Shocking Business Bankruptcy Law
abstract. The intersection of major crises and financial distress generates no shortage of stock stories. This Essay offers one more: how shocks can be used opportunistically in big Chapter 11 cases to unravel bankruptcy law, and to shift the system further away from the objective of responding to overindebtedness.
“To hear the principal dissent tell it, the world will end not in fire, or ice, but in a bankruptcy court.”
— Justice Sotomayor1
The founders of my favorite ice-cream shop, Ample Hills Creamery, named it after a Walt Whitman poem.2 Perhaps with more knowledge of poetry and ice cream than of business and finance, the owners expanded production and scoop shops beyond a sustainable point.3 On March 15, 2020, Ample Hills filed for bankruptcy.4 The COVID-19 pandemic did not prompt this filing, but it shaped what happened next. In the midst of the uncertainty and shutdowns this crisis fostered, the bankruptcy court approved the only proposal on the table: sale of Ample Hills to an Oregon gas-tank manufacturer for a disappointing one-million dollars.5 The founders not only would lose all equity and leave the company but would also have to file for bankruptcy themselves to get relief from obligations they had personally guaranteed.6
The intersection of financial distress and major crises generates no shortage of stock stories. In a global pandemic, failure might seem all but inevitable among concert venues, cruise lines, airlines, hotels, and the like. Or one might think of the oil and gas industry, struggling with excess supply as demand plummeted.7 But other stories that intersect with crises take different trajectories, and they too should be told.
In recent work, I considered how a shock like the global financial crisis prompted formal government responses, such as the creation of new administrative agencies.8 Other work has highlighted how profound changes develop through routine acts of repeat players within a legal system.9 One does not need Congress, an executive order, or a major Supreme Court decision to alter the law.
This Essay considers how a shock fuels problematic models of business bankruptcy, particularly the practices I label “bankruptcy à la carte” and “off-label bankruptcy.” I focus on the liberties taken with Chapter 11 of the Bankruptcy Code by enterprises much larger than my favorite ice-cream shop. Bankruptcy à la carte extracts the tools of Chapter 11 meant to be available only as part of a package deal and redistributes the benefits.10 These tools override state law on matters of contracts, asset sales, and loan priority. To the extent that these tools are valid exercises of federal law through the Constitution’s Bankruptcy Clause,11 they make sense only as part of Chapter 11’s package deal. Standing alone, they are suspect. Whatever the legal foundation, proponents of bankruptcy à la carte (including financial institutions, hedge funds, private- equity funds, and their restructuring professionals) misappropriate value meant for a more diffuse group of stakeholders and capture it for themselves.12 Major shocks help them get away with it.
In off-label bankruptcies, parties use the system to solve problems other than unpayable debt loads (such as litigation management), and these parties demand additional perks that the Bankruptcy Code does not authorize (such as protecting a wide range of nondebtors during and after the bankruptcy). 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 off-label bankruptcy proponents on their bluff, risking the loss of any benefits the deal was expected to bring. Of course, major shocks increase the pressure to keep the deal together.
One prominent add-on is called a “nondebtor release” or “third-party release.” It uses bankruptcy to insulate third parties from liability even though they have not undertaken the burdens of bankruptcy.13 A particularly high-profile example comes from the case of Purdue Pharma, the OxyContin producer purporting to use the bankruptcy system to resolve a national crisis it fueled: widespread opioid addiction and overdose.14 Purdue Pharma and its owners, members of the Sackler family, aggressively marketed opioids and downplayed addiction risks. Yet, the Purdue Pharma Chapter 11 case provided members of the Sackler family, and over a thousand other parties, with full insulation from liability without filing for bankruptcy themselves.
This Essay unfolds as follows. Part I establishes the baselines for understanding Chapter 11 as a package deal with diffuse stakeholder beneficiaries. Part II introduces the role of shocks in the financial distress world and explores multiple paths by which shocks influence Chapter 11, with an emphasis on the bankruptcy-á-la-carte and off-label models. Part II further recognizes the logistical costs of a major shock, including impeding in-person negotiations. This Essay concludes by noting the need for significant structural changes to restore Chapter 11 as used by large enterprises.
