit bill caused by offering security to one creditor is offset by a corresponding increase in the cost of unsecured credit."). This zerosum hypothesis is incorrect. See David G. Carlson, On the Efficiency of Secured Lending, 80 Va. L. Rev. 2179 (1994) (demonstrating that the zero-sum hypothesis is incorrect in the simplest case where the debtor finances with only a single secured creditor). 14 Jackson & Kronman, supra note 5, at 1157 (emphasis added). 15 Id. at 1158. HeinOnline --- 80 Va. L. Rev. 1892 (1994)

1994] Unsecured Creditor's Bargain 1893 arrangement was better for everyone involved-debtor, preferred creditor, and subordinated creditor. The proof was that those apparently disadvantaged by security knowingly and voluntarily agreed to it and it flourished. Jackson and Kronman's reasoning was based on two false 16 assumptions. First, they assumed that unsecured creditors agree to subordinate status when in fact a substantial number of unsecured creditors are creditors such as tort victims whose unsecured status is imposed on them against their willp Second, Jackson and Kronman assumed that voluntary creditors contract for unsecured status with a full awareness of the consequences when in fact they contract under varying levels of coercion with varying levels of awareness. 1S In the ensuing debate, the falsity of these assumptions did not go unnoticed. 19 But neither were their implications developed. In an article published in the Journal of Legal Studies in 1981, Alan Schwartz argued that it is impossible to prove that security is efficient without first understanding how it reduces social costs.20 He tested several economic theories to see if they might account for the pattern of secured and unsecured debt he thought he saw. None did, and he pronounced the efficiency of secured debt to be unproven. 21 Schwartz' article took the debate in a new and ulti- 16 The word may seem to harsh to some. The use of assumptions that are known not to accord with reality is customary and accepted in economic modeling because with realistic assumptions, the economic models become unmanageably complex. Economists derive conclusions based on unrealistic assumptions, and then attempt to transfer those conclusions from the world in which the model operates to the world in which we live. I have argued elsewhere that (1) "false" is an appropriate description of those assumptions; and (2) conclusions can be transferred only by loose analogy, with the result that they prove nothing and at best suggest what theories might be tested through realistic models. See Lynn M. LoPucki, Strange Visions in a Strange World: A Reply to Professors Bradley and Rosenzweig, 91 Mich. L. Rev. 79, 106-10 (1992). 17 See infra notes 38-42 and accompanying text. 18 See, e.g., Schwartz, Security Interests, supra note 7, at 30-31: James H. Scott, Jr., Bankruptcy, Secured Debt, and Optimal Capital Structure: Reply, 34 J. Fin. 253, 254 & n.2, 256 (1979). 19 See supra note 18; infra notes 38-42, 112 and accompanying text. 20 See Schwartz, Security Interests, supra note 7, at 7 ("Firms issue and creditors buy secured debt when the private gains from doing so exceed the costs. An efficiency explanation of secured debt must show when this is so and also that the social gains from security exceed the social costs."). 21 See supra note 11. HeinOnline --- 80 Va. L. Rev. 1893 (1994)

1894 Virginia Law Review [Vol. 80:1887 mately unsuccessful direction. Even though his theories could not explain the pattern of secured and unsecured debt, other scholars thought that theirs would. 22 Like Cinderella's sisters, they began offering their own theories in the hope that they would fit the glass slipper. 23 Because no one really believed that security might be unjustified, the focus was on what Dean Robert Scott called the benign theories 24 -the good things that secured debt does that might also explain why debtors and their creditors agree to it in some circumstances, but not in others. To explain secured debt, scholars advanced theories that its existence reduces the total cost to creditors of monitoring the debtor,25 ensures that necessary monitoring will occur,26 reduces the risk of asset substitution,27 22 For a brief history of the puzzle debate, see Shupack, supra note 7, at 1073-83. 23 The glass slipper in this analogy is, of course, the actual pattern of secured and unsecured debt. In the Cinderella story, the Prince had the slipper and the sisters had to fit their feet into it. But in the debate over the puzzle of secured debt, each debater can control, for purposes of his or her own article at least, the shape of the slipper. The debater does that by asserting the pattern of secured and unsecured debt that the debater seeks to explain. Under the rules by which the debate has been conducted, evidence that the pattern asserted is the pattern that actually exists has been considered unnecessary by both the writers and the journals in which they have published. See, e.g., Schwartz, The Continuing Puzzle, supra note 7, at 1059 (stating that "[the facts disconfirm the prediction] that debtors always will secure all of their debt until they run out of assets to offer" but providing no supporting authority); id. at 1061 (discounting White's explanation for the efficiency of secured debt, which relies on recent U.C.c. changes, because "the pattern of secured lending seems not to have changed materiaily in the last two decades" but providing no supporting authority); id. at 