Rethinking Freedom of Contract: A Bankruptcy Paradigm

This article tests the limits of private contracting by examining what it means to contract about bankruptcy. Bankruptcy law is governed by a statutory code that defines the relationship between debtors and creditors when a debtor enters the bankruptcy regulatory scheme. May debtors and creditors contract in advance to change that relationship? Or would these contracts be "Faustian" bargains that the state should not enforce? Both courts and scholars are in conflict, yet the answer is critical because it affects not only bankruptcy costs but also the structuring of corporate reorganizations and securitization transactions. I maintain that the threshold question, what freedom should parties have to contractually override a statutory scheme, has not yet been adequately addressed in this context. I first examine the principles by which parties should, or should not, be allowed to contractually alter statutory schemes. I then apply those principles to a model of prebankruptcy contracting by taking into account the policies underlying the bankruptcy code and also by analyzing the extent to which, under contract law, externalities should render a contract unenforceable. I conclude that, within defined limits, bankruptcy law should be viewed as default provisions and not mandatory rules. Finally, I show that my model of prebankruptcy contracting can have important applications, not only to making corporate reorganization and securitization transactions more efficient but also to understanding when parties should be allowed to contract about statutory schemes generally and when externalities should override freedom of contract.