Publication Date



This Article provides a framework for analyzing side agreements among stakeholders in corporate bankruptcy, such as intercreditor and “bad boy” agreements. These agreements are controversial because they commonly include a promise by a stakeholder to remain silent—to waive some procedural right they would otherwise have under the Bankruptcy Code—at potentially crucial points in the reorganization process.

Using simplified examples, we show that side agreements create benefits in some instances. But, in other cases, parties to a side agreement may attempt to extract value from nonparties to the agreement by contracting for specific performance or excessive stipulated damages that impose negative externalities on those nonparties. By using more extreme (and inefficient) remedies, the parties to the agreement can commit themselves to charging more to nonparties who—seeking to avoid the externalities—pay them to breach the agreement. While this can be profitable for the parties to the agreement, it can also lower the collective value of the estate for all stakeholders.

We develop a proposal that not only preserves the efficiency benefits of side agreements but also limits negative externalities and opportunities to extract value from nonparties. Where a nontrivial potential for value-destroying externalities exists, the court should enforce the agreements but limit the remedies for breach to expectation damages. Our proposal is superior to the current approach in the case law, which focuses on tougher contract interpretation standards instead of limitations on remedies.

We also use our model to determine whether intercreditor agreement disputes should be resolved by the bankruptcy court or by other courts. If the nonbreaching party asks for expectation damages, the bankruptcy court has no particular expertise and should defer to forum selection clauses. Where the nonbreaching party seeks specific performance or stipulated damages, by contrast, our model suggests that the dispute should be resolved exclusively in bankruptcy proceedings.