1068 (stating that "[r]etailers that borrow, for example, seemingly are secured more frequently than manufacturers that borrow," but again providing no supporting authority). Professor F.R. Buckley states that two predictions "fly in the face of the reality that banks, the most typical secured creditors, are generally long term creditors" but provides no authority. Buckley, supra note 7, at 1444. Buckley's "reality" in fact flies in the face of data published by the Federal Reserve, which shows that only about 8% of lending by commercial banks is long term. See Fed. Reserve Bull., Aug. 1993, at A76 tbl. 4.23 (listing amounts for the week of May 3-7,1993). Robert Scott is correct in stating that "the existing literature fails to assemble and evaluate even the most rudimentary data on patterns of secured and unsecured lending." Scott, supra note 7, at 912. Given the ground rules under which the puzzle debate has been conducted, the likelihood that a particular debater who is looking for a fit will find one is considerably better than the chances of Cinderella's sisters. 24 See Scott, supra note 7, at 901 ("What purposes, whether benign or malignant, does security serve?"). 25 Jackson & Kronman, supra note 5, at 1149-61. 26 Levmore, supra note 7, at 55-57. 27 Schwartz, Security Interests, supra note 7, at 11. HeinOnline --- 80 Va. L. Rev. 1894 (1994)

1994] Unsecured Creditor's Bargain 1895 makes more credit available,28 lowers the costs of screening firms to determine their creditworthiness and anticipated bankruptcy value,29 prevents the debtor from wasting the assets in reorganization,30 and gives creditors the opportunity to sort themselves out by their levels of vulnerability to loss.31 They found it much more difficult to explain the existence of unsecured debt, but eventually came up with the following explanations: (1) transaction costs are higher for entering into a secured credit contract, and sometimes the benefits of security are not worth it;32 (2) the existence of unsecured debt serves to bond management to the interests of equity holders;33 and (3) unsecured creditors are less vulnerable to loss than their competitors and accordingly lack the incentive to outbid them for secured status. 34 Two promising malignant explanations for the existence of secured debt were commonly noticed but rarely explored. 35 Security might have flourished because it facilitates the exploitation of involuntary36 creditors or of voluntary creditors who failed to react to security.37 Probably the reason for the lack of interest in these explanations is that both the Law and Economics scholars and the Law and Law scholars knew where they wanted to get to-secured 28 Kripke, supra note 5, at 941. 29 Buckley, supra note 7, at 1469. 30 White, supra note 7, at 487-89. 31 See Bowers, supra note 7, at 56-67. 32 Scott, supra note 7, at 937-38. 33 See Adler, supra note 7, at 74-75. 34 See Bowers, supra note 7, at 66. 35 Only one of the puzzle scholars, Professor Shupack, chose to pursue either as a solution to the puzzle. His work in this regard has not been given the recognition it deserves. I discuss his ideas principally infra at notes 93-95 and accompanying text. 36 I will use the more descriptive "involuntary" rather than the more common "nonconsensual" to describe creditors who were made such without their consent and "voluntary" rather than "consensual" for their opposite. I believe that this usage originated with Professor Elizabeth Warren. See Elizabeth Warren, Bankruptcy Policymaking in an Imperfect World, 92 Mich. L. Rev. 336, 354 (1993) (referring to "involuntary creditors, such as tort victims and environmental cleanup funds"). 37 Schwartz, Security Interests, supra note 7, at 30-31. Although Schwartz noticed the tendency for such redistributions to occur and considered these redistributions undesirable, he still found the case against security unconvincing and did not support any change. Instead, he set forth an agenda for research and suggested that things ought to remain the same until someone completed the agenda. Id. at 34-37. Shupack also noticed the tendency for such redistributions to occur and considered them undesirable but argued that existing law has countervailing provisions. See Shupack, supra note 7, at 1118-21. HeinOnline --- 80 Va. L. Rev. 1895 (1994)

1896 Virginia Law Review [Vol. 80:1887 credit is good-and these two explanations seemed to point in the wrong direction. A. Involuntary Creditors The few data available suggest that a substantial portion of all unsecured creditors do not consent to their status in any meaningful sense. They become creditors only by the wrongful acts of their debtors. For example, Professors Teresa Sullivan, Elizabeth Warren, and Jay Westbrook found that twenty-three percent of the unsecured debt of persons filing bankruptcy under Chapters 7 and 13 of the Bankruptcy Code was owed to what the researchers called "reluctant creditors."38 By that they meant that those creditors were not in the business of extending credit and did not seek credit relationships.39 In the cases studied by Sullivan, Warren, and Westbrook, the debtors were principally consumers and their reluctant creditors were (1) tort victims, (2) former spouses and children with unpaid support orders, (3) government agencies, (4) educationallending agencies, (5) health care providers, (6) tax authorities, (7) landlords, and (8) utilities. 