[Texas Two-Step and the Future of Mass Tort Bankruptcy Series] Vertical Forum Shopping in Bankruptcy

By Jonathan C. Lipson (Temple University-Beasley School of Law)

Note: This is the second in a series of posts on the Texas Two Step, the bankruptcy of LTL Management, and the future of mass tort bankruptcies.  Check the HLS Bankruptcy Roundtable throughout the summer for additional contributing posts by academics from institutions across the country.

The first post in this series can be found here.

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Jonathan C. Lipson

Forum shopping has long been an issue in chapter 11 reorganization, chiefly because liberal venue rules permit gamesmanship.  Section 1408 of the Judicial Code allows a corporate debtor to “bootstrap” into the bankruptcy court of any district where at least one entity in the group was formed.  If a forum is chosen “strategically,” Professors Lynn LoPucki and Bill Whitford first warned (in 1991), “the choice can have an important effect on the distribution of the losses emanating from a bankruptcy reorganization.”

They were describing what may be called “horizontal” forum shopping:  picking among the nation’s roughly 200 bankruptcy panels to find the one the debtor considers best for its situation.  Cases such as LTL Management and Purdue Pharma suggest there is another kind to think about, a variation on what proceduralists call “vertical” forum shopping.

Vertical forum shopping typically concerns competition between state and federal courts, and the rule of decision they apply (i.e., Erie v. Tompkins).  Bankruptcy has a similar state-federal dynamic, but also presents the potential for broader, and more problematic, competitions.

LTL involves the chapter 11 reorganization of Johnson & Johnson’s tort-feasing talc subsidiary.  The debtor had been formed shortly before bankruptcy in a controversial “divisive merger,” which many viewed as little more than a fancied-up fraudulent transfer.  Talc plaintiffs moved to dismiss the case on grounds that it was not commenced in good faith.

In a thorough and thoughtful opinion, U.S. Bankruptcy Judge Michael Kaplan denied the motion because he believed the economic benefits of reorganization appeared to outweigh alternatives.  But, the motion to dismiss also raised “a far more significant issue: which judicial system—the state/federal court trial system,” or chapter 11 “serves best the interests of th[e] bankruptcy estate, comprised primarily of present and future tort claimants with serious financial and physical injuries.”

This question—which system?—is bankruptcy’s version of vertical forum shopping.

On one hand, Judge Kaplan is probably right about the economics:  chapter 11 is likely to pay more to more talc claimants than litigation in other courts.  Nonbankruptcy litigation might produce a few outsize winners—billion-dollar verdicts or multi-million-dollar settlements—but there may be little left for most judgment creditors to collect.

On the other hand, chapter 11’s distributive benefits can trade off against what we might call “dignitary” interests, including individual rights to a “day in court” and a jury trial.  Congress intended to preserve some dignitary protections in chapter 11 cases, including the right to a jury trial of contingent and unliquidated personal injury and wrongful death claims.  But the rise of channeling injunctions and nondebtor releases has undermined those protections.

In Purdue Pharma, for example, the debtor’s controversial plan would give personal injury creditors a bare right to a jury trial against the company, and cap recoveries at about $48,000—surely not enough to cover the cost of the trial.  Worse, it would eliminate the right entirely as to the Sackler family, which owned and controlled the company when it committed two sets of confessed drug crimes.  The viability of those releases is pending before the Second Circuit Court of Appeals.

Vertical forum shopping in chapter 11 can threaten not only the role of other courts, but also other branches of government.  Again, while LTL spotted the issue, Purdue crystallized it.

A supplemental injunction at the beginning of Purdue halted administrative and regulatory actions against Purdue and the Sacklers.  While this left the possibility of criminal prosecution, the U.S. Department of Justice negotiated deals with the Sacklers and Purdue that made it practically impossible for states to prosecute (and, of course, many preferred to settle with the Sacklers rather than fight, anyway).

