In Defense of Chapter 11 for Mass Torts
by | posted in: Bankruptcy, Chapter 11, Mass Torts, Texas Two-Step, Third-Party Releases, Valuation | 0

By Anthony J. Casey and Joshua Macey (University of Chicago Law School)

Anthony J. Casey
Joshua Macey

Recent high-profile bankruptcies involve the use of Chapter 11 proceedings to resolve mass tort claims. In these cases, debtors have employed controversial maneuvers to facilitate global resolution and to minimize operational disruptions that can result from bankruptcy filings. Most notorious among these maneuvers are the third-party release (a key feature in every mass tort bankruptcy) and the two-step bankruptcy (a recent innovation in asbestos cases, also known as the “Texas” two-step).

While most bankruptcy courts have blessed the use of Chapter 11 to resolve mass torts claims, scholars, policymakers, and media commentators have argued that bankruptcy proceedings provide an improper forum for resolving these cases. Critics have taken special aim at the use of the third-party release and the two-step bankruptcy.

In an Essay forthcoming in the Chicago Law Review, we argue that Chapter 11 proceedings provide an appropriate and often superior forum in which to resolve mass tort claims. We further argue that legal innovations such as the two-step bankruptcy and the third-party release can reduce bankruptcy costs and preserve value for all claimants. As a result, these maneuvers and others like them should be welcomed as long as courts are attentive to the potential for opportunistic abuse.

Bankruptcy law resolves the collective action problem that arises when creditors pursue their claims in a variety of separate proceedings. When creditors worry they will not recover the full value of their debt, they race to the courthouse—or courthouses—to collect what they are owed. The result is the destruction of value and potential dismemberment of viable firms. This leaves all claimants and stakeholders worse off. The Bankruptcy Code’s core provisions—the automatic stay, priority rules, prohibitions on fraudulent transfers, preference rules, and treatment of unpaid claims—are all designed to address these problems. This point has never been controversial.

Mass tort cases present this exact collective action problem. When a firm is unable to pay all its tort claims, claimants who file early, or who find themselves before a sympathetic jury, or whose injuries happen to manifest quickly, may receive a large payout. Late claimants risk being left with nothing if the firm’s resources are depleted. And the costs of a decentralized, lengthy resolution of mass torts claims can be large and value destructive for all stakeholders.

Chapter 11 proceedings can mitigate these problems and provide an appropriate and often superior forum in which to resolve mass tort claims. Despite the rhetoric surrounding recent cases, the bankruptcy community has recognized the resolution of mass tort claims as a widely accepted core function of bankruptcy courts for decades. And for good reason: Chapter 11 provides tools for dealing with holdouts and future claimants that are unavailable in conventional class actions or multidistrict litigation proceedings.

Moreover, bankruptcy tools that facilitate efficient, lower-cost resolution should be welcomed. The two-step bankruptcy and the third-party release are such tools, as long as courts guard against opportunistic abuse. Properly used, the third-party release prevents holdout behavior and incentivizes perpetrators of corporate misconduct to disclose their role in the company and to contribute assets to the bankruptcy estate. Similarly, the two-step bankruptcy allows a firm to quarantine mass tort liabilities from operations facilitating resolution in a single, streamlined bankruptcy proceeding without involving all nontort counterparties. These maneuvers thus further the Code’s purpose by providing a single forum in which to efficiently and fully resolve the firm’s mass tort liabilities.

Of course, debtors and managers can abuse the third-party release and the two-step bankruptcy. But given their potential to benefit all claimants, these tools should not be altogether prohibited. Instead, because the potential for abuse is identifiable, targeted procedures and reforms can mitigate it.

For example, courts should ensure bankruptcy proceedings do in fact mitigate collective action problems and do make tort claimants as a class worse off. Courts should be aggressive in demanding disclosures from the released parties, in requiring strong proof about the value of assets and liabilities, and in policing fraudulent transfers.

Perhaps a trickier issue is that unequal bargaining dynamics and information asymmetries may allow managers to use the reorganization process to take advantage of tort claimants. With full control of the bankruptcy proceeding, managers can pressure tort claimants with take-it-or-leave-it offers. They may also have private information about asset and claim values. Though these are serious concerns, we think that they, too, are best addressed through reforms to the bankruptcy process. To that end, we consider a menu of reforms that would inhibit insiders from taking advantage of their superior informational position.

Click here to read the full article.

Bankruptcy & Bailouts; Subsidies & Stimulus: The Government Toolset for Responding to Market Distress
by | posted in: Bankruptcy, Bankruptcy Reform, Bankruptcy Roundtable Updates | 0

By Anthony J. Casey (The University of Chicago Law School)

Anthony J. Casey

In the spring of 2020, as the Covid-19 pandemic shut down economies around the world, pressure arose for governments to respond to the growing threat of pandemic-related market distress. In the United States, the initial proposals for government action varied in nature and focus. Some proposals targeted the financial system while others targeted small businesses and individuals. Others were intended to bail out large businesses and specific industries. Still other proposals took a more institutional focus. In the context of bankruptcy law, many imagined building up the bankruptcy system as a primary bulwark against a seemingly imminent wave of economic and financial distress.