I. business bankruptcy: a public-private partnership and a package deal
Business bankruptcy is a public-private partnership. This characterization comes from how the system is funded, who oversees it, and who sets the substantive rules.15 Meant to facilitate the reorganization and preservation of for-profit and nonprofit enterprises, Chapter 11 bankruptcy is funded, for better or worse, from a mixture of public and private sources.16 Liabilities come from diverse legal doctrines, including contract, tort, statutory, regulatory, and sometimes even constitutional law.17 The Bankruptcy Code allocates oversight responsibilities to both public parties (e.g., judges and a government watchdog) and private parties (e.g., creditors’ committees and sometimes trustees).18 Many of Chapter 11’s requirements are mandatory, but the Bankruptcy Code also allows parties some latitude to craft the terms of a restructuring deal.19
In creating the architecture of this system, lawmakers balanced competing concerns rather than promote a single interest. Normative pluralism is an acknowledged feature in other areas of law.20 The resulting statute is supposed to respect a variety of public values regardless of whether they are expressly named. The very short clause in Article I of the U.S. Constitution that authorizes Congress to enact uniform laws of bankruptcy—known as the Bankruptcy Clause—generally should not override other constitutional protections.21 We do not discard fundamental considerations of due process and equal protection, for example, simply because of financial difficulty. Rather than provide a license to do anything and everything in the name of advancing one policy or another, conceptualizing business bankruptcy as a public-private partnership supports bankruptcy minimalism by strictly adhering to the law as written to focus on the system’s core function: resolving overindebtedness.
To address overindebtedness, the bankruptcy system includes potent powers: a temporary injunction to provide a breathing spell from collection,22 allowance of the majority of creditors to bind a minority to a new deal,23 and a permanent injunction against debt collection.24 To increase the odds of a confirmed Chapter 11 plan, thought to be particularly important when an enterprise is worth more alive than dead, Congress provided legal perks not available in other laws. These include incentives to provide financing,25 incentives to buy assets of the bankruptcy estate with more legal certainty,26 and alterations to the state-law baseline regarding the treatment of contracts and leases.27 These perks, which have significant distributional consequences, are hard to justify, and indeed make little sense, if delinked from the Chapter 11 package deal. Standing alone, they are federal subsidies in strong tension with federalism. In addition, while the statutory language is far from perfect, Congress wrote these perks with limits and standards that day-to-day practice and court decisions have eroded.28
Two core features of Chapter 11 should also be flagged. First, relief is supposed to be premised on extensive and prompt disclosure. For example, when the gun and bullet maker Remington Outdoor Company filed for a second bankruptcy, grieving parents who lost children in the Sandy Hook murders wanted more time to gather information about the company’s finances.29 Remington protested, “[J]ust because we filed for bankruptcy doesn’t give [the Sandy Hook families] a right to sort of walk around and look and snoop around our business.”30 But it was wrong. Bankruptcy entitles claimants to do exactly that.31
Second, access to Chapter 11’s package deal is premised on
having a good-faith reason to file for bankruptcy in the first place. A
particularly high-profile example is the National Rifle Association (NRA),
which filed for bankruptcy in 2021 in order to exert leverage over state
regulators, rather than to address overindebtedness
or some other financial problem.32
Although the NRA received four months of bankruptcy protection and multiple
opportunities to explain why it was a valid candidate for federal bankruptcy
relief (including a twelve-day trial), it was ultimately thrown out of the
system because it was unable to show that it had a valid financial reason to be
Overall, the Bankruptcy Code offers a balanced process to reorganize or sell a company as a going concern through a Chapter 11 plan. It includes disclosures, creditor voting, and a list of substantive standards by which to measure a plan’s propriety, including that the plan be “fair and equitable.”34 The integrated package is meant to promote due process, as well as more accurate valuation and distribution.35 As we will see in Part II, shocks and crises create leverage to alter the package deal, both by unbundling it and adding consequential extralegal ornaments.
II. crises remake big-business bankruptcy
Never is there a dull moment for a teacher and scholar of bankruptcy law, but some moments are more consequential than others. So far, my academic career has spanned the 9/11 terrorist attacks, the global financial crisis, and the COVID-19 pandemic—events that materially changed the financial landscape and context of debtor-creditor relationships, along with everything else. In looking back on my own publications, it is striking how many have been reactions to a major crisis.36 This timeframe has also covered localized disasters such as Hurricane Katrina in August 2005, Hurricane Maria in September 2017, and the polar-vortex storm in Texas in February 2021.
