The partitioning of businesses into separate legal entities has been the focus of financial and legal study for decades. This literature has looked at the implications of legal separations across various dimensions such as corporate governance, limited liability, tax, and risk partitioning. In a recently published article, No Exit: Withdrawal Rights and the Law of Corporate Reorganizations, Douglas Baird and I look at the intersection of entity partitioning and bankruptcy law.

Many recent high-profile bankruptcy cases have presented complicated questions of how legal entities should be treated in the bankruptcy process. These cases were particularly challenging because the entity partitioning before the courts could not be explained by traditional considerations such as risk allocation and limited liability. These entities were set up in a way that partitioned off assets that were part of one interconnected economic operation that could not function without the partitioned assets. The structures did not provide a liability shield and each part shared in the risk of the entire operation.

In response to these cases, the bankruptcy courts have tended to push against the edges of black-letter bankruptcy law and blur the boundaries between legal entities. The motivation for this tendency is easy to identify: The courts, all else equal, want to preserve going concern value. And that is best accomplished (from their ex post view) by keeping entities that are part of one economic enterprise together. But this tendency may be undercutting a new form of bankruptcy that has evolved to address some of the central challenges to efficient bankruptcy design.

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