40 Corresponding data with regard to business debtors do not exist. But on the basis of the data that are available, I would speculate that money owed to reluctant creditors constitutes an even larger portion of the debt of financially distressed companies. 41 In the 38 Teresa A. SuIlivan, Elizabeth Warren & Jay L. Westbrook, As We Forgive Our Debtors 18, 294 (1989). Not all of these "reluctant" creditors should be regarded as involuntary for purposes of the argument I make here. See infra note 42 for the argument that government is a voluntary creditor. But neither is it appropriate to treat them as voluntary merely because their relationship with the debtor was voluntary. A spouse claiming support claims on the basis of a voluntary relationship but may not have actually contemplated a credit relationship at the time of his or her dealing with the debtor. Reluctant creditors are perhaps best seen as occupying places along a continuum from voluntary to involuntary. 39 SuIlivan et ai., supra note 38, at 294. 40 Id. at 294-98. 41 Many debtors have substantial involuntary liabilities. For example, in our empirical study of the 43 largest reorganizations of the 1980s, Professor Whitford and I found that for two of the companies (5% of the population we studied), more than two-thirds of the unsecured debt was involuntary. (The companies were Manville Corporation, with well in excess of $2 billion in asbestos personal injury claims alone, In re Johns-Manville Corp., 36 B.R. 743, 746 (Bankr. S.D.N.Y. 1984), and Smith International, which had a $205 million judgment against it for patent infringement.) Similar cases not included in our study were Texaco, Inc. ($11.1 billion tort judgment), see Texaco, Inc., 1985 Annual Report 29 n.16 HeinOnline --- 80 Va. L. Rev. 1896 (1994)

1994] Unsecured Creditor's Bargain 1897 business cases, the categories of reluctant creditors include (1) product liability claimants; (2) victims of business torts, ranging from negligence to intentional interference with contractual relations; (3) victims of antitrust violations, unfair competition, and patent, trademark and copyright infringement; (4) environmental agencies that perform clean-ups; (5) taxing authorities;42 (6) creditors who became such through the debtor's fraud, including securities fraud; (7) government agencies, such as the Pension Benefit Guarantee Corporation; and (8) utility companies. Regardless of where one draws the line among these creditors, involuntary unsecured credit clearly exists in substantial amounts. The ability to victimize involuntary creditors may in significant part explain "why secured credit is such a widespread phenomenon."43 Simply by entering into a security agreement, the debtor and a favored creditor can expropriate for themselves value that, (1986), and A.H. Robins ($2.5 billion in tort claims), see In re A.H. Robins, 88 B.R. 742, 747 (E.D. Va. 1988), aff'd, 880 F.2d 694 (4th Cir.), cert. denied, 493 U.S. 959 (1989). Other companies in our study with substantial "reluctant unsecured debt" included Baldwin-United (the insurance regulators of various states were major creditors), Braniff (ticket holders), Charter Company (possible veil piercing of a subsidiary, IPC, to hold Charter Company liable for the infamous dioxin contamination of Times Beach, Missouri), and McLouth Steel Corporation (Pension Benefit Guarantee Corporation). In at least 7 more of these 43 companies, management had fraudulently concealed the financial problems of the company in the period before bankruptcy, casting doubt on whether any of their unsecured creditors should be considered to have consented to the status they were given. Four of the cases resulted in criminal indictments; three others resulted in charges by the Securities Exchange Commission ("SEC"). See Lynn M. LoPucki & William C. Whitford, Corporate Governance in the Bankruptcy Reorganization of Large, Publicly Held Companies, 141 U. Pa. L. Rev. 669,738 & nn.226-27 (1993). Thus, in nearly a third of the cases we studied, substantial portions of the unsecured debt were held by creditors who had not meaningfully agreed to their status as such. 42 Government and its agencies arguably do not belong on this list. They are voluntary creditors in that they voluntarily engage in the programs that cause them to become unsecured creditors. They could deem themselves secured creditors or, if they chose to remain unsecured, could adjust the rate of interest as necessary to react to the increased risk resulting from their debtors' grants of security. I find this argument unconvincing because governments do not in fact appear to act as profit maximizers in their extensions of credit. Although governments realize that they inevitably will extend credit, they do not seek to do so. Even though governments can, and sometimes do, charge rates of interest that reflect their assessment of the risk on each extension of credit, they more often charge the same rate of interest to all borrowers, regardless of the riskiness of the extension. For example, the Internal Revenue Service charges all delinquent taxpayers the same rates of interest. In doing so, it is not behaving like the voluntary creditors of economic theory. 43 See supra note 15 and accompanying text. HeinOnline --- 80 Va. L. Rev. 1897 (1994)

