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Narrowing The Bankruptcy Safe Harbor For Derivatives To Combat Systemic Risk, Bryan G. Faubus

Duke Law Journal

Bankruptcy law establishes proceedings designed to rehabilitate debtors while protecting creditors, but a series of safe harbors effectively exempts from bankruptcy proceedings certain financial contracts known as derivatives. Accordingly, when a party to a derivative contract goes bankrupt, the counterparty may terminate the contract and seize what it is owed from the debtor's assets. Congress enacted these safe harbors to combat the risk of systemic failure by maintaining liquidity in troubled markets; in doing so, however, they allowed counterparties to engage in opportunistic behavior and inefficiently consume a debtor's limited assets. Because these two consequences may harm the debtor and …