Bankruptcy and commercial law and the myth of the economically rational actor

“Bankruptcy and commercial law provide the essential rules necessary for any country’s daily life; these laws affect every type of exchange, from buying a Twinkie to building a hydroelectric dam.  No company or entrepreneur can do anything without considering their effect on each transaction undertaken.”

Do you agree?

The quote above comes from Bruce Markell, currently a professor of law at Florida State University, formerly a highly regarded United States Bankruptcy Judge, and a very long time ago the partner for a bankruptcy research project assigned to me when I was a summer associate in a large law firm.  I have an enormous amount of respect for Judge Markell, and I genuinely like him, and for many years I would have been inclined to say that his statement above is correct.  However, I can’t agree with his statement as drafted.  To help the analysis, let’s separate the statement into two separate components, each to be evaluated independently:

Bankruptcy and commercial law provide the essential rules necessary for any country’s daily life; these laws affect every type of exchange, from buying a Twinkie to building a hydroelectric dam.

I agree with this as an absolute truth, and you probably do, too.  OK, there’s a reasonable challenge to this assertion as applied to countries whose exchanges are driven by cultural norms as much as (or even more than) laws.  But in modern industrial democracies, it’s hard to argue with the accuracy of the first part of Judge Markell’s statement. Now on to part 2:

No company or entrepreneur can do anything without considering [the] effect [of bankruptcy and commercial law] on each transaction undertaken.

I agree that no company or entrepreneur can rationally do anything without considering the effect of bankruptcy and commercial law on each transaction undertaken.  However, business decisions, like personal ones, sometimes get made with irrational disregard for factors that would be dispositive to a rational actor.  I know this from my own experience, and you probably do, too–maybe it’s because of trust in a valued relationship.  Or maybe it’s fear of derailing a deal’s momentum, or some other psychological factor.  Ultimately, companies act and decide through people, and people are, well, human, with human psychological foibles.

Most economists now recognize that the long-cherished hypothetical rational actor is just that, hypothetical.  If you’re a traditionalist and continue to believe in the economic rationality of people, then I encourage you to read Predictably Irrational by Duke professor Dan Ariely.  (If you’re more comfortable reading in French, its translated version is called C’est (vraiment) moi qui décide?)  In that book, Professor Ariely summarizes many of the insights of the field now known as behavioral economics, and makes them accessible, relevant, and entertaining. (He himself is responsible for some of those insights, even if the Nobel prize glory for behavioral economics went to his psychologist colleague and occasional collaborator Daniel Kahneman.)

We’ll come back to American bankruptcy and commercial law in future Law Talks.  If you do business in the United States, or if you advise companies that do business in the United States, then it truly is irrational for you to ignore their effect.  To paraphrase Judge Markell, “no company or entrepreneur doing business in the US can rationally do anything without considering the effect of American bankrupcty and commercial law on each transaction undertaken.”

For now, simply enjoy Dan Ariely’s entertaining and informative 2008 TED Talk “Are we in control of our own decisions?”:

And if you have an experience with irrational decision-making in business, whether or not it involves bankrupcty and commercial law, please feel free to share it in the comments!

Maternity leave in the US: a representative demonstration of federalism

President Obama recently mentioned paid maternity leave as a priority goal in his State of the Union message to Congress. Maternity and parental leave laws vary from state to state in the United States, in a representative demonstration of American federalism.  Today’s Law Talk blog article will help the reader understand both American federalism and American parental leave policies.

First, though, an observation: the US doesn’t seem very generous when its national paid parental leave policy–there is none–is compared with that of other countries (16 weeks in France, for instance, or 50 in Canada).

A fundamental characteristic of American government is that the country consists of 50 sovereign states in a federal system where the national government has limited power.  The roots of this federalism go back to 1776: through their famous Declaration of Independence from Great Britain, the 13 colonies became 13 “states” joined in a battle for independence. They organized themselves under a document, finalized in late 1777 and ratified over the next few years, known as the Articles of Confederation.  After their independence was confirmed through the 1783 Treaty of Paris, these new states—countries—remained bound together for limited purposes under the pre-existing Articles of Confederation.  The many flaws with the Articles of Confederation led to the drafting of a proposed replacement constitution at a 1787 convention, and this new document, the US Constitution, went into effect in 1789.  Between its initial text and the 10th amendment ratified a few years later, the US Constitution confirmed three categories of government authority:

-the national government has exclusive authority in some areas (such as defense and interstate commerce);

-the national and state governments have concurrent authority for other areas; and

-the state governments have exclusive authority for areas where the Constitution doesn’t grant authority to the national government.

