A capital markets approach to mass tort bankruptcy.

AuthorSmith, Thomas A.

A Capital Markets Approach to Mass Tort Bankruptcy

CONTENTS

  1. THE FAIR DISTRIBUTION PROBLEM IN MASS TORT BANKRUPRCY

    1. Mass Tort Bankruptcies and Mass Tort Bankruptcy Trusts

    2. Defining Fair Distribution in the Mass Tort Bankruptcy Setting

  2. ORIGINS OF THE FAIR DISTRIBUTION PROBLEM

    1. Factors Affecting Allocational Decisions

      1. Psychological Factors

      2. Judicial and Attorney Incentives

      3. Strategic Bargaining in the Bankruptcy Process

      4. Strategic Behavior by Equity in the Manville Reorganization

    2. The Roe Proposal for Mass Tort Reorganization

  3. A CAPITAL MARKETS APPROACH TO MASS TORT BANKRUPTCY

    1. Solving the Fair Distribution Problem: Structuring the Trust and

      Compensation

    2. The Pricing of Trust Shares and the Fair Distribution Problem

    3. A Capital Markets Approach to Mass Tort Bankruptcy at Work

      1. Marketable Trust Shares and New Information

      2. Capital Markets and Biased Price Determination

      3. Capital Markets and the Cost of Rent Seeking

      4. The Liquidation Process and Rational Expectations

      5. The Market for Trust Shares

      6. Risk Sharing Among Participants in the Trust Share Market

    4. The Fairness of the Capital Markets Approach

      1. The Role of Government

      2. The Problem of Inefficient Capital Markets

      3. Administrative and Capital Markets Approaches as Risk

      Management

  4. THE CAPITAL MARKETS APPROACH AND UNCERTAINTY ABOUT INSOLVENCY

    1. Tranches of Trust Shares and Priority in Bankruptcy

    2. A Capital Markets Approach to Uncertainty Concerning Insolvency

    1. Tort Bonds

    2. The Pricing of Tort Bonds

    3. Operational Costs

    4. Triggering Bankruptcy

    5. Current Bankruptcy Law and Tort Bonds

    6. Controlling Opportunism by Equity Holders and Managers

  5. CONCLUSION

    432

    After six years of complex litigation, the Manville Trust finally opened for business in 1988.(1) Its mission was to compensate as fully as possible the thousands of persons injured by Manville asbestos products. The long latency period of asbestos-caused diseases made the Trust's mission deeply problematic. No one could know at the time of the reorganization how many Manville asbestos victims there would ultimately be.(2) Indeed, Manville's victims, and those of other companies that formerly produced asbestos, will still be coming forward, in all likelihood, well into the twenty-first century.(3) The Manville reorganization purportedly took into account the interests of these so-called "future claimants"--persons whose identities and injuries could not be known when the plan of reorganization was formulated and confirmed, but who would certainly emerge as each victim's disease followed its course.(4) The Trust was large. Manville(5) and its insurance companies funded it with approximately $5 billion in assets.(6) Yet, after operating for less than two years, the Trust was all but empty.(7) Notwithstanding its looming liability to future claimants, the Trust paid virtually its whole value to the "present claimants"--those persons who were sick at the time the court confirmed the reorganization plan-and to their lawyers and the lawyers of the Trust.(8) Federal courts in New York now face the Herculean task of restructuring the Trust.(9)

    Anxious to avoid the fate of Manville, twenty other companies that formerly produced asbestos have recently structured a massive class action settlement between themselves and a broadly defined class of persons who were exposed to asbestos. Controversy over this settlement centers in part on whether it adequately takes into account the interests of future claimants. The settlement proposes to provide compensation to persons exposed to asbestos through an administrative procedure that awards scheduled compensation to persons suffering from defined categories of diseases.(10) Deciding whether the settlement treats the future claimants with fairness inevitably raises the question of what fairness to the future claimants really means.

    The vexing question of how to estimate total mass tort liability has also haunted the recent silicon gel breast implant settlement.(11) Representing the largest product liability settlement in history, the agreement provides approximately $4.25 billion to cover tort liability that is expected to emerge over the next several years.(12) Some critics have already charged, however, that the settlement fund is based on inadequate information and is certain to treat claimants unequally.(13) If these critics are correct, later silicon implant claimants may find themselves seeking relief from a trust fund as depleted as the one that future Manville claimants will face.