1898 Virginia Law Review [Vol. 80:1887 absent the agreement, would go to involuntary creditors. 44 To take the simplest example, assume that Debtor has assets of $100 and debt of $100 owed to a creditor ("C"). Debtor then inflicts a tortious injury of $100 on a victim ("T"). Debtor becomes liable for the tort, but does not gain from it, so that Debtor has assets of $100 and debt of $200. Debtor is then liquidated. If the debt to C is unsecured, C and T each receive distributions of $50. If the debt to C is secured, C receives $100, and T receives nothing. Because C collects $100 with security and only $50 without it, Debtor's cost of borrowing from C likely will be lower if the loan is secured. The cost saving thus achieved is not offset by higher costs of borrowing from T, because T had no opportunity to bargain. 45 Professor David Leebron refers to the phenomenon described here as the "extemalization of tort risk. "46 Any debtor who either has, or expects in the future to have, involuntary unsecured creditors will find economic advantage in "selling" secured status to its voluntary creditors. The use of an allequity capital structure exposes the shareholders of the tortfeasors to liability to the extent of the capital they contributed to the enterprise. Critics have argued that such a structure is already too generous to the shareholders of the tortfeasor.47 When unsecured debt is introduced into the capital structure of a potential tortfeasor, the shareholder's real exposure 48 to tort liability declines further.49 When all assets, including the future income stream of the tortfeasor, are encumbered to their full value, the company's real exposure to tort liability can be almost eliminated. 50 Because of 44 See David W. Leebron, Limited Liability, Tort Victims, and Creditors, 91 Colum. L. Rev. 1565, 1646-49 (1991) (noting that granting security "will remove assets from potential tort claimants for the benefit of creditors"). 45 For similar illustrations, see id. at 1639-40. 46 Id. at 1648. 47 Id. at 1646-49; see also Henry Hansmann & Reinier Kraakman, Toward Unlimited Shareholder Liability for Corporate Torts, 100 Yale L.J. 1879, 1920 (1991) (arguing that limited liability prevents tort law from determining the appropriate allocation of costs among stakeholders in a corporation). 48 By "real exposure," I mean only exposure to tort liability that the debtor can be made to pay. Tort liability that the debtor can defeat through insolvency or bankruptcy will not have a deterrent effect. 49 See supra notes 44-45 and accompanying text. 50 Real exposure to tort liability can be reduced, but never entirely eliminated, by this method. Even when secured debt exceeds the entire liquidation value of the company, tort HeinOnline --- 80 Va. L. Rev. 1898 (1994)

1994] Unsecured Creditor's Bargain 1899 this "expropriation effect" of secured debt on involuntary unsecured creditors, debtors will tend to issue secured debt to reduce their real exposure to tort liability.51 The tort example illustrates the fundamental nature of security. It is not, as Jackson and Kronman present it, a contract among debtor, secured creditor, and unsecured creditor. Only the debtor need sign; the "consent" of the unsecured creditor is implied in the best case and a blatant fiction in the worst. Security is an agreement between A and B that C take nothing. 52 Law and Economics relies heavily on consent to prove the inherent justice of the way things are. 53 When the analysis requires the consent of a party to some aspect of social organization, but that party clearly did not give it, the standard economic move is to argue that the party would have agreed to that aspect ex ante, by which they mean before the party knew what role it would have in society.54 creditors may retain substantial leverage to negotiate settlements. Those settlements will be paid from the collateral of secured creditors. See infra text accompanying notes 191-200. 51 This point was noted in Buckley, supra note 7, at 1417 ("A firm known by its claimants to face large potential tort liability... could strategically issue secured debt, thereby subordinating tort creditors and making its cost of credit lower than that of an equivalent-risk firm whose creditors are predominantly consensual."). 52 I am not the first to notice this fact. See, e.g., Jackson & Kronman, supra note 5, at 1147 ("At first blush, it may seem unfair that a debtor should be allowed to make a private contract with one creditor that demotes the claims of other creditors from an initial position of parity to one of subordination."). Some may think I put the case too strongly because the contract between A and B merely subordinates C's claim rather than prevents C from recovering. The only importance of subordination, however, is in the situation in which the subordinate claims will not be paid in full. Thus, if subordination does anything, it prevents full recovery by the subordinate party. S3 See infra notes 247-48 and accompanying text. S4 For examples of such ex ante analyses in the context of whether secured credit is beneficial to involuntary creditors, see, e.g., Leebron, supra note 44, at 1646-47 (concluding that tort claimants generally would not agree ex ante to secured credit); Shupack, supra note 7, at 1099-1102 (examining the potential harm of secured credit to tort claimants by analyzing whether they would agree ex ante to secured credit). Baird and Jackson sought to bind tort creditors through the use of a similar argument: "Nonconsensual" creditors, be they tort or tax, would not necessarily want different limits of restraint than would consensual creditors. Indeed, in many respects, their interests in controlling the debtor are identical. As a result, the limits that consensual creditors would impose on investments by a debtor also largely will protect nonconsensual claimants because of the congruence in their interests. HeinOnline --- 80 Va. L. Rev. 1899 (1994)

