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On December 14, 2012, Adam Lanza killed twenty children and six adults at Sandy Hook Elementary School and then killed himself—all in a matter of minutes with a semiautomatic rifle made for military combat. Grieving families sued gun and ammunition maker Remington Outdoor Company. In pursuing wrongful death claims, coupled with punitive damage requests, representatives of the families told the press their goals were not remunerative: they wanted to publicize information about the marketing of deadly weapons and to prevent future harms.
Having overcome many hurdles, the Sandy Hook families were preparing for trial when Remington filed for Chapter 11. In its first bankruptcy a few years earlier, the company emerged having flushed over $600 million of debt. This time around, Remington had a different agenda: to sell itself, and fast.
When Congress passed the Bankruptcy Code in 1978, drafters envisioned a multistep process to sell an operating company through Chapter 11. That process gave control and governance rights to claimants of many kinds to help chart the company’s future and allocate its value. Remington, its lenders, and potential buyers preferred to follow a different script that has developed through practice, one that allows consequential decisions about the company to happen without creditor governance and voting or the raft of statutory requirements in the Bankruptcy Code. Buyers demand sale orders insulating them from responsibility for the seller’s alleged wrongdoing, no matter how profitable the company becomes under new ownership.
Remington is not an outlier. Today, powerful parties regularly use Chapter 11 for games of chicken. Dismantling the statutory package of benefits and obligations allows powerful parties to extract and divert the benefits of Chapter 11 for themselves, overriding many other laws in the process.
In 1978, when Congress enacted the Bankruptcy Code, giving companies latitude to reorganize was said to foster competition and preserve jobs, as well as promote equal treatment of similarly situated creditors. Because the new Bankruptcy Code defined “debt” broadly, Chapter 11 would sweep in liabilities arising from diverse legal doctrines far beyond contract law, including tort and statutory, regulatory, and constitutional law, and it could change claimants’ rights without their consent.
This power came with trade-offs. Creditors of all kinds would collaborate with the company on a restructuring plan. In addition to shared governance and creditor voting, the Chapter 11 package included responsibilities to investigate and potentially remedy wrongdoing. The threat and reality of these checks and balances, including the possibility of displacing management, were designed to make the system operate fairly for everyone.
Chapter 11 puts a thumb on the scale in favor of reorganization through provisions that boost the odds a troubled company will recover. Lenders that offer new financing to a financially distressed company can get legal protection unavailable in private transactions. The bankrupt company also gets to make decisions (subject to court review) about its ongoing contracts without counterparty consent.
Particularly if separated from the package deal, these Chapter 11 “boosters” create tension with federalism. If powerful parties can dislodge the perks of bankruptcy law from the checks and balances, a wide range of people are at risk of losing important legal protections, and other non-bankruptcy policies may be shortchanged. Quick sales risk overriding a wide range of state laws and initiatives, and expanding the reach of national law and federal courts.
If the Chapter 11 package is so important, why is that package unbundled on a regular basis? Money.
Section 364 of the Bankruptcy Code provides incentives for lenders to extend credit to a troubled company. The lender gets more assets of the bankruptcy estate as collateral to secure the loan and higher priority repayment rights. Backed by an enforceable federal court order, these loans involve government intervention that private credit markets value greatly. Section 364 was meant to attract lenders to compete to fund distressed but viable companies. Studies consistently show that these loans are profitable and extremely low risk.
Unfortunately, these loans too often are also financially extractive, reallocating value away from other creditors. What’s more, however, lenders frequently use the leverage of their position to unbundle the Chapter 11 package deal meant to protect all stakeholders, including refusing to fund investigations and other elements that promote the integrity of the process.
As noted earlier, Bankruptcy Code drafters envisioned sales of entire companies happening through a Chapter 11 plan approval process, with creditor voting. Yet, lenders commonly insist that the company sell itself quickly without voting or satisfying the requirements of a Chapter 11 plan. That dynamic is captured in a Wall Street Journal quotation: “More companies that wind up in bankruptcy court are facing a stark demand from their banks: sell yourself now.” Appellate courts have tolerated these practices if the company can articulate a good business reason. That approach invites sale advocates to recite a parade of horribles if their request is opposed or denied: value destroyed, jobs lost.
