Creditors Strike Back: The Return of the Cooperation Agreement

In the low interest rate environment that followed the Great Recession, a fanatical demand for high-yield investments provided private equity firms an opportunity. Newfound borrower leverage facilitated credit documents with few creditor safeguards and various loopholes. Borrowers subject to these “sponsor-favorable” terms now had options in times of financial distress. More specifically, they had the option to strike first. Utilization of coercive exchanges began in earnest around 2015 and has since flourished. Unmonitored portfolio companies experiencing financial distress now regularly rely on questionable interpretations of ambiguous contractual provisions to surreptitiously move assets away from creditors’ collateral baskets and subordinate lenders. These unprecedented acts of financial war are pure, self-interested behavior designed to seize and redistribute value. Creditors in this multiplayer prisoner’s dilemma have two choices: (i) cooperate with its creditor group and attempt to prevail by securing a majority coalition, or (ii) defect and work with the borrower who promises to share some of the spoils of victory. Scholars have thoroughly detailed private equity’s plan of attack. But what is missing is an exploration of creditor countermeasures to these new coercive exchanges. This Essay attempts to conceptualize the decision to coordinate and analyze the benefits and costs of cooperation. Further, this Essay explores the prevalent terms and basic design of cooperation agreements based on my unique review of a number of private disputes. The possibility of opportunistic behavior casts a long shadow in these battles of financial titans. The benefits of a coordinated response are clear, but there still exist many obstacles, including threats of free riding. And borrowers have myriad weapons in their arsenal to splinter adversary groups. In choosing between cooperation and defection, creditors know there may be no honor among thieves. “The first principle of Economics is that every agent is actuated only by self-interest. [But invariably an agent must choose to act] without, or with, the consent of others affected by his actions. In [a] wide sense[], the first species of actions may be called war; the second contract.

Scarlet-Lettered Bankruptcy: A Public Benefit Proposal for Mass Tort Villains

Financially distressed companies often seek refuge in federal bankruptcy court to auction valuable assets and pay creditor claims. Mass tort defendants—including 3M, Johnson & Johnson, and Purdue Pharma—introduce new complexities to customary Chapter 11 dynamics. Many mass tort defendants engage in malfeasance that inflicts widespread harm. These debtors fuel public scorn and earn a scarlet letter that can destroy value for an otherwise profitable business. Scarlet-lettered companies could file for bankruptcy and quickly sell their assets to fund victims’ settlement trusts. This Article argues, however, that this traditional resolution option would eviscerate victim recoveries. Harsh public scrutiny has diminished the value of the resources necessary to satisfy claims, creating a discount that must be borne by victims. My public benefit proposal charts a new course. Instead of accepting fire-sale prices and an underfunded settlement trust, the scarlet-lettered company emerges from bankruptcy as a corporation for the public benefit. This modified reorganization offers victims the greatest recovery. The continued operation preserves value during a transition period, after which the going concern can be sold efficiently. Assets that have been tainted by tortious conduct are cleansed behind a philanthropy shield and then sold to capture the value rebound. The victims’ collective is the owner of the new company and can participate in a shareholder windfall if there is strong postbankruptcy performance. At the forefront of a new trend in aggregate litigation, this Article proposes a public benefit alternative to traditional resolution mechanisms. This approach delivers utility that will support application in a variety of contexts, assuming certain governance safeguards are maintained. In our new age of greater personal and corporate accountability, more scarlet-lettered companies will emerge and ultimately land in bankruptcy. The need to address the disposition of tainted assets will be paramount in compensating mass tort victims trying to reassemble fractured pieces. This Article explains a new phenomenon and reconceptualizes resolution dynamics in a way that will have policy implications that transcend aggregate litigation

The New Mass Torts Bargain

Mass torts create a unique scale of harm and liabilities. Corporate tortfeasors are desperate to settle claims but condition settlement on the resolution of substantially all claims at a known price—commonly referred to as a global settlement. Without this, corporate tortfeasors are willing to continue with protracted and fragmented litigation across jurisdictions. Global settlements can be elusive in these cases. Mass torts are oftentimes characterized by heterogeneous victim groups that include both current victims and future victims—individuals whose harm has not yet manifested and may not do so for years. Despite this incongruence, future-victim claims must be aggregated as part of any global settlement. This is the tragedy of the mass tort anticommons: without unanimity, victim groups are unable to access settlement resources in a timely or meaningful way, but actual coordination across the group can be impossible. Current resolution structures have proven ill-equipped to address the novel challenges posed by mass torts. Many cases cannot satisfy Federal Rule of Civil Procedure 23’s (“Rule 23”) requirements for class action certification because of too many individual issues surrounding causation and damages. Multidistrict litigation (MDL) is the most frequently invoked resolution structure, but the MDL process has infirmities. MDL lacks many of Rule 23’s fundamental safeguards that protect process integrity and victim autonomy. MDL has become a captive settlement process. In response, a new strategy for resolving modern mass torts has emerged. Corporate defendants—including 3M, Johnson & Johnson, and Purdue Pharma—have turned to bankruptcy. These mass restructurings automatically halt the affected MDL cases and transfer proceedings to a bankruptcy court, a process I describe as “bankruptcy preemption.” Unfortunately, bankruptcy preemption replaces one deficient structure with another. Mass restructuring debtors are exploiting statutory gaps in the U.S. Bankruptcy Code in order to bind victims through an unpredictable, ad hoc structure. The new bargain creates myriad risks, including insolvent settlement trusts and disparate treatment across victim classes. This Essay is the first to attempt a reconceptualization of how modern mass torts should be resolved and delivers an unprecedented normative construct focused on addressing anticommons dynamics through statutory amendments to the Bankruptcy Code. These changes, coupled with an evolved perspective on fundamental structural anomalies, are designed to improve predictability, efficiency, and victim recoveries