1900 Virginia Law Review [Vol. 80:1887 Even assuming there is some validity to this method of analysis,55 it is not likely to save the institution of security. A tort award typically means more to the tort victim than to the defendant who is to pay it. 56 If we do not know whether we will be tortfeasor or tort victim in the world under consideration, other things being equal, I think that most of us would opt for the tort judgment to be paid. The arguments likely to change our minds about that are all variations of the same one: The system in which the tort judgment would be paid would have higher transaction costs and therefore would be less efficient than the system in which it would not be paid. Unfortunately for the economists, they have no set of tools for comparing transaction costs in two systems. To make such a comparison, they are relegated to the methods of ordinary law professors. They must begin by asserting that the current system, which subordinates the tort creditor, works smoothly, then explain why the proposed system without that subordination will cause big problems, and close with the assertion that surely the transaction costs in the former are less than the transaction costs in the latter. Defenders of the status quo may be tempted to substitute the consent of legislatures for the consent of tort creditors in the argument justifying secured debt. The defenders would assert that the various legislatures set the aggregate level of tort liability with full knowledge of the difficulties tort creditors face in trying to collect. Legislatures, by not enacting rules limiting tort liability, allowed overly generous liability to give tort victims the leverage to extract reasonable compensation. The conclusion of this argument is that suddenly to render nearly all tort judgments collectible by giving Douglas G. Baird & Thomas H. Jackson, Fraudulent Conveyance Law and Its Proper Domain, 38 Vand. L. Rev. 829, 835 n.20 (1985). 55 I find it difficult to understand how the "party," stripped of its role in the societal organization under consideration, is any different from the average law professor in policy mode but equipped with the Golden Rule rather than Rawlsian methodology. Both sit back in their armchairs and try to imagine what kind of social organization will have the most appeal to those subject to it. To interpose the hypothetical party with no self-identity between the law professor and the proposed societal organization adds nothing. 56 Bowers has noted that some creditors value a dollar of recovery more than others. He puts the observation to a very different use, however, arguing that it justifies security. His model, like that of Schwartz, assumes that all creditors are voluntary and thus does not reach the issues I discuss here. See Bowers, supra note 7, at 57-68. HeinOnline --- 80 Va. L. Rev. 1900 (1994)

1994] Unsecured Creditor's Bargain 1901.' them priority over the claims of secured creditors would result in higher levels of compensation than legislators ever intended. 57 These arguments fail for at least two reasons. First, the idea that the victims of torts should be fully compensated is today grounded in economic theory,58 not in the command of the legislature. That is, full compensation of tort victims ensures that tortfeasors cannot externalize costs attributable to their operations. 59 That in tum ensures an appropriate allocation of resources. If a legislature decided that there should be less than full compensation, the legislature would simply be wrong. 60 Second, legislative intent on an issue such as this one is largely fictitious. What the legislatures have actually decided is that those who can pay their tort victims should do so-to the full extent of their wealth. In all likelihood, no legislators have ever actually decided that firms should be able to limit or substantially to eliminate their real exposure to tort liability by using secured debt in their capital structures. As I have previously noted, many of the models used to justify security are based on the assumption that all creditors consent to their roles. 61 Those who create the models know that involuntary debt exists. That they create them anyway suggests their belief in a two-stage approach to the puzzle of secured debt. In the first stage, these theorists justify security as a voluntary and therefore efficient relationship. In the second stage, which they tend not to 57 Thompson notes use of this "runaway tort damages" argument in the debate over limited liability. Robert B. Thompson, Unpacking Limited Liability: Direct and Vicarious Liability of Corporate Participants for Torts of the Enterprise, 47 Vand. L. Rev. 1, 23 (1994). S8 See Guido Calabresi, The Costs of Accidents: A Legal and Economic Analysis 69-70 (1970); A. Mitchell Polinsky, An Introduction to Law and Economics 86-88, 91-93 (1983); George J. Stigler, The Theory of Price 110-12 (3d ed. 1966); Kathryn R. Heidt, Cleaning Up Your Act: Efficiency Considerations in the Battle for the Debtor's Assets in Toxic Waste Bankruptcies, 40 Rutgers L. Rev. 819, 832-35 (1988); Christopher M.E. Painter, Note, Tort Creditor Priority in the Secured Credit System: Asbestos TImes, the Worst of TImes, 36 Stan. L. Rev. 1045, 1056-66 (1984). 59 See Calabresi, supra note 58, at 70,73-74. 60 See James Boyd & Daniel E. Ingberman, Noncompensatory Damages and Potential Insolvency, 23 J. Legal Stud. 895, 896 (1994) ("Standard analyses conclude that [full] compensatory damages are optimal unless enforcement is imperfect."). 61 See supra notes 53-54 and accompanying text. HeinOnline --- 80 Va. L. Rev. 1901 (1994)

