Ghosts of Bankruptcy’s Past Haunt Bills to Address J&J, Purdue

Bankrupt and imprisoned, Revolutionary War financier Robert Morris helped kickstart bankruptcy law in the US. Today, after nearly two decades of little action, the US Bankruptcy Code has seemingly hit a rut, despite bipartisan calls for change.

Lawmakers on Capitol Hill are seizing on high-profile and large-scale bankruptcies to introduce amendments to the code. A bipartisan group from both chambers introduced parallel legislation in July to curtail a controversial asset-separation tactic known as the Texas Two-Step, citing attempts by Johnson & Johnson to use the maneuver to fend off mass litigation alleging its talc-based products caused cancer.

But moving the opaque subject to the forefront of a gridlocked Congress during a turbulent election year is a tall order.

“Unfortunately, it has not been a particularly productive Congress,” said Rep. Emilia Sykes (D-Ohio), who introduced the Texas Two-Step legislation in the House. On top of that, “many members are not well versed” in bankruptcy law, she said.

Still, Sykes is hopeful that the legislation will pass because it extends beyond party lines into issues of fairness, consumer protection, and access to justice. She is the former law clerk to the chief judge of the US Bankruptcy Court for the Northern District of Georgia.

“This goes beyond the conversation of lawmakers trying to introduce a bill. It’s, ‘I know that you have people in your community who have cancer and people who have filed lawsuits because of large corporations not giving appropriate disclosures or attempting not to be held liable for things that they have done wrong,’” Sykes said.

Democrats from both chambers introduced two other bills in July to amend the bankruptcy code to increase focus on patient care in health-care bankruptcies and to limit protections to nonbankrupt entities.

If history serves as a barometer, these bills are in store for an uphill battle. The last major overhaul of the bankruptcy code was in 2005. Since then, lawmakers have made some narrow changes—including the creation of Subchapter V in 2019 to make bankruptcy benefits more accessible to small businesses—but have had little success in pushing sweeping changes through.

“The chances of bankruptcy legislation passing are always low,” said Ralph Brubaker, University of Illinois law professor and former bankruptcy and corporate reorganization attorney.

Despite the long odds, lawmakers throughout American history have found ways to enact major overhauls to the bankruptcy code, gradually moving toward a more generous structure for debtors.

Preventing Abuse

In the early 19th century, bankruptcy was illegal in the US. Robert Morris, unable to pay his debts, found himself in prison. Congress, in part to free him, passed the first bankruptcy law in the country’s history in 1800, according to the Federal Judicial Center.

It was repealed less than three years later and a century of fleeting bankruptcy laws ensued. It wasn’t until 1898 that Congress passed the first long-term bankruptcy law. Financial panics in the later half of the century and perceived abuses of the system were instrumental in driving Congress to act.

The law was amended over the years and had “a bit of a hodgepodge quality about it,” Brubaker said. “That created enough problems that those who dealt with the system all the time recognized that there needed to be a more comprehensive reform effort.”

Thus was born the Bankruptcy Reform Act of 1978, which overhauled the system. It created two new chapters and established bankruptcy courts in each district.

In the 1980s and 90s, Congress passed a handful of measures that altered the structure of bankruptcy courts, created Chapter 12 for farmers and fishermen, and made the Justice Department’s bankruptcy watchdog, the US Trustee, permanent.

“There was not a polarization that there is today,” said Lynn LoPucki, a professor at the University of Florida Levin College of Law who founded a database of public company bankruptcies. “People in Congress were actually concerned about whether the system functioned.”

While bankruptcy law began on a very limited scale in the US, it eventually became recognized that anybody could incur legitimate debt and should be able to file for bankruptcy for relief, Brubaker said.

The Boiling Point

The evolution in bankruptcy law has largely stalled since 2005, when a Republican-controlled Congress passed and George W. Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act. It was designed to make it harder to file for Chapter 7 bankruptcy, which is typically used for individuals or companies that are liquidating.

A major force behind its passage was sustained concern over abuses of the bankruptcy system by individual filers. That concern is picking up again, but is being aimed elsewhere in the system.

“There’s a growing perception that the system is dominated by insiders, to a specific extent that has been true in the recent past, and that the insider dominance seems to be leading to some abuses,” said David Skeel, a professor of corporate law at the University of Pennsylvania Carey Law School. Those insiders include bankruptcy professionals, lawyers, and a small group of financial advisers, he said.

Sykes’ and Sen. Sheldon Whitehouse’s (D-R.I.) companion bills to limit the Texas Two-Step (H.R. 9110 and S. 4746) follow perceived abuses of the system by large corporations. In response to the US Supreme Court’s June ruling in the bankruptcy case of opioid maker Purdue Pharma, which banned nonconsensual liability releases to nonbankrupt entities, Rep. Jerrold Nadler (D-N.Y.) reintroduced a bill (H.R. 9223) to extend the ban to other bankruptcy protections.

But concern over abuses of the system hasn’t hit a “critical mass” to cause lawmakers to enact sweeping changes like they did in the past, Skeel said.

“The water is heating up, but it hasn’t reached the boiling point yet,” Skeel said.

Also, the high court’s Purdue ruling could give the perception that there is nothing in need of fixing, making it harder to pass Nadler’s bill, Brubaker said.

“The Purdue Pharma decision kind of took the urgency out of the issue,” Skeel said.

Sustaining Momentum

Sen. Edward Markey (D-Mass.) introduced a bill (S. 4804) that would require courts, in confirming a bankruptcy plan, to put “substantial weight” on how the plan maintains health care access, quality, and safety. Markey cited the controversial bankruptcy of the Steward Health Care System, which operates 31 hospitals across the country.

The bankruptcy, filed in May, drew lawmaker scrutiny over private equity involvement and wealthy executives. After a private equity firm bought up a handful of hospitals, it created the system and sold the property under the hospitals to a real estate investment trust, which leased the land back to the system. The firm then sold the system, making a roughly $800 million profit in all.

Steward was unable to pay the rents and operational costs, leaving patients and health-care workers across the country with an uncertain future. A bipartisan Senate committee voted last month to investigate Steward’s bankruptcy and subpoena its chief executive officer.

“Because everybody’s hearing about Steward and hearing about how that case is going, there’s momentum to pass a bill like this,” Laura Coordes, a professor at Arizona State University’s Sandra Day O’Connor College of Law, said about Markey’s bill. But Congress is on recess until Sept. 9 and Election Day is less than two months after that.

“The question is ‘Will the momentum be lost with this particular bill?’” said Coordes, whose research focuses on bankruptcy and financial distress. “Because I do think we see that a lot.”

Still, the fluctuating nature of corporate bankruptcy use indicates there’s room for growth in the code.

“The cases that are being brought to the bankruptcy system have changed a lot, and practice, especially Chapter 11 practice, has changed a lot,” she said.