Failing Cities and the Red Queen Phenomenon

Cities and counties are failing. Unfunded liabilities for retirees’ healthcare benefits aggregate to more than $1 trillion. Pension systems are underfunded by as much as$4.4 trillion. Many local government capital structures ensure rising costs and declining revenues, the precursors to service-delivery insolvency. These governments are experiencing the Red Queen phenomenon. They have tried a dizzying number of remedies, but their dire situation persists unchanged. State legislatures have failed to respond. More specifically, many states have refused to implement meaningful debt restructuring mechanisms for local governments. They argue that giving cities and counties the power to potentially impair bond obligations will lead to a doomsday scenario: credit markets will respond by dramatically raising interest rates on new municipal and state bond issuances. This argument—which we term the “paralysis justification”—has been employed widely to support state inaction. The paralysis justification, however, is anecdotal and untested. This Article attempts to fill a significant gap in the literature by reporting the results of an unprecedented empirical study. Our study aggregated data for every fixed-rate general obligation, municipal bond issued in the United States from January 1, 2004 to December 31, 2014. It included over eight hundred thousand issuances in total. By employing multivariate regression analysis, we conclude that the paralysis justification is a false narrative. Municipalities located in states that offer meaningful debt restructuring options enjoy the lowest borrowing costs, all other things equal. This Article removes one of the largest obstacles to financial relief for many cities and counties. We hope to encourage recalcitrant state legislatures to enact the structural changes their local governments need desperately

Due Process Alignment in Mass Restructurings

Mass tort defendants have recently begun exiting multidistrict litigation by filing for bankruptcy. This new strategy ushers defendants into a far more hospitable forum that offers accelerated resolution of all state and federal claims held by both current and future victims. Bankruptcy’s structural, procedural, and substantive benefits also provide defendants with unique optionality. Bankruptcy’s resolution promise is alluring, but the process relies on a very large assumption: that future victims can be compelled to relinquish property rights in their cause of action against the corporate defendant and others without consent or notice. Bankruptcy builds an entire resolution structure on the premise that the U.S. Bankruptcy Code’s untested interest-representation scheme satisfies due process strictures. This Essay questions that assumption and identifies two compromised pillars that could render bankruptcy’s mass tort framework unconstitutional. First, the process for selecting the fiduciary that represents future victims’ interests and irrevocably binds them to the agreed settlement is fundamentally broken. Second, the process by which bankruptcy courts estimate the value of thousands of mass tort claims places too much pressure on a jurist unfamiliar with personal injury claims. These compromised pillars raise the risk that the victims’ settlement trust will be underfunded and will fail prematurely. In this outcome, future victims would have no recourse but to argue that the restructuring process did not satisfy due process and the entire settlement should be unwound. This Essay proposes that the risk of a prematurely insolvent victim’s trust can be reduced considerably by bolstering these two pillars. Our proposal seeks to (1) rebuild the future claimants’ representative role in order to ensure that future victims’ interests are effectively represented and (2) recalibrate the claim estimation process by facilitating coordination between the bankruptcy court and nonbankruptcy federal and state courts

Due Process Alignment in Mass Restructurings

Mass tort defendants have recently begun exiting multidistrict litigation by filing for bankruptcy. This new strategy ushers defendants into a far more hospitable forum that offers accelerated resolution of all state and federal claims held by both current and future victims. Bankruptcy\u27s structural, procedural, and substantive benefits also provide defendants with unique optionality. Bankruptcy\u27s resolution promise is alluring, but the process relies on a very large assumption: that future victims can be compelled to relinquish property rights in their cause of action against the corporate defendant and others without consent or notice. Bankruptcy builds an entire resolution structure on the premise that the U.S. Bankruptcy Code\u27s untested interest-representation scheme satisfies due process strictures. This Essay questions that assumption and identifies two compromised pillars that could render bankruptcy\u27s mass tort framework unconstitutional. First, the process for selecting the fiduciary that represents future victims\u27 interests and irrevocably binds them to the agreed settlement is fundamentally broken. Second, the process by which bankruptcy courts estimate the value of thousands of mass tort claims places too much pressure on a jurist unfamiliar with personal injury claims. These compromised pillars raise the risk that the victims\u27 settlement trust will be underfunded and will fail prematurely. In this outcome, future victims would have no recourse but to argue that the restructuring process did not satisfy due process and the entire settlement should be unwound This Essay proposes that the risk of a prematurely insolvent victim\u27s trust can be reduced considerably by bolstering these two pillars. Our proposal seeks to (1) rebuild the future claimants\u27 representative role in order to ensure that future victims\u27 interests are effectively represented and (2) recalibrate the claim estimation process by facilitating coordination between the bankruptcy court and nonbankruptcy federal and state courts