A new approach to valuing secured claims in bankruptcy

In a business bankruptcy in which the firm is to be preserved as a going concern, one of the most difficult and important problems is valuing the assets that serve as collateral for secured creditors. The value of a secured creditor's collateral is important because it affects the payout that must be made to the creditor at the end of the proceeding. Valuing such assets is generally thought to require either litigation or bargaining among the parties, both of which give rise to uncertainty, delay, and deviations from parties' entitlements. We propose a new approach to valuing collateral that involves neither bargaining nor litigation. Under this approach, a market-based mechanism determines the value of collateral in a way that gives no participant in the bankruptcy reason to complain that secured creditors are either over- or undercompensated. Our approach would considerably improve the performance of business bankruptcy and could constitute an important element of any proposal for bankruptcy reform.