The rise of corporate bankruptcies over the last few years has prompted legislators and academics alike to push for bankruptcy law reform. Fearing the death of legal liability, these reformers are calling for increased creditor protectionism through the weakening of limited liability and the reversal of “judgment proof” transactions such as the creation of special purpose entities (SPE) commonly used for the sequestering of assets.
“Letting intellectual property (IP) assets slip into a bankruptcy estate is a dangerous idea,” says Troy Paredes, associate professor of law at Washington University in St. Louis.
Bankruptcy raises a central problem for IP rights that it does not raise for other assets such as land or commercial paper.
“IP rights disappear over time (especially patents and trademarks), and when in force their core private and social value is tied to the right to exclude other market actors – the credible threat of an injunction,” says F. Scott Kieff, an expert on IP law and an associate professor of law at Washington University in St. Louis. “The uncertainty and delay of the administrative process in bankruptcy can almost wipe out the credibility of this threat. As a result, the creation of a bankruptcy remote SPE is especially important for IP assets.”
The proposed bankruptcy law reforms, in addition to damaging IP rights, will “bring a host of costs that are significant and difficult to mitigate,” says Paredes, an expert in corporate and securities law.
“To the extent legal liability needs to be shored up even further, a number of options exist outside of corporate and bankruptcy law. These include minimum capitalization requirements, mandatory insurance, and more stringent product safety regulation.”
Overall though, Paredes notes that reformers’ fears about the demise of legal liability are overstated.
“The death of legal liability may be greatly exaggerated,” Paredes says. There are already holes in the limited liability veil, and a variety of constraints keep judgment proofing in check.
“Even if it is dying, it might not be worth mourning. First, many creditors are compensated up front for the risk they bear in extending credit to a corporation. Second, tort liability taxes the economy. Finally, additional restrictions on financial arrangements can be expected to limit the pool of available capital and drive up the cost of capital.”
A full article on this subject, co-authored by Paredes and Kieff, will be in an upcoming issue of the Washington University Law Quarterly. This issue will contain a selection of articles from the recent F. Hodge O’Neal Corporate and Securities Law Symposium.