1902 Virginia Law Review [Vol. 80:1887 address in their writings, the involuntary creditors will be added to the model, with whatever priority is appropriate. 62 When these theorists do reach the second stage, they face a choice among three alternatives: (1) leave the involuntary creditors where they are now-subordinate to the secured creditors; (2) attempt to ensure payment of the involuntary debt through insurance; or (3) give the involuntary creditors priority over secured creditors. 63 I conclude that the third solution would produce the best allocation of resources and should be adopted. In discussing the economic effects of each of these alternatives, I will assume that transaction costs are small. 64 62 This argument is made most explicitly in Robert K. Rasmussen, Debtor's Choice: A Menu Approach to Corporate Bankruptcy, 71 Tex. L. Rev. 51, 67 (1992) ("[O]nce policymakers decide the optimal treatment of nonconsensual creditors, this treatment should be unalterable by any debt contract."). Rasmussen returned to the subject later to endorse priority for tort creditors on the basis of a Rawlsian analysis. See infra note 88. Schwartz has also developed a theory of priorities based on the assumption that all creditors are contract creditors and then, late in the article, fitted a single class of tort claimants, product liability plaintiffs, into the scheme. Schwartz, supra note 8, at 257-59. Schwartz proposes to subordinate the product liability plaintiffs to substantial, earlier loans, even if the earlier lenders are unsecured. Id. at 257, 260. He defends his solution by asserting that it will make no difference because (he assumes) nearly all tort liability is covered by insurance. Id. at 259. His assumption is incorrect. See infra note 81. Bowers explicitly declines to resolve the difficult issue of the priority appropriate to tort creditors. See James W. Bowers, Groping and Coping in the Shadow of Murphy's Law: Bankruptcy Theory and the Elementary Economics of Failure, 88 Mich. L. Rev. 2097, 2140 n.l00 (1990) ("Like other writers before me, I ignore the substantial difficulties involved in resolving potential conflicts of interest by contract for creditors like tort victims and tax collectors, whose claims arise nonconsensually." (citation omitted)). Shupack is a notable exception; he addresses the plight of the tort creditors directly. Shupack, supra note 7, at 1099-1102, 1111-18. Unfortunately, he reaches the wrong conclusion, deciding that economics cannot provide an answer to whether tort creditors should have priority over secured creditors. Id. at 1117. 63 Other solutions may be possible. See, e.g., Lucian Bebchuk & Jesse Fried, The Uneasy Case for Providing Secured Creditors with Absolute Priority in Bankruptcy 37-42 (Nov. 24, 1993) (unpublished manuscript, on file with the Virginia Law Review Association) (examining alternative systems in which (1) involuntary creditors have priority equal to secured creditors and (2) secured creditors have priority for only 80% of their claims). Neither of the solutions considered by Bebchuk and Fried seems sufficiently promising to warrant consideration here. 64 The reason for not testing under the traditional assumptions of perfect markets and zero transaction costs is that those assumptions are nonsensical. As the Coase Theorem demonstrates, under conditions of perfect markets and zero transaction costs, every proposed scheme of rules and entitlements works equally well. See LoPucki, supra note 16, at 106-10. To test a theory assuming a pattern of relatively low but realistically achievable transaction costs may provide useful information. If the assumptions are HeinOnline --- 80 Va. L. Rev. 1902 (1994)

1994] Unsecured Creditor's Bargain 1903 1. Leaving Involuntary Creditors Subordinate to Secured Creditors Assume that the legislature ratifies the status quo, leaving the involuntary creditors subordinate to secured creditors and equal in priority with voluntary unsecured creditors. As the transaction costs of secured financing fall, the use of security as a means of shifting tort risk back to the victims will tend to expand. 65 There is no apparent reason why this incentive would not eventually render security ubiquitous and reduce tort recoveries to a fraction of tort liability.66 To freeze out their involuntary creditors, firms would have to incur secured debt to the liquidation value of their assets and be willing to go through some kind of liquidation if the involuntary creditors refused to settle. But, as I discuss in Part II.B.1, most small firms already have secured debt in excess of their liquidation values. 67 Chapter 11 provides a vehicle for a liquidation that can discharge unsecured creditors even while the owner-managers retain contro1. 68 If tort recoveries pose a significant threat to a firm that is not already judgment proof, the firm can solve the problem in two easy steps. First, the firm can convert substantially all of its equity into debt through a refinancing, a leveraged buyout, or a stock repurchase. Second, the firm can grant security sufficient to exceed the liquidation value of its assets. That the resulting firm might have only a small net worth will not hamper its ability to do business; the firm's shareholders can provide whatever accurate, such a test may show us how the appropriateness of the theory will change as, over time, actual transaction costs approach those assumed. 