[Texas Two-Step and the Future of Mass Tort Bankruptcy Series] A Qualified Defense of Divisional Mergers

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

Note: This is the fourth 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.

Earlier posts in this series can be found here (by Jin Lee and Amelia Ricketts), here (by Jonathan C. Lipson), and here (by Jared A. Ellias).

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Anthony Casey
Joshua Macey

One of the most important contexts in which Chapter 11 proceedings can facilitate the preservation of value is the resolution of financial distress related to mass tort claims. Over the last forty years, Chapter 11 has been invoked to facilitate settlement in dozens of large mass tort cases. Without Chapter 11, these value-preserving settlements would have never been possible.

Mass tort cases involve complex claims of multiple—often tens of thousands of—claimants looking to recover value from a business enterprise. The core provisions of Chapter 11, which are designed to coordinate behavior among claimants, address precisely these types of multilateral-claims situations. These provisions allow the quick, efficient, and fair resolution of claims and preserve value for the claimants and the other stakeholders of the business.

Providing a mechanism for the resolution of these mass tort cases is a quintessential function of bankruptcy law. Without bankruptcy resolution, the uncertainty of future liability in mass tort cases can prevent a debtor from productively carrying on its business and undertaking projects or asset sales that could create value and facilitate a cooperative resolution.

How do divisional mergers fit with this purpose? A divisional merger is a state-law transaction where a business entity divides itself into two new entities. It is attractive in some cases because it is simple and requires fewer steps than other methods for creating entity partitions. But the substantive outcome is no different. Any laws penalizing and prohibiting divisional mergers would therefore have little substantive effect. Rather they would simply channel transactions from one form of entity partitioning to another.

The important question, therefore, is whether a divisional merger—or any other form of entity creation—is being used to facilitate a socially valuable outcome consistent with the purpose of Chapter 11. When used appropriately, a divisional merger preceding a bankruptcy filing can facilitate a socially valuable resolution of mass tort claims, isolating (but not limiting) the mass tort liability for resolution independent of the other operations of the business.

To see why this is true, consider a large otherwise solvent business enterprise facing tens of thousands of potential tort lawsuits. One option would be for the entire enterprise to enter bankruptcy. But there are major costs to an enterprise-wide proceeding. The tools of Chapter 11 are blunt. The automatic stay applies across all creditors even those unrelated to the mass torts. Similarly, the filing triggers all sorts of enterprise-wide rules and restrictions. All creditors—including those with no connection to the mass tort litigation—must file their claims and can demand to be involved in the proceedings and in plan confirmation. The enterprise-wide filing brings extra parties and extra claims into the process and creates opportunities for those parties to take strategic litigation positions that can delay or prevent resolution.

The divisional merger structure reduces these enterprise-related complications. In the right situation, this structure can simplify the process and focus the proceedings on the specific mass tort resolution that is necessary for the preservation of value.

The proper way to address divisional mergers, in our view, is not to prohibit them altogether, but rather to make sure that they do not leave tort victims worse off. The transaction should therefore provide a source of adequate funding to resolve the tort liabilities. Consistent with this principle, recent cases that have utilized the divisional merger structure prior to a Chapter 11 petition have provided funding agreements that ensure that claimants have access to the same or more value in pursuing their claims against the business.

The bankruptcy proceedings that follow the merger should also provide meaningful disclosure and discovery about the merger, the funding agreement, and the underlying tort claims to allow a fair valuation of liability and a reasonable estimate of the number of claimants. Fortunately, bankruptcy judges are willing and able to provide these procedural safeguards.

The alternative of prohibiting divisional mergers will likely leave claimants worse off. Drawn out proceedings transfer value from tort claimants to bankruptcy professionals. It might also lead to unfair outcomes where some tort claimants receive large recoveries and others receive nothing at all. In turn, potential claimants will race to the courthouse chasing early judgments that leave the firm without funds to pay later claimants.

The purpose of Chapter 11 is not to reduce liability, but rather to reduce complexity and cost. And a well-designed divisional merger promotes that purpose while providing a fair and efficient system for resolving group claims.

 

Bankruptcy Shopping: Domestic Venue Races and Global Forum Wars

By Anthony J. Casey (Professor, The University of Chicago Law School) and Joshua Macey (Assistant Professor, The University of Chicago Law School)

Anthony J. Casey
Joshua Macey

The United States Bankruptcy Code gives debtors wide discretion to reorganize in the venue of their choice. These lenient venue selection rules long have allowed bankruptcy courts in the District of Delaware and the Southern District of New York to dominate the market for large Chapter 11 cases, though recently the Southern District of Texas has also begun to attract a large number of cases.

This state of affairs has produced a vigorous debate. Critics of liberal venue rules charge that bankruptcy districts are engaged in a “race to the bottom” as judges compete for blockbuster cases. Others counter that competition for cases improves efficiency and predictability as judges develop expertise in overseeing large Chapter 11 cases.

This Article cautions that developments in foreign jurisdictions may limit the effectiveness of these venue reform proposals. In recent years, foreign jurisdictions have emerged as convenient forums for distressed debtors. For instance, in many cases, the English scheme of arrangement now represents a viable alternative to the American bankruptcy system, and over the past decade, a number of companies have chosen to use an English scheme of arrangement to restructure their debt instead of chapter 11, with the first United States-headquartered business doing so in 2019. Other jurisdictions have also sought to entice foreign debtors, with insolvency specialists speculating that Singapore, in particular, could become a restructuring hub.

Because American bankruptcy courts freely recognize foreign insolvency proceedings, firms that are directed to file in less favored districts may instead choose to reorganize in a foreign jurisdiction. In this environment, attempts to limit venue selection within the United States will have the opposite of their intended effect, replacing domestic venue shopping with even worse global forum shopping. By ignoring the availability of global forums, current venue reform proposals could, perversely, drive opportunistic debtors and creditors to restructure in foreign jurisdictions.

To address this, we argue that, rather than limit domestic venue choice, lawmakers should: (1) support the development of ex ante commitment to mechanisms for choosing venue and forum; and (2) whenever possible, resolve inconsistencies in substantive law across venues and forums. These are general principles of reform, and the implementation will depend on context. For example, commitment mechanisms look different for venue than they do for forum. But, if designed properly, these measures can reduce the costs of venue and forum shopping without giving up the benefits that come from allowing some choice of venue and forum.

It is worth noting that the merits of our proposal are independent of one’s view on the current state of venue shopping. If venue shopping is a real problem, the principles we introduce address that problem. If venue shopping is not a problem, the principles do no harm and even expand the choice set for debtors. Similarly, while the principles address the problem of global forum shopping, the benefits with regard to venue shopping exist with or without global forums. The same cannot be said of the status quo or the reforms currently being considered.

The article can be found here.