By Professor Jared Ellias (Harvard Law School) and Professor George Triantis (Stanford Law School)
Bankruptcy is becoming increasingly a forum for debating public policy issues in fields such as cryptocurrency investment, health care delivery, pharmaceutical sales or climate change. If history is any indication, regulatory agencies in the U.S. are likely to see bankruptcy as an impediment to their efforts to investigate and punish past illegality as well as to regulate prospective activity. Therefore, they will often work to minimize the bankruptcy court’s interference with the regulatory processes. An example of the adversarial relationship that can exist between regulators and the bankruptcy system, is the Federal Energy Regulatory Commission’s recent and unsuccessful strategy to obtain court orders declaring that its regulatory power was unaffected by Chapter 11 filings. The breakdown between regulators and bankruptcy courts is a shame, because bankruptcy law also shares the broader goal of promoting the public interest and provides a useful set of tools. Therefore, to the degree that there are conflicts between bankruptcy and the executive branch of government, it is not as much one of competing objectives as one of clashing institutions (as the Fifth Circuit noted earlier this year in FERC v. Ultra Resources).
This competitive institutional framing dominates both the academic analysis and the real-world approach of administrative agencies. Commentators have debated whether bankruptcy court or administrative agencies are superior in protecting the public interest. Meanwhile, in practice, the executive branch largely views bankruptcy as a forum for collecting taxes and fines, and otherwise seeks to remove itself and administrative proceedings from the reach of the bankruptcy stay.
Administrative agencies are missing opportunities to leverage the bankruptcy process to achieve policy goals. In a recently published Essay, we show that administrative agencies typically react to a bankruptcy filing by taking a defensive posture, and move to limit the authority of bankruptcy law over regulatory matters. We hand-collect a new dataset of interactions between Chapter 11 debtors and regulators from large bankruptcy cases from 2004 to 2019, and we find evidence that regulators rarely leverage the special powers of bankruptcy to promote their policy goals (in contrast to collecting debts) – they do so in only 3.5% of observed regulator-Chapter 11 debtor interactions.
We argue that this approach is misguided for three sets of reasons. First, these motions are often unsuccessful in bankruptcy and appellate courts. Second, the agencies miss opportunities to better promote their policy objectives by participating in the bankruptcy hearings and negotiations, especially if they also bring financial support to the table. Third, and perhaps most importantly, the agencies’ defensive approach reflects a fundamental misunderstanding of bankruptcy. Bankruptcy is a collective process, designed to engage all stakeholders in a financially distressed debtor with a view to preventing the liquidation of viable operations that would occur if each stakeholder enforced their rights individually. In Chapter 11, creditors and other parties are successful in achieving this goal when they provide a debtor with solutions to their financial distress, often by contributing new value. The legal framework of bankruptcy increases the space for deal-making that could not otherwise happen outside of bankruptcy and parties serve their collective purpose when they enlarge that space and contribute to a deal. This ideal applies to the stake of the public interest promoted by administrative agencies as much as the stake of commercial or individual creditors. In other words, the pursuit of regulatory goals without regard to either the financial distress of the debtor or the collective bankruptcy process threatens the survival of the going concern and thereby the success of the regulatory goals themselves.
There are many tools that regulatory agencies can exploit to have influence in Chapter 11. For one, bankruptcy can bring to light relevant information about the debtor that might not be as readily accessible otherwise, and this is likely to be particularly valuable in the current crypto bankruptcies. The information may be gleaned from the required filings by the debtor, but also through the findings of officials such as the trustee and examiner and through interactions with other stakeholders in committees and even adversarial hearings. Beyond superior access to information, the government entities can also influence the governance and future activity of the debtor in various ways, especially if they contribute new financial support to the debtor’s reorganization efforts. Value can go beyond money, though, and private parties routinely contribute expertise, advocacy, and business savvy. Administrative agencies have an additional potential form of currency by relieving the debtor of burdensome regulation. We argue that governments will do better in bankruptcy if they seek to “speak bankruptcy” – either by hiring bankruptcy lawyers or by retaining outside counsel – and approaching Chapter 11 cases as opportunities instead of jurisdictional challenges, working to make deals possible instead of imposing roadblocks that ultimately undermine the success of not only the bankruptcy but also the regulatory goals themselves.
We support this argument by contrasting the strategy of the California State Attorney General and that of the County of Santa Clara in the 2019 bankruptcy of Verity Health Systems. The County was notably more successful in achieving its public health objectives by working with bankruptcy instead of against it. Such government activism represents a view of the administrative state in bankruptcy instead of against bankruptcy.
Click here to read the full article.