Legislation could end corporate bankruptcy forum shopping

Have events in 2021 triggered the end of forum shopping in corporate bankruptcy law? Critics who call the practice corrupt say yes.

The Bankruptcy Venue Reform Act of 2021, introduced in September by U.S. Senators Elizabeth Warren, D-Mass., and John Cornyn, R-Texas, would require large corporations to file for bankruptcy in the state in which they are headquartered or where significant assets are located.

"Wealthy corporations should not be able to run across the country to find a favorable court to file bankruptcy," Warren said in a September news release. "While they manipulate the system to file for bankruptcy wherever they please, affected communities -- like workers, creditors and consumers -- lose."

Unlike in civil litigation, corporate debtors in bankruptcy law are free to survey the country in search of a favorable court in which to seek protection. Critics of the practice have long decried it as a way for big corporations to game the system, but a number of eyebrow-raising developments in Chapter 11 filings this year have reignited calls for change.

In September, U.S. Bankruptcy Judge Robert Drain in the one-judge district of White Plains, New York approved a reorganization plan that would allow OxyContin maker Purdue Pharma and its founder, the Sackler family, to avoid all current and future liability from the nationwide opioid litigation. After the plan was announced, many attorneys wondered why the case was heard in White Plains in the first place, since Purdue is headquartered in Stamford, Connecticut.

After Drain approved the plan, which included a third-party release, the Sacklers, not the party that filed for bankruptcy, escaped all liability from the opioid litigation, in exchange for $4.5 billion. Twenty-four state attorneys general expressed their opposition. California Attorney General Rob Bonta along with his colleagues in Connecticut, Delaware, Maryland, Oregon, Rhode Island, Vermont, Washington, and the District of Columbia, filed an appeal, saying, "The Sackler family must be held accountable for its role in creating and fueling the devastating opioid crisis."

The National Association of Attorneys General later endorsed the Bankruptcy Venue Reform Act in a letter signed by 43 states' chief prosecutors.

Drain subsequently announced his retirement.

In a stunning turn of events last Thursday, Purdue Pharma's bankruptcy settlement plan was overturned by U.S. District Judge Colleen McMahon in New York.

Bonta applauded McMahon's decision to reverse the New York bankruptcy court's confirmation of Purdue Pharma's reorganization plan in a statement.

"The Sackler family must be held accountable for their contribution to the ongoing opioid crisis," Bonta said. "Too many California communities have unfairly paid the price for their willful misconduct, and the bankruptcy plan would have allowed them to exchange money for lifetime immunity -- falling far short of true accountability. I applaud the district court for its ruling today, and remain committed to bringing relief to our communities."

More recently, U.S. Bankruptcy Judge Craig Whitley in the two-judge Western District of North Carolina said pharmaceutical giant Johnson & Johnson had more than forum shopped when one of its subsidiaries filed for bankruptcy in his court. "It manufactured a forum and created a venue," he wrote.

In an effort to end mounting liabilities from nearly 40,000 lawsuits filed nationwide accusing it of selling cancer-causing baby powder, J&J underwent what is called a "Texas Two Step" corporate restructuring. Under a Texas divisive merger statute, it dissolved one of its subsidiaries, Johnson & Johnson Consumer Inc., and created two entities, one to continue business as usual, the other to dump liabilities and debts from the talcum powder litigation.

J&J's lawyers from Jones Day argued the company, called LTL Management Inc., should be allowed to file for bankruptcy in North Carolina, since J&J's parent company deposited $6 million into its bank account there before it filed for bankruptcy two days after its creation.

However, under a rarely used statute, Whitley, through his own motion, punted the case to New Jersey where J&J's parent company is headquartered and the vast majority of talcum powder lawsuits are being heard.

"Here, the debtor is trying to manufacture venue and is attempting to outsmart the purpose of the statute," Whitley wrote in an order transferring the case. "[A]ny forum shopping by the parties weighs against them both in looking at the factors, but in this case, the debtor is not just forum shopping; the debtor is manufacturing forum and creating a venue to file bankruptcy."

Whitley pointed out that Jones Day had used this same bankruptcy strategy in four other cases, all filed in his Western District of North Carolina.

"In each of these cases, a corporation with substantial asbestos liability hired the law firm of Jones Day, the corporation used the 'Texas Two Step' to create a North Carolina entity with limited assets and all or most of its predecessors' asbestos liability, and the North Carolina entity filed for bankruptcy in this district shortly after its creation," Whitley wrote.