This division of authority across levels of government often leads to disagreement.  The disagreement once rose to the level of war—the Civil War of 1861-1865—and was quite heated during the civil rights battles of the 1950’s and 60’s, such as when President Eisenhower called upon the military to ensure Arkansas compliance with federal court desegregation orders in the face of resistance in the name of “states’ rights.”  The tension is usually less violent, but still ever-present.

As a result of this division of authority, some areas of policy will be developed through laws at the national level alone; others will be developed through laws at both the national and state levels; and still others will be developed through laws at only the state level.

Where does parental leave policy fit into this framework?  It’s pretty clear that the Constitution is silent on whether the national government has the authority to compel employers to allow parent employees to take time off in connection with the birth of a child.  If that were the end of the analysis, then it would be clear, given the limited authority of the national government, that there’s no authority to enact a federal parental leave policy.

However, there are at least two constitutional grants of authority to the national government that might permit a national parental leave policy: the Commerce Clause’s grant to the national government of authority to regulate interstate commerce; and the Fourteenth Amendment’s grant of authority to the national government to enforce the “Equal Protection” clause of the Fourteenth Amendment, including that clause’s judicially-identified freedom from gender-based discrimination in the workplace.

This was the constitutional framework when President Clinton signed into law, very early in his first term, the Family and Medical Leave Act of 1993. The FMLA required (and continues to require) covered employers to provide eligible employees with job-protected but unpaid leave for qualified medical and family reasons, including the birth of a child. Given that not all employers are covered, and not all employees are eligible, not all employees in the US benefit today from the FMLA: according to a 2007 study, two-thirds of American workers worked then for covered employers, and 54% of American workers were then eligible for FMLA leave.

What does the FMLA guarantee to eligible workers?  The right to take up to 12 work weeks of unpaid leave during any 12-month period to attend to the serious health condition of the employee, parent, spouse or child, or for pregnancy or care of a newborn child, or for adoption or foster care of a child.

The constitutionality of the FMLA was reviewed by the US Supreme Court in a case that arose because the law applied to state government employers . In 1997, the State of Nevada fired a worker for failure to show up to work after having exhausted his FMLA leave.  The fired worker sued the State of Nevada for alleged violations of the FMLA, and in its defense the State of Nevada challenged the FMLA’s constitutionality, arguing that the national government didn’t have the authority to impose a family leave policy on a state government employer under the Eleventh Amendment (which addresses a state’s sovereign immunity). The lawsuit made its way up to the US Supreme Court, and in 2003, a divided Court upheld the constitutionality of the FMLA: first, the Court found that the FMLA was a valid exercise of authority under the Fourteenth Amendment; and then the Court found that the FMLA validly impinged on state sovereign immunity, notwithstanding the Eleventh Amendment.  (One justice, in a concurring opinion that agreed with the conclusion but not the reasoning, would have upheld the constitutionality of the FMLA under the Commerce Clause but not under the Fourth Amendment.)

It’s still the case that the US has no national law providing for paid time off for new parents. However, some of the 50 states do.

States can also enact FMLA-like laws with their own rules that impose a job-protected leave requirement on a broader range of employers than under the FMLA, or expand eligibility to a broader range of employees than under the FMLA.

The culture of federalism is such that a national lawmaker (a representative or senator) might support the expansion of paid leave as good policy, yet oppose a national law to get there (such policies best being left to the states).

This is the context today for President Obama’s recent State of the Union message.  (The State of the Union message is itself a feature of the US Constitution, which requires the President to periodically give Congress information on the state of the union and recommend measures believed to be necessary and expedient.)  In January’s State of the Union message, President Obama announced a plan to expand paid leave for workers, starting with the federal government.  The plan has three components:

  1. Calling on Congress to pass legislation that would guarantee paid leave for employees throughout the United States.
  1. Proposing the appropriation of funds to encourage states to develop their own paid leave programs.
  1. Using presidential authority over the federal workforce to provide paid leave for federal employees. (The President has already signed an order to this effect.)

You now know enough about federalism and family leave policies in the US to delve further.  Here are a few resources to get started:

A recent news article on President Obama’s plan to expand paid leave

The majority, concurring, and dissenting opinions in Nevada vs Hibbs

The US Department of Labor page on the FMLA

A Wikipedia article on the FMLA

The US Constitution