With the exception of measures related to financial markets, the actual responses formed a chaotic mix of disconnected half-measures that neither stabilized the economy nor provided meaningful relief to those most affected. While that failure may be attributed in part to general government dysfunction and legislative gridlock, a large part of the problem arises from the lack of a clearly identified framework to guide government responses.

The main lesson here is that the appropriateness of tools deployed to alleviate a crisis depends on the nature of the specific problem at hand, and scattershot approaches are unlikely to work. As obvious as that principle may seem, it was largely ignored in 2020. Much of the confusion in the pandemic responses is attributable to using the wrong tools and implementing measures that lacked any clear purpose.

In particular, governments and commentators lost sight of two important distinctions in deciding how to act. The first is the distinction between tools appropriate for addressing economic distress and those appropriate for addressing financial distress. The second is the distinction between a systemic crisis where distress is spreading and an instance of firm-specific distress where the harm—though perhaps large—is contained.

These distinctions present four types of market distress: specific economic, systemic economic, specific financial, and systemic financial. Each type is distinct from the others, and for each there is a category of appropriate government responses (respectively): direct subsidies, general stimulus, bankruptcy proceedings, and financial bailouts. We thus have this matrix:

Systemic Specific
Economic General Stimulus Direct Subsidies
Financial Financial Bailouts Bankruptcy Proceedings

(Chapter 11)

 

The importance of understanding these classifications is most evident in the flawed proposals for pandemic-related fixes to bankruptcy law and in the lack of a centralized economic plan to support failing small businesses around the country.

In a new article, I lay out this framework for identifying the right tools for responding to different forms of market distress.  I describe the relationship between the category of tools and the type of distress. Having presented the framework, I then use it to closely examine the interaction between pandemic responses and bankruptcy law. This analysis is particularly important because efforts to understand the bankruptcy system’s role during the pandemic provide the starkest example of confused analysis of appropriate responses to systemic crises, and because a striking decline in bankruptcy filings in 2020 has puzzled many commentators.

The New Bargaining Theory of Corporate Bankruptcy and Chapter 11’s Renegotiation Framework
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, Bankruptcy Roundtable Updates, Jurisprudence | 0

By Anthony J. Casey (University of Chicago Law School)

The prevailing theory of corporate bankruptcy law states that its purpose is to vindicate or mimic the agreement that creditors would have reached if they had bargained with each other to write their own rules. That idea – the Creditors’ Bargain theory – has held a central place in the minds of lawyers, judges, and scholars for almost forty years. At the same time, Creditors’ Bargain theorists have struggled to explain what actually prevents creditors from bargaining with each other and how efficient rules that interfere with creditors’ bargained-for rights fit into the theory.

Meanwhile, in other areas of the law, scholars have long recognized the limits of hypothetical contract theories. Notably, scholars have shown that when parties have limited or asymmetric information and incentives to bargain strategically, their contracts will be incomplete in ways that the law cannot remedy with a hypothetical contract. Bankruptcy scholars have never squarely addressed this challenge.

Taking aim at these issues, my article, The New Bargaining Theory of Corporate Bankruptcy and Chapter 11’s Renegotiation Framework, proposes a new law-and-economics theory of corporate bankruptcy. Financial distress routinely presents uncertainty that is not contractible. By its very nature – given the number of parties engaged in strategic bargaining and the number of contingencies – financial distress poses questions that are impossible to predict, define, and negotiate in an ex ante contract. As a result, relationships involving a distressed firm are governed by incomplete contracts that allow parties to hold each other up.

Corporate bankruptcy law’s purpose is to solve this hold-up problem. The problem is familiar in law, but its frequency in the distress context invites a special bankruptcy solution. The noncontractible uncertainty associated with financial distress is a recurring characteristic across all firms. Because every relationship of this type is incomplete and requires judicial intervention upon the occurrence of the same event, a uniform bankruptcy system that deals with those relationships will produce consistency, efficiency, and market predictability.

In Chapter 11 that uniform system takes the form of a structured renegotiation framework. Because of the high level of ex ante uncertainty, the system relies mostly on procedural protection rather than specific substantive prescriptions. The framework allows parties to renegotiate their relationships within a system that imposes prices and burdens on the bargaining process and then subjects the results to high-level judicial oversight. The specifics of this framework are targeted at reducing the worst and most likely instances of hold up that block renegotiation efforts.

Bankruptcy, then, is not about mimicking a hypothetical ex ante bargain. It is about facilitating an actual ex post bargain. The normative claim of my article is that bankruptcy law’s core purpose is to solve the hold-up problem. The descriptive claim is that the ex post renegotiation framework is the fundamental attribute of Chapter 11. The remaining normative question is whether Chapter 11 succeeds at its purpose. This New Bargaining Theory of corporate bankruptcy can help identify the metrics by which to answer that question.

The full article is available here.