Purdue Pharma and LTL are likely to be very different cases.  The bankruptcy judge and the debtors in Purdue resisted important efforts to vindicate dignitary concerns, such as a bellwether trial of allegations against the Sacklers or a fulsome examination of them.  Tragically, the lack of those efforts may have undercut the Sacklers’ proposed payout, leading the judge to declare himself “bitter.”

In LTL, by contrast, Judge Kaplan and the debtors have signaled a willingness to deploy these types of mechanisms, should the case remain in bankruptcy.

At this point, it is too early to know.  Angered by the brazen nature of the divisive merger, the talc plaintiffs have appealed to the Third Circuit.

I discuss dignitary issues implicated by vertical forum shopping in chapter 11 in a draft paper, The Problem of Social Debt, which I can share if you email me (jlipson [at] temple [dot] edu).

Don’t Just Do Something—Stand There! A Modest Proposal for a Model Standstill/Tolling Agreement

By Jonathan C. Lipson (Temple University Beasley School of Law), Norman M. Powell (Young Conaway Stargatt & Taylor, LLP)

Jonathan C. Lipson
Norman M. Powell

As we write, the COVID-19 pandemic is having a profound, and profoundly unpredictable, effect on the economy. We profess no knowledge as to what lies ahead, or the timetable on which it will unfold. Indeed, this unknowing is precisely what led us to produce a model standstill and tolling agreement which you can access here in an annotated version and here in a version without annotations.

The current uncertainty will lead businesses to conserve cash if they have it or to miss scheduled rent or other payments if they don’t, resulting in what could be massive cascades of defaults. Some, perhaps many, will be tempted to take legal action, whether in the form of collection suits, bankruptcy or a combination.

We believe that negotiated resolutions are in most cases preferable to those that are litigated. At the same time, we believe it is particularly unlikely that parties will divine, let alone agree upon, optimal resolutions until they can look to the future with greater certainty.

We’ve prepared a model standstill and tolling agreement that is intended to be a template for businesses facing problems of performance under contracts, including payment or collection, which may soon be overwhelming to the parties, and to the legal system. It provides a balanced way for businesses to place a legal “freeze” on their commercial relationship while the economy stabilizes. This model agreement is, needless to say, neither intended as nor a substitute for legal advice. All users are encouraged to retain counsel when possible.

The full article is available here.

Purdue Examiner Letter

By Jonathan C. Lipson (Temple University Beasley School of Law), Adam J. Levitin (Georgetown Law Center), Stephen J. Lubben (Seton Hall University School of Law)

Jonathan C. Lipson
Jonathan C. Lipson
Adam J. Levitin
Stephen J. Lubben

Recently, we (along with colleagues at other law schools) asked that an examiner be appointed in the Purdue Pharma chapter 11 bankruptcy case, pending in the Southern District of New York. Although the Bankruptcy Court has not yet acted on that request (technically, it was in the form of a letter to the United States Trustee), it has generated controversy and media attention (e.g.WSJWaPoRachel Maddow), which will likely persist until there are credible answers to the questions that motivated our request:

  1. What was the role of the Sackler family (the owners of Purdue) in Purdue’s role in the opioid crisis? and
  2. To what extent did the Sacklers or other insiders strip assets out of Purdue in anticipation of bankruptcy?

Chapter 11 of the Bankruptcy Code governs corporate reorganizations, such as Purdue Pharma’s, and provides that an examiner can be appointed if, among other things, it is in the interests of creditors and the debtor’s bankruptcy estate. Here, we argued that there is an overwhelming public interest which overlaps with the estate’s interest. This makes the need for an independent report on these two questions compelling.

As is well known, Purdue Pharma is at the center of the opioid crisis in America, having developed and marketed Oxycontin (among other drugs). This crisis has generated more than 2600 lawsuits against Purdue and the Sacklers, many brought by state and local governments that have had to bear the costs of drug addiction. The debtors and the Sacklers have proposed a settlement under which the Sacklers would cede the company to a “public trust” and make additional contributions, in exchange for releases. The settlement is alleged to be between $10 and $12 billion, with $3 billion of that coming from the Sacklers directly.  While some plaintiffs have agreed to the settlement, others have not, and are fighting the bankruptcy process.

