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