Bloomberg Law
April 25, 2022, 8:00 AM

Reforming Corporate Bankruptcies to Stop the Mass Tort Shakedown

Lawrence A. Friedman
Lawrence A. Friedman
Friedman Partners LLC

The bankruptcy process is a historically quiet part of the U.S. legal system that functions well for the most part and usually doesn’t get much attention. Tight circles of lawyers in each geographic area generally keep things running smooth enough, and there is rarely anyone who isn’t playing by the rules.

But fraud in the bankruptcy system occurs, and when I was director of the Executive Office for U.S. Trustees in 2002, we restructured the office and created both civil and criminal enforcement divisions to address fraud. Then, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005 with the goal of preventing fraud and leveling the playing field in the individual bankruptcy process.

Now, there appears to be problems on the corporate side of the bankruptcy system due to the recent rise in mass tort issues.

Corporate Bankruptcy Process

At its core, the corporate reorganization process is all about restructuring the company in a manner that maximizes its value and then redistributes that value efficiently to creditors. But trial lawyers have sensed an opportunity to exploit the claims process in bankruptcy by using mass tort shakedown strategies when companies enter bankruptcy because of tort liability.

The scheme the trial lawyers use is simple, albeit devastating. They set up a full-on sales operation with sophisticated “lead generation” teams that find new potential claimants and “lead conversion” specialists that turn the leads into claims with maximum value. Social media ads, television ads, radio ads, they do it all.

There plan is to bring a deal-crushing stack of potential claims to the table—if there are $8 billion in assets and $10 billion in traditional liabilities, the lawyers would look to bring billions more in unexpected tort claims.

This scheme effectively throws a wrench into the traditional restructuring, forcing the debtor and every other creditor to deal with a new, burgeoning class of unsecured creditors. Insurance companies, the debtor, creditors, and sometimes principals of the debtor are forced back to the drawing board.

Compensation Funds

But fear not, the trial lawyers typically offer an easy solution: create a separate bucket of cash to be held in trust as the sole source for resolution of the mass tort claims (including mountains of fees for the lawyers). The creation of this fund (and payday) dislodges the wrench thrown by the trial lawyers, essentially clears the lawyers and new class of unsecured creditors from the field, and allows the restructuring to proceed in the traditional fashion.

For example, the current Boy Scouts of America bankruptcy in Delaware is a perfect vignette. The judge has just concluded a trial on whether to confirm the proposed plan. A decision is expected soon.

At the center of the Boy Scouts bankruptcy are sexual abuse claims. At the time of the initial bankruptcy filings the number of actual lawsuits filed by abuse claimants was less than 300, with the number expected to grow to about 2,000. That was back in 2020.

Mass Tort Lawyers Given Seat at the Table

Then the mass tort trial lawyers walked in, turned on the scheme machine, and flipped everything upside down by bringing over 80,000 new sexual abuse claims into the case. There have been allegations of lawyers cutting corners to generate these claims and skirmishes over the content of the advertising, with warnings from the judge.

But the result of the scheme has been that the mass tort lawyers were given a seat at the table where they seize control of the proceedings and shake down the other parties for a massive payday. The costs are real.

If the plan confirmation hearing doesn’t serve as a springboard for the judge to refuse final plan approval and demand greater scrutiny of these claims, the resulting mess will without a doubt dilute the funds available to the original victims whose claims were the impetus for the bankruptcy filing.

Make no mistake, we have the beginning of a real problem here. This shakedown gambit takes massive value away from creditors, including—as in the Boy Scouts bankruptcy—real victims. And the opportunities don’t seem to be disappearing, just look at the quick succession of the Purdue Pharma opioids bankruptcy, the Boy Scouts of America bankruptcy, and the new J&J talc bankruptcy.

Possible Solution—Judicial Conference

Congress could, of course, tackle systemic solutions. But a more viable avenue is the Judicial Conference of the U.S., which prescribes the official rules and forms governing bankruptcy practice and procedure. The Judicial Conference could quickly change the claim forms to require greater up-front disclosures and heightened certification requirements for the lawyers (and others) who help file claims on behalf of tort claimants.

In the meantime, and as longer-fused rule changes proceed, bankruptcy judges could appoint claims examiners in cases where large numbers of mass tort claims are brought into the bankruptcy proceedings. These examiners would shed light on how tort claims are solicited and would reveal whether victims are being subjected to abuse or mistreatment in the submission process.

Courts could then take corrective action. The increased transparency from systematic use of claims examiners together with action by the Judicial Conference could dissuade future abuses and protect real victims from getting crushed in a mass tort trial lawyer gold rush.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Author Information

Lawrence A. Friedman is the managing member of Friedman Partners LLC. He was the director of the Executive Office for U.S. Trustees from 2002-2005 and prior to that served as a Chapter 7 & 11 bankruptcy trustee.

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