We present a model of an insolvent firm that may take advantage of a `soft-touch’ government creditor in order to buy time before filing for reorganization, behavior we refer to as `claims substitution.’ We show that deviations from absolute priority reduce the incentive for claims substitution and that strict government priority is economically efficient. We discuss the implications of our findings for bankruptcy law reform, especially with respect to the priority of tax claims in bankruptcy and the enforcement of absolute priority.
FISHER, T.C.G., MARTEL, J. et GAVIOUS, I. (2016). Tax claims, government priority, absolute priority and the resolution of financial distress. International Review of Law and Economics, 48, pp. 50-58.