The New Corporate Web: Tailored Entity Partitions and Creditors' Selective Enforcement

Firms have developed sophisticated legal mechanisms that partition assets across some dimensions but not others. The result is a complex web of interconnected affiliates. For example, an asset placed in one legal entity may serve as collateral guaranteeing the debts of another legal entity within the larger corporate group. Conventional accounts of corporate groups cannot explain these tailored partitions. Nor can they explain the increasingly common scenario in which one creditor is the primary lender to all or most of the legal entities in the group. This Article develops a new theory of selective enforcement to fill these gaps. When a debtor defaults on a loan, the default may signal a failure across the entire firm, or it may signal an asset- or project-specific failure. Tailored partitions give a primary monitoring creditor the option to select either project-specific enforcement or firm-wide enforcement, depending on the signal that the creditor receives. In this way, the creditor can address firm-wide risks and failures globally while locally containing the costly effects of project-specific risks and failures. This option for selective enforcement reduces the costs of monitoring and enforcing loan agreements and, in turn, reduces the debtor's cost of capital. These concepts of selective enforcement and tailored partitions have important implications for legal theory and practice. In addition to providing a cohesive justification for the web of entity partitions and cross liabilities that characterize much of corporate structure today, they also inform how bankruptcy courts should approach a wide range of legal and policy issues, including holding-company equity guarantees, good-faith-filing rules, fraudulent transfers, and ipso facto clauses.