Warren on Bankruptcy

Bankruptcy makes the pie larger by preserving the going concern value of the business. When investors became aware of the potential tort liabilities facing Johns Manville, financing for the company dried up. No one was certain whether the company could survive massive lawsuits, and voluntary creditors—such as commercial investors—could simply pass up this business. To reassure commercial lenders that the company would develop a plan to deal with its asbestos liability and to halt the flow of lawsuits, Manville filed for Chapter 11. If it had not, a company that had ceased producing the product that injured people, that was profitable in its current operations, and that employed thousands of people, would have been driven into quick liquidation. By the time the mortgages had been paid off and equipment had been sold at distress prices, there would have been little left for the tens of thousands of asbestosis victims who eventually collected from the company. Instead, while the Manville trust has had its troubles, the company remains operational and the asbestosis victims receive compensation.

In a mass tort case, value is preserved in yet another way. Dow Corning is a profitable company that quit manufacturing breast implants in 1992. Epidemiological studies have not linked its breast implants with the alleged injury, connective tissue disease, but the company has faced a torrent of lawsuits nonetheless. The company vigorously defended itself and was willing to litigate the issue of causation, but as the cases multiplied the company agreed to pay $2 billion to settle the claims. While 400,000 women were willing to be bound by that arrangement, 6,000 were not. By the time it filed for bankruptcy, Dow Corning faced 91 trials in the next six months alone. It was spending more than $3 million a week just on litigation expenses. Chapter 11 offered the possibility of sharply reducing the number of lawsuits—and the number of lawyers—needed to determine whether Dow Corning was responsible for any injuries. Even if Dow Corning had no legal responsibility for injuring women, litigation costs and the distraction of multiple lawsuits would sink the company outside bankruptcy. If Dow Corning were liable, the money saved on attorneys’ fees would fund significant repayments.

The second question—how to divide the pie—is the same in mass tort cases as in most Chapter 11 cases. Even if it is clear that the company owes the money, it may not have the resources to pay everyone in full. Non-bankruptcy law is a race of the diligent, permitting the first creditors on the scene to collect in full, leaving nothing for the later creditors. Bankruptcy law, by contrast, halts payments to the early tort claimants—and to all other creditors—while the debtor works with everyone to develop a plan to pay a similar distributional share to each claimant. No doubt the first claimants lose; they are unable to collect their jury verdicts in full and without delay. But because bankruptcy law focuses on all the claimants, what the early claimants lose is preserved for the later claimants who did not rush to the courthouse as quickly.

A finer distributional question lurks in the mass tort cases as well: the distribution of payment between injured parties and their lawyers. Because Chapter 11 may establish compensation procedures that do not require an attorney, some people will be compensated without sharing their recoveries with lawyers. A trust may also compensate the lawyers directly, limiting their recovery and effectively rewriting the terms of the agreement between lawyer and client.

While nearly all people except lawyers usually favor cutting lawyers’ fees, the last point demonstrates the dynamic impact of a bankruptcy resolution. If lawyers understand that in mass tort cases they may pursue difficult and expensive suits, only to see the company file for bankruptcy and force limited, pro rata recoveries on them, their enthusiasm for such cases may diminish. Similarly, if a company understands that it can deal with thousands of lawsuits scattered around the country in a single forum if it files for bankruptcy, it may not agree to an unfavorable settlement of those suits. Bankruptcy rules cast a long shadow on decisions made by parties who may never find their way to the bankruptcy courthouse.

The Commission recommendations are detailed, but their real impact lies in the ratification of the use of the bankruptcy courts to deal with mass tort problems. Much of what the Commission proposes has already been tried out in mass tort cases as courts have fashioned on-the-spot remedies with little statutory guidance. Although some commentators thought these courts had exceeded their authority, every successful reorganization strengthens the view that mass tort cases can—and will—be resolved in bankruptcy. With or without Congressional action, it appears that the bankruptcy courts will be part of the next wave of tort reform.

Professor Elizabeth Warren served as the adviser to the National Bankruptcy Review Commission. She wrote the Commission’s 1,400-page report explaining its 175 proposals. The report was delivered to Congress on October 20, 1997. Warren is the author of numerous books and articles on bankruptcy and commercial law, including As We Forgive Our Debtors, The Law of Debtors and Creditors, and Business Bankruptcy. She teaches Bankruptcy, Contracts, and Commercial Law.

See the next segment for Warren's own answer to the question: "Will the tobacco companies be the next to file for bankruptcy?"

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