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On December 15th, 2023, a federal jury awarded $148 million in damages  to two Georgia election workers, Ruby Freeman and Shaye Moss, in a defamation suit  against former New York City mayor Rudy Giuliani, who had repeatedly accused the plaintiffs of manipulating ballots during the 2020 presidential election.  Unfortunately for Freeman and Moss, they now find themselves in a position that has become all too familiar for many successful tort claimants: Just one day after a federal judge ordered him to begin paying the judgment, Giuliani filed for bankruptcy, signaling that the plaintiffs can ultimately expect to recover only a fraction of the total amount they are owed.

If these facts sound familiar, it may be because they bear a striking resemblance to the ongoing bankruptcy of conspiracy theorist Alex Jones.  In December 2022, Jones filed for bankruptcy after he was ordered to pay $1.5 billion in a defamation suit brought by the families of eight victims of the Sandy Hook Elementary School mass shooting.  For nearly a decade, Jones had repeatedly asserted on his radio show the family members were secretly “crisis actors” involved in a government-orchestrated “false flag operation” to facilitate gun control legislation, causing the plaintiffs to endure years of stalking, harassment, and death threats from his followers.  Yet much like Giuliani, Jones’s liabilities far exceed his assets, leaving him with little choice but to seek bankruptcy protection.

Although Rudy Giuliani and Alex Jones are perhaps the latest high-profile tortfeasors to wind up in bankruptcy, they are certainly not the first.  Firms facing large tort judgments and settlements have used Chapter 11 bankruptcy to restructure their debts since at least the 1980s, when a growing number of asbestos producers began filing for bankruptcy as a result of asbestos-related litigation.  And over the last several years, high-profile corporate defendants—including 3M, Purdue Pharma, Johnson & Johnson, Remington Outdoor Co., Pacific Gas & Electric, U.S.A. Gymnastics, and others—have increasingly turned to bankruptcy in an effort to manage enterprise-threatening tort liabilities.

From the debtor’s perspective, filing for bankruptcy provides an opportunity to restructure overwhelming debts, including even those that arise from the debtor’s own tortious conduct.  For tort creditors, however, a defendant’s bankruptcy can severely limit their ability to recover compensation for the harm they have suffered.  In bankruptcy, secured claims—that is, claims secured by a lien on property of the estate—enjoy higher repayment priority than unsecured claims, meaning that unsecured creditors can be paid only after all secured claims are paid in full (up to the secured amount).  Because tort claims are unsecured, the result is that secured creditors—who, in many cases, largely consist of financial institutions and other sophisticated market participants—will generally recover a much larger percentage of what they are owed than tort victims in bankruptcy.

Perhaps unsurprisingly, the fact that the Bankruptcy Code sometimes allows tort creditors to go unpaid while large, sophisticated financial institutions are paid in full has become a focal point of bankruptcy scholarship in recent years.  In the absence of tort claims, prioritizing secured debt in bankruptcy does not ordinarily generate negative externalities because other creditors who are subordinated can (and do) respond by raising interest rates to compensate for the higher risk they now face if the borrower goes bankrupt.  Tort creditors, however, do not choose to become creditors and cannot adjust the terms of their claims to reflect their expected recoveries in bankruptcy.  Hence, when tort liabilities are present, prioritizing secured claims imposes a negative externality on tort creditors by reducing their allocations in bankruptcy without compensating them for doing so.

In response, many scholars and commentators have advocated for granting tort claims priority over secured claims in bankruptcy, meaning that tort creditors would be entitled to repayment ahead of secured creditors (and all other lower-priority claims).  And while prioritizing tort claims would only imperfectly address the distributional concerns that tort creditors face in bankruptcy, such a rule could still provide several promising improvements over the present system.  Most obviously, allowing tort creditors to leapfrog other creditors in the bankruptcy hierarchy would tend to dramatically increase their rates of recovery when a defendant files for bankruptcy.  But prioritizing tort creditors in bankruptcy would also have the benefit of encouraging borrowers, albeit indirectly, to avoid tort claims in the first place.  This is because voluntary creditors will wish to charge interest rates that accurately reflect the expected risk of having their bankruptcy allocations diluted by tort claims.  Hence, a borrower can reduce its overall interest expense by investing in precautions that reduce the probability or size of future tort claims against it. 

Of course, even if elevated priority would help tort creditors fare better in bankruptcy, this does not necessarily mean that such a rule would do more good than harm.  In particular, a rule prioritizing tort claims is unlikely to induce a socially optimal level of care on the part of potential tortfeasors unless creditors are capable of accurately differentiating between “good” and “bad” borrowers.  Often, this requires the creditor to gather and analyze detailed information about a specific borrower’s risk characteristics, much of which may or may not be readily available.  And while institutional lenders are well-positioned to do so, others might struggle to price credit effectively and could respond by charging uniform interest rates across broad groups of borrowers and/or reducing investment in highly litigated industries.  

On balance, however, prioritizing tort claims ahead of secured claims would most likely constitute a marked improvement over the status quo.  At best, the present system facilitates antisocial redistributive norms by transferring value from tort victims to financial institutions.  At worst, it allows the most sophisticated debtors to externalize the costs of risky activities by shifting the enterprise’s downside risk onto a group that cannot contract to protect themselves.  A rule prioritizing tort claims in bankruptcy would mitigate both of these concerns, and as tort victims continue to occupy central roles in today’s highest-profile cases, revisiting how these creditors are treated in bankruptcy might be more important now than ever before.

 

Suggested Citation: Zachary Hunt, Tort Creditors in Bankruptcy, Cornell J.L. & Pub. Pol’y, The Issue Spotter (February 1, 2024), http://jlpp.org/blogzine/tort-creditors-in-bankruptcy/.