65 F.R. Buckley and James Scott both argue that debtors have incentives to reduce their exposure to tort liability by issuing secured debt. Buckley, supra note 7, at 1417; James R. Scott, Jr., Bankruptcy, Secured Debt, and Optimal Capital Structure, 32 J. Fin. 1,2 (1977) ("By the issuance of secured debt, the firm can increase the value of its securities by reducing the amount available to pay legal damages in the event that the firm should go bankrupt."). As the cost of obtaining secured financing decreases, it becomes easier for the debtor to take advantage of this means for transferring wealth from its unsecured creditors to its shareholders. 66 There may be benefits inherent in the use of equity as part of the capital structure that could offset or entirely overcome the advantage of security examined here. The difficulty that finance scholars have had in demonstrating them and thereby defeating the Modigliani-Miller Theorem, however, suggests that these benefits are minimal. 67 See infra note 172 and accompanying text. 68 Lynn M. LoPucki, Strategies for Creditors in Bankruptcy Proceedings 11.11.2, at 642-45 (2d ed. 1991). HeinOnline --- 80 Va. L. Rev. 1903 (1994)

1904 Virginia Law Review. [Vol. 80:1887 guarantees are necessary to induce third parties to deal with the firm-without offering the involuntary creditors equivalent protection. 69 If such strategies were employed brashly enough, they might cause a court to disregard the corporate entity and hold the shareholders of the firm liable for the firm's torts or to determine one of the transfers to have been fraudulent. But practically speaking, neither of these doctrines provides a meaningful check on the debtor's strategy. The corporate law doctrine that permits disregard of a corporate entity appears to be applied principally in contract cases; courts rarely disregard a corporate entity for the benefit of tort creditors?o The mere fact that security interests exceed the liquidation value of a company's assets, rendering the company judgment proof, is not grounds for disregard; if it were, most corporate entities would be vulnerable to disregard already. The disregard doctrine seems to be reserved for cases in which the effort to freeze out the tort creditors is virtually the sole purpose for the corporate structure employed. The doctrine probably has never been applied in favor of tort creditors against an initially adequately capitalized corporation that sank into insolvency and continued to operate in that condition. 71 Theoretically, any transfer of property is fraudulent and avoidable if made with the "actual intent to hinder, delay, or defraud" present or future creditors. 72 A d~btor that announced that it would be following LoPucki's two-step program for defeating its 69 The use of guarantees would be manageable even in the case of a public company with numerous investors. The investors would own shares in a holding company that held most of the equity of the corporate group and that guaranteed the contract debts of the operating company. 70 In an empirical study of veil piercing in nearly 1600 reported cases, Professor Robert Thompson found that only 14% of the cases arose in tort settings. Robert B. Thompson, Piercing the Corporate Veil: An Empirical Study, 76 Cornell L. Rev. 1036, 1058 & tbl. 9 (1991). Among the 226 tort cases, undercapitalization was mentioned in only 12. The court pierced the veil in only nine of the undercapitalization cases. Id. at 1066 n.149; Memorandum from Robert B. Thompson, Professor of Law, Washington University, to Lynn M. LoPucki (Sept. 17, 1993) [hereinafter Thompson-LoPucki Memorandum] (on file with the Virginia Law Review Association). 71 In his study, Professor Thompson separately tabulated undercapitalization cases in which the firm initially had been capitalized, but had become undercapitalized (either intentionally or unintentionally) at a later date. There were 19 such cases, none of which was a tort case. Thompson-LoPucki Memorandum, supra note 70. 72 Unif. Fraudulent Transfer Act 4(a)(1), 7A U.L.A. 652 (1984) ("UFTA"). HeinOnline --- 80 Va. L. Rev. 1904 (1994)

1994] Unsecured Creditor's Bargain 1905 involuntary creditors 73 might have a difficult time defending the transaction against later attack. 74 But debtors who merely stumbled into such capital structures or were swept into them by the invisible hand,75 and thus had no wrongful intent, should have nothing to fear. The specific provisions of fraudulent transfer law most directly applicable to the two-step process described above seem to approve of it.1 6 Our current system, in which secured creditors have priority over involuntary creditors, appears to work only because transaction costs 77 and reputational concems 78 prevent many firms from adopting an all-secured-debt capital structure and liquidating when necessary to defeat the claims of involuntary creditors. Although current law allows a judgment-proof debtor to slough off its unsecured creditors as often as necessary,79 it remains costly and disreputable to do so. Scholars who favor the current, secured-first system ought to be uneasy about the equilibrium toward which this 73 See supra text accompanying notes 65-69. 