Jones Day responded to accusations that it had forum shopped by arguing that the Western District of North Carolina was "the obvious place" for LTL Management to file its Chapter 11 petition. Since the southern state, like Delaware, is known for handling corporate bankruptcies, the North Carolina court has gained a reputation for handling Texas Two-Step style corporate mergers.

"In the same manner that, for instance, the District of Delaware has become known for its expertise in handling large, complicated Chapter 11 business cases, this court now has become known for its expertise in handling complicated mass tort cases of national significance, including cases involving divisional mergers," the Jones Day opposition brief read. "It has become routine for national business cases to file in Delaware based solely on state of incorporation, even where the debtor has substantial physical assets elsewhere."

Jones Day went on to argue that J&J and LTL, like other large corporations, have assets dispersed throughout the country and should, like other companies that file in Delaware, be allowed to file in the venue of their choosing.

"For these large cases, there is no nexus of creditors located in one, defined location," the opposition brief read. "Instead, the creditors, as well as the debtor's physical assets, are dispersed throughout the country. As a result, the experience of the Delaware court is the dominant driver of the debtor's decision to file in Delaware, as well as uniform acceptance of that decision."

However, as bankruptcy and transactional expert David S. Kupetz of SulmeyerKupetz PC pointed out, Whitley would later signal, through his order to transfer the case, that Jones Day had attempted an "abusive tactic" to get the case before him.

"I think he ended up feeling that while it wasn't technically improper, since technically, the creation of the entity in North Carolina within two days of the bankruptcy meant that that's where the entity resided ... and technically, it came within the venue," Kupetz said. "But he's saying, 'This is really forum shopping and forum shopping isn't a good thing. But more than that, it's a bad thing when you set up a company with the sole intent of filing bankruptcy in this district, and that's really going too far.'"

However, Whitley is perhaps the first bankruptcy judge to send an allegedly forum shopped case involving a large corporation back to its headquarters' jurisdiction. Of the last 193 cases involving a large public company accused of forum shopping, none were returned to the jurisdiction where the company is physically located, according to UCLA School of Law professor Lynn M. LoPucki.

LoPucki closely tracks large companies that he said forum shop in bankruptcy as part of a data collecting project with the university called the UCLA-LoPucki Research Database. It tracks more than 1,000 large public companies that have filed bankruptcy cases since 1979.

According to LoPucki, the forum shopping rate among large public companies rose steadily from about 20% in the early 1980s, shortly after bankruptcy law changed to allow for corporate forum shopping, to over 90% in recent years. The reason for the increase, he said, is more courts are competing for cases.

"Before 1990, there had only been one large public company that had ever filed in Delaware and it was a steel mill that was physically located there," LoPucki said. "Then, in 1990, the Delaware court got two big cases."

"The more important of the two was Continental Airlines," he continued.

After that case, Delaware began attracting several large, public company bankruptcy filings. By 1996, 13 out of 15, 87%, of large corporate bankruptcies, were filed in Delaware, LoPucki said. From 1980 to 2011, Delaware and New York were the two most popular states to file corporate bankruptcy cases, he added.

However, in the last 10 years, three other courts have attracted large corporations. According to the LoPucki database, the bankruptcy courts in the Southern District of Texas; Richmond, Virginia; and White Plains, New York had 62% of the large company bankruptcy market by 2020, leaving Delaware and New York with a total of 28%.

Besides the prestige that comes with them, bankruptcy judges compete for big cases because of the local bankruptcy bar and the industry that big cases create, LoPucki said.

"Almost all of the big cases are forum shopped to someplace else," he said. "And if you practice law in a place, let's say Houston, in 2010, you're practicing in a desert. All the big cases go to Delaware and New York. But if the judges can compete for cases and bring cases to Houston, then bankruptcy practice prospers there."

"And to some degree, these bankruptcy lawyers who practice in a court are the judges' constituents," LoPucki continued. "When the judge comes up for reappointment, the Court of Appeals will ask for letters from the lawyers who practice before this judge asking 'how good the judges are.' If you're the judge that drove all the cases away, the lawyers probably don't think you're a great judge. Judges have not been reappointed solely because they drove the cases away."

LoPucki said he was consulted on the drafting of the Venue Reform Act, and according to his sources, if Congress ever put it to a vote, it would pass.