I avoid the qualifier “exogeneous” to describe shocks, as it can bring more heat than light. A business’s existing financial state affects how it bears a major shock. Even when a company blames the pandemic for its bankruptcy, we should ask whether it was in stable condition beforehand, or whether it kept itself afloat by using easy access to cheap credit.37 As rank-and-file employees of high-touch industries suffered health-wise and financially during the pandemic, companies found creative ways to further boost the compensation of their wealthiest executives.38
Bankruptcy is meant to make the best of a bad situation. However, its potent tools do not always align with the problems brought to its door. We should look closely when large enterprises with the highest-compensated professionals—as well as their lenders and potential acquirers—use a crisis to justify cutting corners or pushing legal boundaries. In this Part, I explore how crises influence Chapter 11, focusing on bankruptcy à la carte, off-label models, and the logistical impact of major shocks.
A. Bankruptcy à la Carte
Congress balanced a variety of concerns in creating Chapter 11’s package deal, and its beneficiaries are diffuse. By contrast, professionals and repeat-player lenders and investors who shape big Chapter 11 bankruptcies today are highly concentrated and relatively homogenous.39 If they can extract Bankruptcy Code perks without having to endure the oversight, checks and balances, and potentially longer timeline the package deal requires, why would they do otherwise?
To accomplish this unbundling, they are assisted by modern-day big-business bankruptcy practice, which flattens many legal issues into the objective of maximizing economic value. That is an unduly simplistic view of the objectives of the normatively pluralistic Chapter 11. Only a few provisions of Chapter 11 specifically mention something akin to value maximization. Other provisions of the Bankruptcy Code concern themselves with matters such as due process, the right to vote, discrimination, and distributional concerns.40 Even if these transactions always maximized economic value (and that proposition is dubious) nothing in these Bankruptcy Code provisions suggests that economic-value maximization trumps statutory requirements. A common variant, especially in the face of crises, is to flip around value maximization and warn that the entity is a melting ice cube.41 To the bankruptcy court, repeat-player lenders and investors essentially say, “give me what we want or all the money and jobs will go away,” picking and choosing among the perks of Chapter 11, using the ones that benefit them and finding creative ways to invalidate the rest.42 They transform the value maximization mantra into a subsidy for themselves.
Unbundling also is fueled by embracing the potential of market forces in their theoretically perfect form rather than in their reality. Some judges understandably want to believe that the presence of private parties and assertions of arms-length bargaining will generate a market-rate transaction.43 But private structuring of transactions does not necessarily yield market value, inside and outside bankruptcy.44 From the perspective of some lenders and acquirers, the key objective is to produce a transaction that is not actually market rate. And it is hard to blame them. They are entitled to represent their own interests and they lack fiduciary duties to the bankrupt enterprise.
A key example involves distressed business buyers’ insistence
on acquiring companies in standalone going-concern sales within a bankruptcy,
rather than as part of a Chapter 11 plan or outside of the bankruptcy system.
That insistence is typically fueled by a lender willing to fund the case as a
bridge to a sale but nothing more.45 The standalone sale avoids
subjecting it to creditor voting, as would be necessary in a Chapter 11 plan,
or complying with all of the substantive plan
requirements. The Bankruptcy Code anticipates going-concern sales to be
accomplished through plans, and does not protect buyers of companies from
potential successor liability in standalone sales.46 Indeed, bankruptcy policy
is widely assumed to respect state and other applicable non-bankruptcy-law
baselines unless it is imperative to do
otherwise.47 Some federal circuit courts nonetheless have upheld broad orders protecting acquirers in standalone sales, fearing that the acquirer will simply walk unless it gets what it wants—even if walking would be economically irrational.48 Bankruptcy therefore presents a loophole to the seriousness with which federal and state courts otherwise take successor liability.49 Insistence on bending the rules to preserve economic value is not neutral. In practice, it tends to suppress the legal rights of individuals with less political, economic, and social power, while the dollars flow elsewhere.
What do major shocks have to do with bankruptcy à la carte? Both nothing and 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.50 When the financial crisis came into the rear-view mirror, bankruptcy à la carte did not. Arguments that value will be lost if the deal is deferred have been in active rotation during the COVID-19 pandemic.51 Threatening a loss of economic value and layoffs can also be effective during more placid times, but it becomes especially persuasive during a crisis for fear of making a bad situation worse. Major shocks increase the power and leverage of the arguments that the Chapter 11 package deal, with its emphasis on creditor voting and specific distributional entitlements, is an unaffordable luxury.52
The Bankruptcy Code is not perfect. But bankruptcy à la carte’s strategic unbundling of Chapter 11’s benefits and obligations is an even less satisfying exercise of federal law, redistributing the perks in ways that tend to favor Wall Street and disfavor Main Street. The tail of COVID-19-related bankruptcies is destined to be long, so it is not too late to issue a warning: if powerful parties are permitted to cite shocks to justify bankruptcy à la carte, the existence of Chapter 11 will become even more difficult to justify.
