In a recent essay, Shocking Business Bankruptcy Law, I discuss how crisis is used strategically to push legal boundaries in large chapter 11 cases in ways that are not readily reversed. I focus primarily on two phenomena. The first is bankruptcy à la carte. Chapter 11 is akin to a fixed price meal; it offers extraordinary perks as part of a broader package meant to promote objectives with diffuse beneficiaries. In bankruptcy à la carte, parties such as lenders and distressed company acquirers extract the perks provided in the Bankruptcy Code without having to endure the oversight, checks and balances, and potentially longer timeline the package deal requires. In other words, they unbundle chapter 11.
What do major shocks have to do with bankruptcy à la carte? In one sense nothing and in another sense everything. The global financial crisis played a significant role in institutionalizing bankruptcy à la carte. After all, the Obama Administration coopted Chapter 11 to complete quick sales, stripped of the typical protections, to “save” Chrysler and General Motors. When the financial crisis was in the rear-view mirror, bankruptcy à la carte was not. Arguments that value will be lost if the deal gets deferred have persisted during the COVID-19 pandemic. And yet, assertions that these deals are value maximizing can often be questioned, along with how the value is being distributed. There are no easy ways to rebundle chapter 11 until the financial plumbing of the system gets rewired.
As some big business bankruptcy cases unbundle the package deal and cherry-pick the perks, other cases add perks that cannot reasonably be found in the Bankruptcy Code and stray from its mission in ways that might challenge even its federal constitutional authorization. This second phenomenon is off-label bankruptcy. Expansive add-ons are claimed to be essential to keeping the deal together. Proponents of off-label cases tout the broader policy benefits of their proposals and warn that the deal will unravel like a wool sweater if any thread is picked, putting the court and potential objecting parties in a bind. Either courts and stakeholders reluctantly sign off on the deal with these add-ons, perhaps demanding modest concessions, or they call proponents’ bluff, risking the loss of any benefits the deal was expected to bring. A notable example is seeking to protect third parties against liability without requiring them to file for bankruptcy themselves, typically termed non-debtor releases or third-party releases.
Like bankruptcy à la carte, off-label bankruptcy does not arise solely from large shocks. But shocks fuel its use and increase the pressure to keep the deal together. Consider Purdue Pharma, the OxyContin producer that went bankrupt to manage litigation arising from the opioid crisis, claiming it was essential to protect members of the Sackler family (and over a thousand other parties) in order to secure the Sacklers’ financial contributions. Although some claimants signed on early to this idea, other families devastated by OxyContin and state attorneys general representing more than half the population of the United States objected to Purdue’s restructuring plans, arguing they did not comport with the law in various respects. From the outset, though, Purdue warned that this integrated deal implemented through bankruptcy was the only way to ensure that resources could be directed to opioid-crisis abatement. In other words, if public or private claimants opposed this plan, it would be the objectors’ fault that resources instead lined the pockets of lawyers for litigation.
The potential irregularities of off-label bankruptcy in the name of an entirely different set of policy objectives are almost unlimited. Bankruptcy is becoming an alternative justice system for problems having nothing to do with over-indebtedness, at least for the biggest enterprises with the fanciest legal and financial advisors.
My essay also flags a premise underlying these points worth noting here. First, the big-business bankruptcy system is best understood as a public-private partnership that has become severely skewed toward the private. The policy objectives of this partnership cannot be boiled down to a single pithy goal such as maximizing economic value but instead must respect a full range of constitutional and democratic principles and limits. Rather than an excuse to use bankruptcy flexibly, this signifies the need for a rule-of-law and minimalist approach to this system, keeping the focus tethered to over-indebtedness.
One last, urgent question is who should get a louder megaphone to weigh in on the issues of bankruptcy and crises. Restructuring professionals, business bankruptcy academics, and repeat players in this world are stunningly homogeneous. The people affected by bankruptcy à la carte and off-label bankruptcy, especially during times of crisis, are anything but.
This post comes to us from Professor Melissa B. Jacoby at the University of North Carolina School of Law. It is based on her recent article, “Shocking Business Bankruptcy Law,” available here.