Tort Creditors in Bankruptcy
February 1, 2024Feature . Uncategorized Article(Source)
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), https://live-journal-of-law-and-public-policy.pantheonsite.io/tort-creditors-in-bankruptcy/.
You may also like
- April 2024
- March 2024
- February 2024
- November 2023
- October 2023
- April 2023
- March 2023
- February 2023
- January 2023
- December 2022
- November 2022
- October 2022
- May 2022
- April 2022
- March 2022
- February 2022
- January 2022
- December 2021
- November 2021
- October 2021
- May 2021
- April 2021
- March 2021
- February 2021
- January 2021
- November 2020
- October 2020
- September 2020
- August 2020
- July 2020
- June 2020
- May 2020
- April 2020
- March 2020
- February 2020
- January 2020
- November 2019
- October 2019
- September 2019
- April 2019
- February 2019
- December 2018
- November 2018
- October 2018
- September 2018
- March 2018
- February 2018
- January 2018
- December 2017
- November 2017
- October 2017
- September 2017
- May 2017
- April 2017
- March 2017
- February 2017
- December 2016
- November 2016
- October 2016
- April 2016
- March 2016
- February 2016
- January 2016
- December 2015
- November 2015
- October 2015
- June 2015
- May 2015
- April 2015
- March 2015
- February 2015
- January 2015
- December 2014
- November 2014
- October 2014
- August 2014
- March 2014
- February 2014
- January 2014
- December 2013
- November 2013
- October 2013
- September 2013
- May 2013
- April 2013
- March 2013
- February 2013
- January 2013
- December 2012
- November 2012
- October 2012
- September 2012
- June 2012
- April 2012
- March 2012
- February 2012
- January 2012
- December 2011
- November 2011
- October 2011
- September 2011
- August 2011
- April 2011
- March 2011
- November 2010
- October 2010
- September 2010