B. Off-Label Bankruptcy
In the previous Section, we learned that when larger enterprises knock on the bankruptcy-court door, what they request often does not match what the Bankruptcy Code offers. A second category of creative Chapter 11 use intersecting closely with major shocks involves expansive add-ons to bankruptcy relief purported to be essential to keeping the deal together. In other words, while some Chapter 11s unbundle the package deal, cherry-picking among the perks, other Chapter 11s add perks to the package.53
A notable expansion is seeking to protect third parties against liability without requiring them to file for bankruptcy themselves. The Bankruptcy Code expressly authorizes nondebtor releases only in the context of asbestos claims, and there, only in a narrow set of circumstances.54 Circuit courts are not permissive on nondebtor releases if you read the fine print; they recognize that a nondebtor release is essentially a discharge without the rest of bankruptcy.55 Requesting nondebtor releases nonetheless has become common.56 Sometimes the potential recipients of releases will even evoke sympathy, particularly if a shock is involved. But sympathy does not make these releases a good policy extension of the federal bankruptcy system.
For example, in February 2021, a polar-vortex storm generated a massive power emergency in the state of Texas, resulting in huge price increases and massive power outages, ill-timed for the extreme cold weather.57 Brazos Electric Power Cooperative, a nonprofit wholesale provider of energy, and Griddy Energy, LLC, a retail electric provider, both filed Chapter 11 in March 2021.58 Griddy used bankruptcy to close its doors after an oversight entity had already transferred away all of its customers. Griddy nonetheless intended for its Chapter 11 plan to result in a release of liability for a variety of third parties, including its customers.59 When the court asked what benefit would flow to the creditors and the estate from these releases, Griddy did not answer directly, instead emphasizing that the releases of nondebtor affiliates were “part and parcel” of the entire deal; if the affiliates do not get the release, the other terms of the deal would fall apart.60 Griddy and the judge directly tied this argument to the extraordinary storm that precipitated the liability.61
Like bankruptcy à la carte, off-label bankruptcy does not arise solely from large shocks. But shocks fuel its use. Recall Purdue Pharma, the OxyContin producer that went bankrupt in response to the opioid crisis. Personal-injury claimants and state attorneys general representing more than half the population of the United States repeatedly objected to Purdue’s restructuring plans, arguing they did not comport with the law.62 From the outset, though, Purdue warned that this integrated deal, including releases for the Sackler family and over a thousand other parties, was the only way to ensure resources could be directed to opioid-crisis abatement.63 In other words, if public or private claimants opposed this plan, it would be the objectors’ fault that resources went to litigation and lawyers instead of to abatement (not to mention compensation for grievous harm).
The Sacklers’ expectation to be
protected by the bankruptcy of the company they owned stands in stark contrast
to the owners of my favorite ice-cream place. The Ample Hills Creamery founders
devoted all their financial resources to the business and provided personal
guarantees on business loans, like so many small-business owners
do.64 To get debt relief, the founders had to file for bankruptcy themselves—a reminder that small-business owners often do not enjoy the largess extended to bigger businesses.65
I highlight nondebtor releases because they are a common yet extraordinary off-label demand, as well as one that Congress has expressed interest in reforming.66 But the potential irregularities that an off-label bankruptcy might incorporate in the name of achieving a far-flung policy objective are virtually unlimited. For example, a settlement agreement in the Purdue Pharma bankruptcy required that the judge appoint a “special master” to carry out particular tasks,67 even though special masters are explicitly disallowed in bankruptcy cases.68 However nitpicky this observation might seem, it reflects a larger issue: the belief that the bankruptcies of large enterprises can continuously override existing law and rules in the name of responding to crises.
