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Melissa Jacoby on How Bankruptcy Favors Fake People over Real People

In 2019, Purdue Pharma filed for Chapter 11 bankruptcy protection. At the time, it had over a billion dollars in the bank and owed no money to lenders.

Melissa Jacoby

Why bankruptcy?

Corporations are now using the bankruptcy courts to shield corporate assets from those pesky victims of their corporate wrongdoing.

Melissa Jacoby, a professor of law at the University of North Carolina School of Law, is now out with a book – Unjust Debts: How Our Bankruptcy System Makes America More Unequal (The New Press, 2024). 

In it, Jacoby lays out how the federal bankruptcy system treats fake people (including corporations) better than real people (you and me.)

Jacoby finds that although many American laws give enterprises the benefit of personhood, the bankruptcy system is more generous and trusting of big enterprises than financially distressed families.  

For example, fake people can cancel legal obligations – including those that arise from bad behavior such as fraud or willful and malicious injury – while real people remain on the hook for a wide array of obligations, even parking tickets and jaywalking fines. 

Corporations get debt relief right away when a court confirms their restructuring plans,

even if they don’t finish repaying their creditors. 

Real people who commit to repayment plans, by contrast, get debt relief only if they finish, and many simply cannot.

Jacoby finds that while Chapter 11 offers many benefits for companies and their workers, as well as the surrounding communities, the biggest businesses, nonprofits, and their elite

lawyers have transformed and manipulated corporate reorganization to accomplish other objectives in a variety of ways – often at the expense of regular people. They pick and choose from Chapter 11 to take the benefits they seek without the corresponding obligations, shedding key creditor protections along the way. 

Jacoby points to specific examples of corporate manipulation of the bankruptcy system – including gun manufacturer Remington in the wake of the Sandy Hook school shooting, the Weinstein Company, Purdue Pharma, Johnson & Johnson, and Boy Scouts of America.

Should corporations be eligible for bankruptcy?

“I stop short of saying they should not be eligible. But they should be way more limited in what they can do in the system,” Jacoby told Corporate Crime Reporter in an interview last week. “Companies took this extraordinary tool set and started treating it like a Swiss Army knife. They started pushing the boundaries of what you can do with that system.” 

“Elite lawyers and other professionals have been able to argue that corners can be cut in the name of getting some money back into some pockets. So I argue for at least a very sharp restriction and a more rule of law approach for big corporate bankruptcies.”

As a human being, if I’m found to have engaged in wrongdoing and I am told to pay the victim for the adverse impact on that person, I don’t get out from under those debts, fines or sanctions. But the corporations do. 

How did that come about?

“Humans are subject to a lot of value judgments,” Jacoby said. “Individual bankruptcy judgments are over-determined to be a matter of morality. No matter how an individual gets into financial trouble – they get laid off during the pandemic, a hurricane knocks over their house and ruins their place of business – there are a lot of moral judgments being placed upon humans.” 

“If you flip it over to the corporate side, it’s more a matter of economic efficiency and dollars and sense. In reality, it has to do with corporate power. But on the corporate side, the argument is usually – lots of people will be better off if we allow the company not to pay. They may be able to maintain more jobs and their supplier relationships. Therefore let the company cancel those obligations or let them pay a couple of cents on the dollar.”

“But there is economic research that suggests there are broader economic benefits to giving people a fresh start. And yet we don’t take that all the way to its conclusion.”

What about legislation addressing corporations that take advantage of the bankruptcy system to get out of mass tort liabilities?

“In 1978, Congress defined a debt very broadly. It includes almost any reason someone might owe a legal obligation to someone else. I don’t think the ramifications for that were fully thought through. Bankruptcy was not meant to be a mass tort court. In a New York Times op-ed in June, I walked through how that happened. In the book, I walk through it a little bit more slowly.” 

“But I would say that it has to include if a business is closing or liquidating. Everybody should have a right to collect from whatever is being sold. But for reorganization, I am very critical of the use of the current system. It is underprotective not only of tort claimants but also of many important values our legal system seeks to protect – federalism, separation of powers to name two.” 

What would be the downside of prohibiting fake people from entering bankruptcy?

“One of the main reasons bankruptcy exists is to treat creditors fairly. That includes when a business has to close its doors. It’s important that a trustee – not appointed by the company – take a close look. And in Chapter 11, the company gets to make those decisions. But it’s important to have an independent trustee look to make sure creditors are treated fairly.” 

“There is an important question as to why you need the bankruptcy power. I don’t go all the way to – corporations should be kept out of bankruptcy. We do want to remember that it was supposed to be a creditor’s remedy in significant part. And that story has been lost.”

Are there any of your academic colleagues who argue that corporations should be kept out of bankruptcy?

“Not out of bankruptcy altogether. There used to be a contingent that only wanted bankruptcy to be used for closing businesses down or selling the business. But some of those scholars in the law and economics framework prefer bankruptcy now because there are so many sales. But the problem is that the way those sales operate may not be maximizing value and have self-distributional effects. All sales are not created equal.” 

“I am not familiar with anyone arguing that corporations should not have access to bankruptcy law.” 

“In Congress, there has been bipartisan criticism of how bankruptcy is used in these mass tort deals. And there is bipartisan legislation that would restrict what corporations can do in bankruptcy as well as where they can file their cases so that they can’t do as much forum shopping as they do now. None of that has crossed the finish line. But those bills have not sought to restrict altogether corporations’ access to bankruptcy, but rather make it more of a creditor’s remedy and make sure it’s perceived as fair.”

[For the complete q/a format Interview with Melissa Jacoby, see 38 Corporate Crime Reporter 45(12), November 18, 2024, print edition only.]

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