Imagine that the Acme Widget Company discovers that, to its horror, no one wants its widgets anymore. [Maybe its âwidgetâ was a buggy for horse-drawn carts, and the automobile had just been invented.] Acme owed $100,000 to its suppliers, but had assets that only totaled $5,000, with no prospect of adding to those assets by building more strollers. To continue to manufacture strollers would lose (waste) even more money. Maybe Acme’s buggy expertise would allow it to profitably manufacture (say) suspensions for these new horseless carriages, but to do that Acme would need fresh capital, and nobody is willing to lend a business “under water” to current creditors. What should Acme do? He could go out of business and leave town, of course â laying off employees, disrupting countless lives and leaving creditors totally embarrassed. But it’s a lose-lose situation.
Acme is a prime candidate for corporate bankruptcy reorganization, a vital area of ââUS law that until recently worked quite well. The US corporate restructuring process (essentially Chapter 11 of the bankruptcy code) is designed to maximize the value of the business, which is then redistributed to creditors of all types (employees, suppliers, bondholders, etc.) , thus avoiding liquidation without a prisoner. provided for in Chapter 7.
As Lawrence A. Friedman pointed out in a nice recent article in the Harvard Journal of Law and Public Policy, occasional episodes of mass fraud hampered the practice of bankruptcy. For example, between 1989 and 2001, credit cards skyrocketed and the savings rate steadily declined. The consumer bankruptcy rate jumped 125% during a period of unprecedented prosperity in the country. During this period, it was not uncommon for a bankrupt debtor to have credit card debt of $50,000, $75,000 or even $100,000 while claiming household items and furniture under $1,500. Too often, the assets listed by the bankrupt debtor were found to be grossly underestimated, playing on the fact that there was really no one to audit or monitor the system at the time. In response, the Executive Office for United States Trustees changed the criminal and civil enforcement mechanisms, and the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 obliged lawyers to certify that they had made a reasonable investigation of the information placed in the lists of debtors.
It was before, it is now. As Friedman’s essay indicates, the most recent fraud problem involves mass tort attorneys bringing their playbook to the bankruptcy courts generating an overwhelming number of previously unknown claims against the bankrupt company. Imagine Larry Lawyer claiming that every citizen who had ever come into contact with one of Acme’s buggies had shortened its lifespan by sniffing the varnish used to coat the wooden chassis. Suddenly, a new competitor for Acme’s limited assets arises, and a new beleaguered debtor (Acme’s insurance company) will suddenly have to defend thousands of claims in an administrative bankruptcy proceeding unsuitable for a tort judgment. tort.
The arrival of mass tort plaintiffs is muddying the waters of bankruptcy reorganizations and leaving parties scrambling to find solutions. A typical arrangement now involves the bankrupt debtor (via their insurer) offering a substantial sum which is nevertheless a reduction from the face value claimed by the burgeoning new and difficult to assess class of unsecured mass tort plaintiffs. In exchange for guaranteed access to this sum, the mass tort attorneys agree, as a provision of the bankruptcy plan, to provide the debtor with a bar to further claims and a release for all future claims. relevant known and unknown. The creation of this fund (and substantial fees for attorneys) dislodges the wrench thrown into the works by mass tort attorneys and allows restructuring to continue in the traditional fashion with the remaining funds.
The current bankruptcy of the Boy Scouts of America (BSA) in Delaware is an illustration of how these issues can play out. At the center of the Boy Scouts bankruptcy are claims of sexual abuse [Full disclosure: our son was an Eagle Scout. He went through Cub Scouts, then Boy Scouts, in Maryland before finishing his Eagle Scout project (planning and executing a central plaza with flagpole at a school for disabled children in Gaithersburg) and in the process encountered over a dozen scout leaders. All were exemplary human beings. I never heard of any Scout abused in any way. The example provided to our son by scouting was, my wife and I believe, instrumental in his choice to become an officer in the United States Marine Corps.] Abuse allegations have dogged the BSA for years, with litigation mounting after a landmark case in 2010 that resulted in the court-ordered release in 2012 of internal reports of volunteer abuse. The 2020 BSA bankruptcy was designed to bring about a resolution of ongoing abuse claims, to compensate the real victims and to move on.
Mass liability firms then ran advertising and marketing campaigns (you’ve probably seen some on TV) and used claim aggregators to bring in more claims. Prior to seeking bankruptcy protection, BSA had been named in 275 actual lawsuits, and the organization told its insurers it was aware of another 1,400 pending claims. But since the bankruptcy, these approximately 1700 claims (which already seemed like a lot to me) have exploded to more than 100,000 (reduced to 80,000 after removing duplicates). More than 55,000 of these unpublished claims came from a group of ten law firms posing as the Coalition of Abused Scouts for Justice, who entered the case in tension with the official panel of tort plaintiffs that the bankruptcy court had already appointed to speak on behalf of the victims. Insurance companies to keep that many of the Coalition’s new claims are barred by the passage of time based on statutes of limitations (Note: several states have suspended statutes of limitations for sexual abuse, but these “elimination laws” themselves are of questionable effect for claims already fully prohibited with their entry into force). Thousands of other claims apparently lack essential information needed to determine their validity, such as identifying any connection to the Boy Scouts or even the name of a perpetrator. How can BSA insurers defend against outdated claims lacking crucial information?
The BSA argues that mass tort attorneys are cutting corners by blindly filing thousands of unverified and potentially fraudulent claims. The judge assigned to the case, Laurie Selber Silverstein of the Delaware Bankruptcy Court, has intervened more than once to control misleading advertisements.
The system is cracking under the pressure of these mass tort claims. The costs of the proceedings themselves are skyrocketing, and there is now a real risk that the money available to the first victims (whose verified claims led to bankruptcy) will be significantly reduced. For example, recent reports indicate that the bill for BSA experts and those hired by official creditors’ committees has soared to over $205 million, which approximates the size of the original trust that was part of the settlement discussions. Experts have noted that bills from attorneys and others connected with the cumbersome process are on track to make up more than 40% of BSA’s self-declared assets, whereas in past megabankruptcies those fees were typically $2-200. 3% and certainly less. by 10%.
Friedman’s essay proposes several legislative and regulatory changes to address mass tort abuses in the bankruptcy process, much as was done to address the credit card fiasco. I hope his suggestions will be followed. The limited assets of a struggling business must be divided efficiently and honestly if insurers are to accurately assess the risks to enable reorganization.