14 March 2016

No Bankruptcy For You: The Indirect Prohibition of Educational Reorganization

My spring semester Bankruptcy class is about to transition from the messy world of individual debt relief to the multi-variable universe of business bankruptcy. While I'm happy to let Dean (and former bankruptcy judge) Rich Leonard teach an advanced seminar in corporate reorganization, it is appropriate for all bankruptcy students to get at least a taste of the intricacies of Chapter 11 reorganization.

With a very few exceptions, the Bankruptcy Code permits any financially stressed corporation (or individual for that matter) to seek to reorganize its debts. Bankruptcy reorganization exists because the value of the whole is greater than its constituent parts. In other words, auctioning the assets of an insolvent business produces less value for its creditors than the same business with a new and improved capital structure. Not only are creditors made better off by reorganization, employees, customers, trading partners, and even the community as a whole do better if the business remains intact albeit under new ownership (and often new management).

At least that's the theory.

The implementation of corporate reorganization law is expensive and it's not clear if all of reorganization's potential gains are realized. Nonetheless, it  seems clear that the practice of corporate reorganization produces a net social gain. And, if that's the case (and I believe it is), there would be no good reason to prohibit an otherwise-eligible corporation from at least trying to reorganize, right?

No, there wouldn't. Yet as Matthew Bruckner explains in Bankrupting Higher Education (download here), institutions of higher education face an insuperable barrier to reorganizing their debts. Upon seeking any form of bankruptcy law relief, they automatically become ineligible to participate in federal financial aid programs, which means in virtually all cases they must shut their doors. Any residual value that creditors and others could realize through reorganization is lost.

You might think my response to this state of affairs would be a firm "meh" given my posts about the sad state of higher education in American (some examples here, here, and here). Yet consider Bruckner's well-tempered observation:
The effects of the college bankruptcy reorganization ban are more strongly felt among certain types of institutions. In particular, small colleges that have traditionally provided a liberal arts education and those that were founded to counter race- and gender-based discrimination appear especially vulnerable to financial distress, and are therefore more likely to need to take advantage of chapter 11’s toolkit. As a result, many of our nation’s most storied institutions have been forced to close their doors, preventing them from fulfilling their important missions, instead of being allowed to reorganize in bankruptcy. For example, almost twenty percent of all historically black colleges and universities (“HBCUs”) have closed since 1980.
To cut to the chase, it is the Higher Education Act and not the Bankruptcy Code that makes impossible reorganization of colleges and universities.

Bruckner's article is 61 pages long because it addresses not only the nature of the "death penalty" for colleges and universities that need to reorganize their debts but also why this should not be the case. In other words, he explains how the possibility of reorganization under federal bankruptcy law can preserve value for several groups of stakeholders and serve the common good, a two-fer that's generally not the case in the reorganization of most commercial enterprises.

None of this is to say, at least not in my opinion, that all colleges and universities in financial distress should reorganize. Bruckner addresses structural and cultural reasons why higher education in America finds itself in distress and Chapter 11 certainly will not solve those sorts of problems. Many schools should close but those for which there is no hope of financial recovery should not poison the well for those that could if given the chance.

In any event, Bankrupting Higher Education is an excellent piece of scholarship and should be of interest to those institutions that can gain the ear of lawmakers in Washington.


  1. Thank you for your post. You given us a very deep and thorough analysis of how to re-structure the educational organization in America. I don't see any bad effects if one organization files for chapter 11 bankruptcy. The time may not favor them but forcefully decided because they don't have a choice. We always have a choice, that is why ending up filing a bankruptcy is the last resorts. |

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