A purchaser in a quick Chapter 11 sale gets significant benefits because even the truncated process delivers what ordinary mergers and acquisitions do not: a federal court order blessing terms and offering finality. Under section 363(m) of the Bankruptcy Code, if the court has approved the sale and the transaction has closed, an appellate court cannot unwind the sale if it later finds it flawed.
That finality has broader ramifications for creditors, particularly when these sales generate few cash proceeds to satisfy their claims. The doctrine of successor liability in non-bankruptcy law typically determines when a buyer should be on the hook for obligations of the seller. The Bankruptcy Code does not say that quick going-concern sales override successor liability. Section 363(f) of the Bankruptcy Code identifies circumstances under which a buyer can take the assets free and clear of interests held by others in those assets. In bankruptcy law, the interest typically means property interest, such as a mortgage on a building, or equity interest, but not a claim held by a creditor. Yet, some appellate courts have adopted an expansive interpretation, overriding successor liability doctrine. The U.S. Court of Appeals for the Fourth Circuit relieved the buyer of a coal company from retired coal miners’ pension and health care benefits mandated by the federal Coal Act because the sale happened in bankruptcy. In TWA’s third bankruptcy, the airline aimed to sell itself quickly to American Airlines, which did not want to honor a settlement TWA had reached with flight attendants for pregnancy discrimination. In its objection, the federal government explained that the Bankruptcy Code did not authorize bankruptcy sales overriding federal antidiscrimination laws. The U.S. Court of Appeals for the Third Circuit blessed the sale and cited job saving and future employee benefits as rationales.
There are no guarantees that these sales save jobs, of course. Consider the Weinstein Company, the entertainment firm. It already was low on employees by the time it filed for Chapter 11 to sell itself quickly to a private equity firm. The company said the sale would save jobs, but the buyer made no binding commitment to keep the remaining employees. Indeed, seemingly at the buyer’s request, the company laid off more employees before the sale was finalized. Although one of the buyers of Remington, the gun and ammunition company, promised to rehire two hundred workers, the Wall Street Journal reported that it fired them in the interim, such that the workers lost their health benefits during the COVID-19 pandemic. Unbundled bankruptcies, which deviate from the package deal Congress prescribed, are themselves a gamble.
Although insulation from successor liability should lead to higher sale prices in theory, many scholars and commentators worry that this does not happen in reality, potentially undercompensating claimants for the protections they have lost in the process. Claimants may receive smaller recoveries from quick going-concern sales—either because the sale did not maximize value, or because the privately negotiated sale procedures distorted the distribution of the sale proceeds, or both. Lenders setting the timeline may not need or be seeking top dollar for the company in order to be fully compensated.
The unbundling of Chapter 11 also greatly affects ongoing contract rights. Chapter 11 gives companies considerable discretion over what to do with pending contracts, to maximize the benefits to the bankruptcy estate. The company can even assign some contracts to a third party without counterparty consent. The catch is that doing so is supposed to increase the feasibility of a business restructuring, or at least maximize the value of the bankruptcy estate. That’s why Congress gave a bankrupt company the right to override state contract law.
This rationale for this federal law of contracts, already rightly controversial, loses steam when a non-bankrupt private party can co-opt this power for its own benefit. And that’s very much a risk in these unbundled bankruptcy cases. Here’s an example: the Weinstein Company was a party to tens of thousands of contracts, many relating to intellectual property from films and television. To have a qualifying bid to compete with the stalking horse bidder to buy the company, other bidders were required to identify on a short timeline which contracts they wanted and how they would cure defaults. The stalking horse bidder, a private equity firm, was given a long period of time to decide, after the sale to it had been approved, which contracts it wanted and how much it was willing to pay. This process not only reduced the ability of others to submit competitive bids, but it also made it impossible to determine whether the contract decisions were in the best interest of The Weinstein Company bankruptcy estate as the law requires.
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