Like many mass tort debtors—from Johns-Manville to PG&E—Purdue seeks to channel and control its liability through bankruptcy reorganization. Bankruptcy Judge Robert Drain, of the Southern District of New York, has stayed the lawsuits, not just against Purdue, but also against the  Sacklers, even though they are not debtors in bankruptcy—in order to permit the debtors to negotiate a plan of reorganization that would embody the proposed settlement.

We argued that an independent examination would answer the two key questions more credibly and efficiently than other mechanisms in bankruptcy for three reasons.

First, unlike many mass-tort bankruptcies, these cases appear to shield non-debtors (the Sacklers) from discovery and potential liability, even though there are credible allegations that they may have actively contributed to the opioid crisis and/or stripped assets from the debtors. The important question is not whether the Sacklers are making a contribution to a bankruptcy plan in exchange for a release from future liability, but whether their contribution is appropriate in light of the answers to our two questions. It will be very difficult to assess that without an independent examiner’s report.

Second, because Purdue Pharma is privately held, it is hard to know what happened at the company before bankruptcy. The debtors have appointed a special committee of the board to look into the pre-bankruptcy transfers, but because the Sacklers apparently still control the debtors, it is hard to know how independent this committee was, or can be.  The committee is, for example, represented by the same counsel as Purdue Pharma, which may hamper the committee’s independence.  In any case, even where other high profile debtors, such as Enron, have used independent committees to investigate allegations of wrongdoing, courts have nevertheless appointed bankruptcy examiners to assess, verify, and supplement the work of those committees. It is hard to see why Purdue should be different.

Third, and perhaps most important, the opioid crisis is not like other mass torts because it has generated extraordinary public interest. Victims of the opioid crisis understandably want their day in court—which is something that bankruptcy tends to eliminate. While thousands of lawsuits would be wasteful, failing to take seriously the dignitary interests of victims of the opioid crisis could threaten the legitimacy and integrity of the bankruptcy system.  At the same time, if an independent examiner exonerates the Sacklers, this may help provide the redemption that they presumably want.

Although the United States Trustee has not yet sought an examiner, there have been three interesting developments since we sent the letter:

  1. On November 6, 2019 Marshall Huebner, counsel to the debtor in possession, emailed us to say that “the Debtors (likely along with other core stakeholders) intend to strongly oppose the request, which, with apologies to its authors, contains many misstatements of fact.”  However, Huebner identified no “misstatements of fact” (much less “many”).
  2. On November 15, 2019, ten days after we sent the letter, the debtors filed a stipulation with counsel to the creditors committee and certain members of the Sackler family. The debtors and the Sacklers agreed to produce certain information to the committee (on a “professional eyes’ only basis”) that may respond to certain of the questions we asked, but in exchange the committee relinquished its right to seek an examiner until mid-April 2020.  It is not clear how estate fiduciaries can properly cede such rights.
  3. On December 16, 2019, the debtors filed a redacted version of the “independent” report noted above.  It indicates that the Sacklers took about $10 billion in cash out of the debtors since 2008.  This is not surprising, since the total value of the proposed settlement would have a face amount of about $10 billion (but a substantially lower present value given its payment schedule, and would not cover interest on the $10 billion).

The takeaway seems to be that, even though no examiner has been appointed, the Sacklers and the debtors in possession have begun to produce some information that may help to answer the questions we believe are central to this case.  In this regard, the mere threat of an examiner might be having an effect.  However, the ability to assess and verify this information is limited, at least for the time being.

That no one has actually requested an examiner is, at one level, not surprising.  It is easy to imagine that managing this case is exceedingly difficult.  The insiders in the case—especially counsel to the debtors and the official committee, and Judge Drain—may view an examiner as a wrench in the delicate machinery of the proposed settlement.  Parties might therefore prefer to maintain the threat of an examiner, even as they are reluctant to pull the trigger on a motion.