C. Logistical Effects of a Shock
The unintended consequences of shocks can have powerful logistical implications. For example, the COVID-19 pandemic has complicated federal courts’ strong preference for settlements and the means courts use to reach them. Like federal courts generally, the bankruptcy system greatly values negotiations and settlements.69 To the extent that a court is experiencing a high volume of cases, or that a crisis makes it more difficult for a court to handle those cases, the pressure to settle might increase.70 Judges are not always subtle about conveying their view that litigation is an unaffordable luxury or that failure to reach agreement will disappoint them.71
Although a major shock might increase the perceived need for nontrial resolution, a crisis can itself alter the process of negotiating toward majority support. For example, when governments mandated social distancing in response to COVID-19, technology allowed the show to go on to some extent. But Zoom negotiations and in-person negotiations are not the same, as a lawyer representing Purdue Pharma made clear:
Unfortunately, one of the realities we all face in this situation and others is that the new remote environment . . . takes away many of the pressurization tools normally open to mediators, including hauling senior principals to meetings or keeping parties sequestered in conference centers, sometimes with no food or water, to facilitate resolution.72
The lawyer continued that “with no ability to be dragooned and stared down by mediators and forced to stay until two in the morning,” lawyers and parties would “need some external help pressurizing this phase of the mediation [to] go on to the next phase.”73The presiding judge ultimately ordered parties to participate in lengthy in-person negotiations overseen by a fellow sitting judge, after which fifteen long-opposed parties agreed to drop their fight.74
The moral of this story: those of us interested in how shocks affect the operation of legal systems must keep our eyes open for the little things as well as the big ones. By shifting the logistics, shocks may also alter negotiations and how matters get resolved.
By the time this Essay went to press, the founders of my favorite ice-cream shop had opened The Social, a new ice-cream and donut business.75 New York’s senior U.S. Senator Chuck Schumer attending the grand opening, pronouncing that “Brooklyn always gets better.”76 Even after having to file their own personal bankruptcy to accompany the Ample Hills bankruptcy, they beat the odds and started fresh.
The impact of major shocks on the lives and livelihoods of real people—from a global financial crisis to a catastrophic storm or hurricane, to a pandemic that has generated death, illness, and financial despair—is profound. When risks are too vast to be privately insurable, we often look to public institutions or public-private partnerships to manage crises.77 Bankruptcy for individuals and small businesses has its own share of problems in need of reform, but sometimes better options are not in sight.
Big-business bankruptcy is a different world. This Essay has observed how crises dovetail with the melting ice-cube arguments that big companies and their lenders and acquirers use to remix the system, redistributing costs and benefits. The federal government already subsidizes the beneficiaries of bankruptcy à la carte and off-label bankruptcy. It does not need to do so through the bankruptcy system.
It will take more than words, tinkering around the edges, or even a lack of shocks to reverse these trends. The financial plumbing of Chapter 11 is at the heart of the problem. For example, so long as a lender to a bankrupt company can dictate by contract how much or little of Chapter 11 can be used, or can attach other strings, it will be difficult to halt the unbundling of modern bankruptcy cases. A roster of alternative financing ideas is out there. In other areas, scholars have argued that the public or nonprofit sectors should offer services to compete with, rather than replace, private options.78 Exploration of alternative Chapter 11 financing, including the use of government guarantees and crowdfunding, has grown in recent years.79 But ultimately, something even more far-reaching might be required to sever the power of funders and buyers to determine which parts of bankruptcy are used and which lie dormant.
We might also consider a different structural question: how many judges should oversee a very large bankruptcy case in the first instance? When a troubled enterprise is on the front page of national news-media outlets, with the effects of the crisis flowing fast and furious, judges can be put in an impossible position, and their cases can feel unduly personalized.80 Bankruptcy courts already have the authority to hold hearings jointly on the trial level.81 In some circuits that have authorized Bankruptcy Appellate Panels, they sit in groups to hear appeals.82 Rather than asking judges to simply try harder to resist personalization of responsibility to avert the alleged consequences of denying the relief powerful parties request, judges could sit jointly in panels, operating en banc, to oversee particularly high-profile cases.
Finally, meaningful reform will hinge on demography. Crises tend to be regressive, hitting hardest the communities already left behind. COVID-19 offered a potent reminder that crisis interventions can double down on existing inequalities.83 The homogeneity of elite restructuring professionals makes it especially problematic for bankruptcy to be the inevitable catchall crisis response.84 This dynamic cannot be solved from the outside in; the restructuring world needs to examine and improve itself from the inside out.
Melissa B. Jacoby is the Graham Kenan Professor of Law at the University of North Carolina at Chapel Hill. Thanks to the Yale Law Journal Board for its interest in this topic and its contributions to improving this Essay.