74 But see Baird & Jackson, supra note 54 (arguing that fraudulent conveyance law should not reach leveraged buyouts, because to extend it so would prevent voluntary creditors from opting out of its coverage). 75 Market forces propel companies in the direction of an all-secured-debt capital structure. To the extent that capital structures include unsecured debt or equity, the firm's real exposure to tort liability is higher, putting it dt a competitive disadvantage. In a world where transaction costs are large, numerous other factors will impact on the firm's decisions regarding its capital structure, and the factor discussed here may show up as only a weak tendency. But as transaction costs are reduced and competition increases, firms must seize whatever advantages are available to them. 76 Probably the most directly applicable provision of the UFfA is 4(a)(2)(i). That section renders fraudulent any transfer made "without receiving a reasonably equivalent value in exchange" if the debtor "was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small." UFfA 4(a) (2) (i), 7 A V.L.A. 652 (1984). Granting security for an antecedent debt will never run afoul of this provision because 3(a) of the Act provides that "[v]alue is given... if... an antecedent debt is secured." Id. 3(a), 7A V.L.A. at 650. That is, to grant security to a creditor is merely to prefer that creditor. The UFfA does not disapprove the making of a preference to a person other than an insider unless it is made with actual fraudulent intent. See id. 5(b), 7A V.L.A. at 657. 77 A firm must be willing to liquidate in order to nullify its tort liability by means of an all-secured-debt capital structure. The transaction costs of liquidation may exceed the benefit to be gained by escaping tort liability. 78 If large firms blatantly and routinely adopted all-secured-debt capital structures and thereby nullified their tort liability, the public would be outraged. 79 LoPucki, supra note 68, 11.11.2, at 642-45. HeinOnline --- 80 Va. L. Rev. 1905 (1994)

1906 Virginia Law Review [Vol. 80:1887 system tends to move. so It is an equilibrium in which tort liability will be almost entirely defeated. 2. Elevating Involuntary Creditors Through Universal Insurance A second possibility for dealing with the priority clash between involuntary unsecured creditors and secured creditors would be to convert the involuntary claims from a potential liability to a current expense through mandatory insurance. That is, if all involuntary liability were insured by responsible insurers, victims could be assured of full recoveries, secured creditors could be assured of their first position, and the priority of involuntary debt would not matter. As our legal system currently operates, substantial amounts of tort liability are uninsured. S! It will do no good to require that debtors insure against it. Much of the liability remaining uninsured 80 Equilibrium probably would be an all-secured-debt capital structure because real tort exposure would be zero. Any change in that capital structure would increase real tort exposure. Reputational concerns would tend to disappear in the intense competition of a world where transaction costs are small. S1 For example, when it filed for reorganization, the Johns-Manville Corporation had over $2 billion in asbestos-related personal injury claims, In re Johns-Manville Corp., 36 B.R. 743, 746 (Bankr. S.D.N.Y. 1984), but it had insurance coverage of only approximately $700 million, In re Johns-Manville Corp., 68 B.R. 618, 621 (Bankr. S.D.N.Y. 1986), aff'd in part and rev'd in part, 78 B.R. 407 (S.D.N.Y. 1987), aff'd, 843 F.2d 636 (2d Cir. 1988). Texaco had negligible insurance against the $11.1 billion Pennzoil judgment. See Texaco, Inc., supra note 41, at 29 n.16 (stating that the Pennzoil judgment is a contingent liability and not mentioning any insurance); Michael A Hiltzik, Texaco Considers Filing Chapter 11 Petition by Monday, L.A Times, Apr. 10, 1987, 4, at 1 (noting Texaco's efforts to avoid pledging company assets as security for the judgment and mentioning no insurance coverage). The Pennzoil judgment was based on a theory of tortious interference with contractual relations. See Thomas Petzinger, Jr., Oil and Honor: The Texaco-Pennzoil Wars 391-93 (1987). AH. Robins had $2.475 billion in personal injury claims, but effectively had only $600 million in insurance. See In re AH. Robins, Inc., 88 B.R. 742, 743-44, 747 (E.D. Va. 1988), aff'd, 880 F.2d 694 (4th Cir.), cert. denied, 493 U.S. 959 (1989). Amatex Corporation had tort liability "conservatively estimated" at $20 million, "well over the combined total of the debtor's assets and insurance coverage [of $9 million]." In re Amatex Corp., 755 F.2d 1034, 1035 & n.1 (3d Cir. 1985). For another example, see Andrew Blum, Keene Truce Announced. But Will it Hold?, Nat'l L.J., July 11, 1994, at A10 (noting Keene Corporation's operation in Chapter 11 with over $600 million in asbestos liability but making no mention of insurance coverage). Insurance policies issued today generally contain pollution exclusion clauses, leaving the debtor without coverage for most damage to the environment. See, e.g., Smith v. Hughes Aircraft Co., 10 F.3d 1448, 1451 & n.1, 1453 (9th Cir.), superseded, 22 F.3d 1432 (9th Cir. 1993); United States Fidelity & Guar. Co. v. Morrison Grain Co., 999 F.2d 489, 491-93 (10th Cir. 1993); see also E. Joshua Rosenkranz, Note, The Pollution Exclusion Clause HeinOnline --- 80 Va. L. Rev. 1906 (1994)