The Purdue bankruptcy is, however, bigger than the financial claims of any of Purdue’s creditors.  Purdue is a not a case that can be run like a standard chapter 11 because there is a strong public interest in establishing a clear and independent record of what Purdue and the Sacklers knew and did about the dangers of opioids, and the extent of the Sacklers’ transactions with Purdue. Establishing these facts credibly is important not just for the dignitary interests of opioid victims and their families, but also so that creditors can properly evaluate any settlement that emerges as part of the reorganization process.

Without credible answers to the questions we asked, there will be a shadow over these cases, one that may ultimately threaten the integrity of the reorganization process.

The full letter is available here.

 

The Secret Life of Priority: Corporate Reorganization After Jevic, 93 WASH L. REV. 631 (2018)

By Jonathan C. Lipson (Temple University – James E. Beasley School of Law)

The Supreme Court’s 2017 decision in Czyzewski v. Jevic Holding Corp. (In re Jevic) reaffirms that final distributions in chapter 11 cases must follow “absolute” priority absent the “consent” of priority creditors. The Court did not, however, define “consent” for this purpose, which is a problem, because consent can be hard to pinpoint in corporate reorganizations that involve hundreds or thousands of creditors and shareholders.

In this paper, I argue that, although the Jevic majority does not define consent, its reasoning reflects concerns about aspects of the reorganization process that may serve as proxies for it: stakeholder participation, outcome predictability, and procedural integrity.

First, I explain why “consent” is indeterminate in this context, inviting an inspection of process quality. Second, I assess Jevic’s process-value framework. Implementing Jevic’s values is not costless, so the Court’s commitment to them suggests that efficiency — the mantra of many scholars — is not the only or necessarily the most important value in reorganization. Third, I argue that these values conflict with the power that senior secured creditors have gained in recent years to control corporate reorganizations. Many worry that this power is the leading problem in corporate bankruptcy, producing needless expropriation and error. I also sketch opportunities that Jevic creates for scholars and practitioners who share these concerns.

Jevic reveals a secret: “priority” is not only about the order in which a corporate debtor pays its creditors, but also about the process by which it does so.

The full article is available here.

Courts As Institutional Reformers: Bankruptcy and Public Law Litigation

Kathleen G. Noonan (University of Pennsylvania), Jonathan C. Lipson (Temple University—Beasley School of Law), and William H. Simon (Columbia Law School)

Wags sometimes ask: What is chapter 11 good for?

In a new paper, we show that, among other things, it provides a template that both legitimates and explicates Public Law Litigation (PLL), civil class action suits against public agencies such as police departments and prison systems. These are among the most controversial disputes that courts face; often criticized, and widely misunderstood. Analogies to chapter 11 practice show how critics err, and how PLL works.

We make three basic points. First, we show that both bankruptcy and PLL, which share roots in the federal equity receivership, are judicial responses to collective action problems that other institutional mechanisms (e.g., markets or electoral politics) cannot or will not address.

Second, we show that courts in neither context “run” the organizations in question. In both types of case, management (of the debtor or agency) remains in possession and control, subject to judicial and stakeholder (e.g., creditor or plaintiff) oversight.

Third, chapter 11 and PLL both operate at the organizational level, through “restructuring.” For chapter 11, this will usually involve a plan of reorganization. The PLL analogue is a settlement agreement in a consent decree. Like plans, consent decrees typically reflect negotiated improvements in operations designed to increase the agency’s chances of success.

Critics of PLL sometimes claim that courts commandeer public instrumentalities, exceeding their expertise and authority. But this is no truer in PLL than it is in chapter 11 reorganization. Rather, judges in both spheres facilitate consensual resolutions that seek to balance stakeholder participation against managerial discretion.

This matters because the Trump Administration has vowed to “deconstruct the administrative state,” which implies a reduction in the amount and quality of public services. Increased PLL would be a plausible response.

If that happens, courts should focus not on whether they can supervise the restructuring of public agencies, but how to do so more effectively. We show that the chapter 11 system can provide helpful guidance.

The full article is available here.