Mass Exploitation

By Samir D. Parikh (Lewis & Clark Law School; Fulbright Schuman Scholar; Bloomberg Law; Fulbright Commission)

Samir D. Parikh

Modern mass tort defendants – including Johnson & Johnson, Purdue Pharma, USA Gymnastics, and Boy Scouts of America – have developed unprecedented techniques for resolving mass tort cases; innovation coupled with exploitation. Three weapons in this new arsenal are particularly noteworthy. Before a filing, divisive mergers allow corporate defendants to access bankruptcy on their terms. Once in bankruptcy, these mass restructuring debtors curate advantageous provisions in the Bankruptcy Code to craft their own ad hoc resolution mechanism implemented through plans of reorganization. This maneuver facilitates various questionable outcomes, including the third-party releases the Sackler family recently secured. Finally, in order to minimize its financial contribution to a victims’ settlement trust, a mass restructuring debtor can agree to convert its tainted business into a public benefit company after bankruptcy and devote future profits – no matter how speculative they may be – to victims.

The net effect of these legal innovations is difficult to assess because the intricacies are not fully understood. Debtors argue that these resolution devices provide accelerated and amplified distributions. And forum shopping has landed cases before accommodating jurists willing to tolerate unorthodoxy. The fear, however, is that mass tort victims are being exploited. The aggregation of these maneuvers may allow culpable parties to sequester funds outside of the bankruptcy court’s purview and then rely on statutory loopholes to suppress victim recoveries.  Mass restructuring debtors are also pursuing victim balkanization – an attempt to pit current victims against future victims in order to facilitate settlements that may actually create disparate treatment across victim classes.

This Essay is the first to identify and assess the new shadowed practices in mass restructuring cases, providing perspective on interdisciplinary dynamics that have eluded academics and policymakers. This is one of the most controversial legal issues in the country today, but there is scant scholarship exploring improvement of the flawed machinery. This Essay seeks to create a dialogue to explore whether a legislative or statutory response is necessary and what shape such a response could take.

The full article will be available at 170 U. Pa. L. Rev. Online ___ (forthcoming 2021) and can be accessed here.

Corporate Reorganization as Labor Insurance in Bankruptcy

By Diana Bonfim (Banco de Portugal; Catholic University of Portugal – Catolica Lisbon School of Business and Economics) and Gil Nogueira (Bank of Portugal – Research Department)

Diana Bonfim
Gil Nogueira

How does corporate reorganization affect labor outcomes in bankruptcy? The existing literature argues that corporate reorganization affects the reallocation of labor because it retains workers in bankrupt firms. In some cases, bankrupt firms remain alive for too long and retain workers inefficiently. In other cases, reorganization reduces the probability of inefficient liquidation.

In this paper we show that resource retention is not the only determinant of labor outcomes in bankruptcy. The decision process in bankruptcy creates a principal-agent problem between firms’ claimholders and other stakeholders (e.g., workers, suppliers). Claimholders decide bankruptcy outcomes but other stakeholders with limited say in the bankruptcy process are also affected by these outcomes. 

Workers are among these stakeholders. They use job contracts with firms as a form of insurance in times of adversity. In the absence of corporate reorganization, workers lose these job contracts and experience persistent costs of job loss. Reorganization improves labor outcomes because it reduces the probability that workers lose the insurance provided by job contracts when the costs of job loss are high.

We test this hypothesis empirically using data from Portuguese reorganization cases. The institutional setting has several features that help design an adequate empirical strategy. First, reorganization cases are randomly allocated across judges. We use this random assignment as a source of variation in the probability of reorganization that is not affected by other factors that also influence workers’ careers. Second, Portuguese firms report financial statements annually, which we use to check whether reorganization affects labor reallocation to more productive or profitable firms. Finally, we link this data to a rich administrative employer-employee matched dataset, which allows us to track workers who eventually change jobs. This dataset is unique because it contains rich job descriptors. We use this data to establish a relationship between corporate reorganization and the scarring effect of bankruptcy on workers’ job functions.

We uncover three main findings. First, we measure the effect of corporate reorganization on the sorting of workers to productive and profitable firms. In five years, only about 20% of the workforce remains in reorganized firms. Many workers from reorganized firms find jobs with new employers. We find no evidence that reorganization affects the reallocation of labor to efficient or profitable firms.

Second, reorganization is an important source of labor insurance against negative productions shocks. In the short term, reorganization increases the probability that workers are employed. In the long term, reorganization increases wages and reduces the scarring effect of job downgrading that is often observed in recessions. Reorganization reduces the probability that workers move to less skill-intensive occupations and increases occupation wage premia. 

Third, we show that reorganization improves job transitions to new employers. Reorganization increases the average time it takes to leave a firm that files for bankruptcy by one year. Reorganization reduces the probability that workers move to low-paying jobs and increases the probability that workers find high-paying jobs with new employers.

Overall, our results show that corporate reorganization is an important source of labor insurance in bankruptcy, thereby mitigating the scarring effect of job loss. The full article is available here.

Reorganization without Bankruptcy: Untying the Gordian Knot That Destroys Firm Value

By Noam Sher (Assistant Professor of Law, Ono Academic College, Israel)

Noam Sher

In a recent article, I present a new theory for analyzing bankruptcy-reorganization proceedings, as well as a reorganization mechanism for public companies that may best meet legislative objectives: maximizing firm value and dividing it according to the claimants’ legal priorities. Called Gordian knot theory, the article suggests that there is a strong structural and material connection between reorganization stages, whereby bargaining and litigation between the claimants over the reorganization pie lead to progressive destruction of the firm’s value and infringement on their legal rights. To demonstrate this theory, this Article focuses on reorganization’s allocation and reallocation stages—where the claimants’ original and new rights are determined, respectively—and how the connection between them prevents the bankruptcy proceedings’ legislative objectives from being met. Alternative approaches suggested for attaining these objectives, including Roe’s, Bebchuk’s, Baird’s, Aghion, Hart and Moore’s, and Adler and Ayres’ models, have focused on the firm valuation problem and suggested solving it by market mechanisms. The Gordian knot theory suggests, however, that it is impossible to attain the legislative objectives strictly by determining the firm’s value efficiently while leaving allocation problems to bargaining and litigation.

This article further presents a new mechanism for public companies, the reorganization without bankruptcy mechanism. This mechanism overcomes the aforementioned allocation problems by structuring reorganization in a single shot that includes the allocation and reallocation of rights, while eliminating the need for bargaining and court proceedings. The mechanism is based around the existing requirement for a firm’s auditors to issue a going-concern warning when there is substantial doubt as to whether the firm can remain solvent over the next twelve months. Under the proposed mechanism, the warning initiates twelve months of voluntary rehabilitation. Then, if the warning is still in place, the junior classes will be able to buy out all of the senior classes at a price of the latter’s claims, similar to Bebchuk’s options model. A successful buy erases the original debt. If the claimants do not purchase the firm, it is considered insolvent.

This Article presents the mechanism and discusses its advantages: inter alia, in the pre-bankruptcy period, the firm is solvent, it has not breached its contracts, and it is not involved in complex allocation disputes. These advantages bring the reorganization process in line with the legislative objectives, and permit firms to achieve rehabilitation by allowing for funding based on market mechanisms and management’s sole discretion, providing management with incentives for adequate disclosure, and initiating rehabilitation based on objective criteria — all free of bargaining and litigation biases.

The full article can be found here.