Bankruptcy Courts Are Good At Adjudicating Tort Claims

Economists tend to view tort law differently than lawyers—or state attorney generals—and this difference explains both the advent of bankruptcy trusts in adjudicating class action liability claims and the complaints by the latter group concerning this development.

Tort law covers someone who was injured because of an action or omission that harms another. Its purpose is to change the essential cost-benefit calculus for a firm so that it does all that is feasible to prevent this from happening.

A classic example of the application of tort law is the manufacture of the Ford Pinto. Engineers placed the gas tank in the very rear of the car as a cost expedient measure even though they knew it would leave the car more vulnerable to a fire or explosion in an accident. They concluded that the liability costs would be less than re-engineering the car to place the tank elsewhere.

The courts found this calculus appalling and contrary to the public interest, and Ford’s liability ended up being many times greater than if it had addressed this vulnerability to begin with.

However, these days tort liability is invariably driven less by a desire to incentivize proper decisions and more by the impetus of trial lawyers eager to make a killing.

Most large liability lawsuits these days are initiated by trial lawyers that spend heavily to search for possible defendants. Most of these are more concerned with making money for themselves—or, for Attorney Generals, procuring funds that would allow them to pursue more headline-grabbing lawsuits—than with allocating money to the ostensible victims.

For instance, a company that tracks tort litigation activities called X-Ante found that there were more than 45,000 TV ads soliciting claims of alleged injury by the heartburn medication Zantac in the first quarter of 2021 alone. The entire litigation advertisement campaign for the class action suit cost nearly $50 million.

Such efforts result in a large number of parties ready to claim injury—whether valid or not—and can cause a company’s potential liability to metastasize far beyond what might be construed as a proportionate penalty. It also makes for a complicated and time-consuming process.

Several companies faced with enormous—and questionable—claims over potential damages have elected to jettison the division with the tortious claim and allow the bankruptcy courts to adjudicate the process.

They put a sizable amount of money into a bankruptcy trust to cover a first approximation of the potential costs of the litigation, and remain on the hook for future contributions as well.

For instance, Johnson and Johnson spun off its baby powder product into a separate entity to deal with nearly 40,000 defendants claiming they were injured by the talcum powder, even though the science purporting to show that it causes illness is far from settled, and placed the newly created company into bankruptcy.

Using a bankruptcy trust to make a liability more tractable for an otherwise solvent company makes a lot of sense in many circumstances. Bankruptcy courts are designed to adjudicate such issues so that legitimate creditors can get compensated for their damages in a timely manner while preserving the viability of the broader business.

Class action suits in ordinary federal courts can take years to adjudicate properly, on the other hand. For instance, Enron’s class action lawsuit took seven years to fully adjudicate.

Unfortunately, courts do not always abide with this strategy. For instance, 3M also tried to avail itself of the bankruptcy courts to deal with the liabilities incurred by Aearo Technologies, which it acquired in 2008. Aearo produced earplugs for the military, and it faces claims that the earplugs were difficult to properly fit in an ear canal, which led to the earplugs being rendered somewhat ineffective. Over 230,000 people filed a claim that they had suffered hearing loss as a result.

3M spun off Aearo, which entered Chapter 11 bankruptcy reorganization shortly thereafter. Aearo indemnified 3M from all existing and future claims and in return 3M agreed to refund Aearo’s reorganization process and put forth an unlimited amount towards settling the earplug litigation.

But last week a bankruptcy court judge held that 3M would not receive the same protection from claims as Aearo and its liability to the 230,000 personal injury lawsuits remained. If that ruling is helpd up on appeal it would mean that people who were injured and are deserving of compensation would likely see any awards delayed for years, and 3M’s viability—which is vital for any claims to be fully paid—is put into question.

It’s important to note that companies are not entirely off the hook when they place their former subsidiaries into bankruptcy: Both 3M and Johnson and Johnson contributed billions of dollars into funds intended to compensate those injured. Indeed, the claimants need the original company to remain solvent if they hope to be fully compensated for any damages they incurred.

My father was a bankruptcy lawyer for fifty years, and he maintained that the efficiency of these courts in adjudicating their (relatively narrow) realms ought to serve as a model for the creation of other specialized courts.

Bankruptcy trusts are a manifestation of their efficacy: By preserving the original company and determining the proper extent of both damages and tort claims, society arrives at a much more efficient and equitable outcome than when it allows trial lawyers or attorneys general to pursue egregious awards that benefit themselves more than anyone else.