    Now is thus a good time to reexamine the approach to mass tort bankruptcy that caused so dramatic a failure in the Manville case and that is likely to do so again unless we change our thinking about mass tort bankruptcy compensation. The problem of unfair treatment has relevance far beyond Manville and mass tort bankruptcy. The Manville reorganization exemplifies the unfairness of persons in the present taking for themselves resources that ought to be reserved for the future. Many of the controversies of our time--the use of natural resources and the preservation of the environment,(14) the status of social security and other "entitlement" programs,(15) and the economic effects of the national debt, (16) for example-involve the potential misappropriation of resources rightfully belonging to future persons. While many acknowledge collective obligations to future persons, the rules and institutions needed to give these obligations more than lip service remain poorly defined.(17) This Article addresses some of these issues in the context of mass tort bankruptcy: What is a "fair" allocation to future claimants in a mass tort bankruptcy? How can it be achieved? Why are current approaches unfair?" These questions are important in their own right, and their answers also shed light on issues of more global significance.

    The first Part of this Article describes the general nature of the distributional justice problem in mass tort bankruptcy. Part II analyzes the institutional, psychological, and strategic factors that permit present claimants in mass tort bankruptcy to secure a disproportionate share of the debtor's assets for themselves.(19) Part III proposes a novel structure for mass tort bankruptcy reorganization. This proposal, which I call a "capital markets approach," produces a fair distribution of the value of the debtor's assets among present and future claimants by using the information-processing capabilities of modern capital markets. At the heart of the capital markets approach is a new kind of security--a security designed to be traded on the capital market at a price that reflects a relatively efficient capital market's estimate of how large the total tort liability of a mass tort debtor will be. The fundamental insight of this Article is its proposal to substitute the superior information-processing capabilities of capital markets for the more limited capabilities of administrators. Part IV tentatively suggests how the capital markets approach might be extended to cases where there is substantial uncertainty about whether future tort liability renders a firm insolvent. Part V is a brief conclusion.

  6. THE FAIR DISTRIBUTION PROBLEM IN MASS TORT BANKRUPTCY

    Mass tort bankruptcies create difficult problems of distributional justice. Bankruptcy law addresses some distributional questions explicitly. The bankruptcy priority rules, for example, mandate that certain classes of claims, such as those of employees, have priority over others, such as those of unsecured trade creditors.(20) While still somewhat controversial, several leading bankruptcy courts have suggested that present and future claimants in mass tort bankruptcy should be treated equally in the bankruptcy reorganization process.(21) This principle of equality, however, is easier to state than to implement. Strong forces militate against equal treatment of present and future claimants, causing what I call the "fair distribution problem." To understand how the problem arises, we must look briefly at some of the main institutions and issues of mass tort bankruptcy.

    1. Mass Tort Bankruptcies and Mass Tort Bankruptcy Trusts

      Dividing the assets of a debtor in bankruptcy among various claimants is

      especially difficult in the context of a mass tort bankruptcy. These difficulties stem in part from the nature of certain mass torts. While courts can estimate accurately the magnitude of harm caused by some mass torts soon after they occur, other torts inflict harms of uncertain magnitudes, which apparently defy judicial estimation. Bankruptcies caused by mass torts of the latter kind have already become a permanent feature of modern economic and legal life. The largest mass torts to date have been of this type.(22) Mass torts of uncertain and evolving magnitude will probably continue to occur, and perhaps even increase in frequency. As economic markets grow to national and international scale, products have the potential to harm significantly more people. Moreover, as technology advances, it seems to harness energies and substances capable of inflicting ever-greater harms over ever-longer periods.

      Several mass tort bankruptcies in the last decade have involved massive yet highly uncertain tort liability for future damages.(23) An important issue for bankruptcy lawyers in the 1980's was whether persons whom past torts would harm in the future, so-called "future claimants," actually had "claims" for the purposes of bankruptcy law.(24) Until their injuries manifested themselves, future claimants were, after all, merely unidentified persons with hypothetical injuries. Some leading bankruptcy courts have accorded future claimants a status in bankruptcy proceedings by appointing legal representatives to guard their interests and by ruling that reorganization plans can apply to future claims.(25) The Manville bankruptcy produced the landmark case in this regard.(26) Other courts have treated future...

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