Welcome back to the Deep Dive. Today, we are
going to talk about a word that I think for most
people feels like the end of the world. Oh, yeah.
It's got some serious weight to it. It really
does. It summons these images of, you know, boarded
up storefronts, everything must go signs, and
maybe the Monopoly man turning out his empty
pockets. With a frown on his face. It's the ultimate
financial taboo. Exactly. Yeah. We were talking
about bankruptcy. And usually when we hear that
word, we think of failure. We think of ruin.
We think game over. Right. But I've been reading
through this whole stack of sources you sent
over. We've got court cases, historical analysis,
corporate strategy docs. And I have to say my
brain is a little broken because the picture
these sources paint is completely different.
It usually is. I mean, if you look past the stigma,
you start to realize that bankruptcy isn't just
about running out of money. It's actually one
of the most sophisticated, complex and powerful
engines in the American economy. An engine. Right.
Not a graveyard. Not a graveyard at all. The
sources basically argue that it's not a funeral
for a business or a person. It's a tool. It's
a reset button. A reset button. And what really
surprised me is how it's used as a strategic
weapon. We're going to talk about how these massive
corporations use the system not just to survive,
but to actually make more money, to break contracts
and even to dodge lawsuits. It is the safety
valve of capitalism. That's probably the best
way to frame it. Without this system, the gears
of the economy would just they'd eventually grind
to a total vault. So our mission today is to
decode this bankruptcy code. We need to understand
the difference between, say, liquidation and
reorganization. And we need to figure out what
a Texas two -step is. And spoiler alert, it's
not a dance. Not a dance. And we need to answer
a really hard question. Is this whole system
designed to help people or is it, you know, rigged
to save corporations? And to answer that, we
have to start at the very beginning. And I don't
mean the 1980s or even the 1920s. I mean the
very foundation of the country. The Constitution.
This was the first shocker for me. I always assumed
bankruptcy laws were these, like modern regulations,
maybe invented when credit cards became a thing.
But it's right there in the original document.
It is. Article 1, Section 8, Clause 4. It's wild.
The founding fathers are sitting in Philadelphia,
sweating in their wigs. They're drafting the
blueprint for a new nation. They're writing about
we the people. They're figuring out how to raise
an army, coin money, declare war. All the big
stuff. The big stuff. And in that exact same
list of superpowers they give to Congress, they
include the power to enact uniform laws on the
subject of bankruptcies. It seems out of place,
doesn't it? You have war, peace, currency and
debt relief. Right. Why were Madison and Jefferson
so obsessed with debt? Was the national credit
card bill already that high? Well, you have to
understand the context of the time. In the 18th
century, especially in England and the early
colonies, debt wasn't just a financial problem.
It was seen as a moral failing, and it was a
criminal offense. A criminal offense. Oh, yeah.
If you couldn't pay your debts, you didn't just
get a bad credit score and some annoying phone
calls. You went to prison. Actual prison. Debtor's
prison. And you would just, you'd rot in a cell
until your family could scrape together the pennies
to buy your freedom. It was a complete dead end.
It took productive people out of the workforce
and locked them away where they couldn't earn
anything to pay back the debt anyway. It was
totally illogical. It's a lose -lose situation.
I mean, the creditor doesn't get paid and the
debtor loses their liberty. Precisely. And the
founders were building a commercial republic.
They wanted to encourage enterprise. They wanted
people to take risks, to borrow money, to build
a ship or start a farm, open a trading post.
But they knew human nature. If the punishment
for failure is life in a cage, nobody is going
to take that risk. You kill innovation before
it even starts. You do. So they baked the concept
of the fresh start right into the DNA of the
United States. They authorized Congress to create
a system where if things went wrong, you could
wipe the slate clean and try again. OK, so let's
unpack this first start concept. It sounds a
bit like a marketing slogan, but legally, what
does it actually mean? It is the philosophical
heartbeat of U .S. bankruptcy law. The Supreme
Court has actually weighed in on this multiple
times. In one famous opinion, they described
the purpose of bankruptcy as giving the honest
but unfortunate debtor a new opportunity in life
and a clear field for future effort. I love that
phrasing. unhampered by the pressure and discouragement
of pre -existing debt. It sounds almost, I don't
know, religious, like being born again, but financially.
It is a form of economic redemption. And here's
where we have to be critical. There is this massive
tension inherent in that idea. Because for you
to get your fresh start, someone else has to
lose money. Right. The creditor. The person who
lent you the cash in the first place. If I lend
you $10 ,000 and you file for bankruptcy, I don't
get that money back. I've been harmed. Exactly.
You lent that money in good faith. You expected
a return on it. So the entire history of the
bankruptcy code is this constant tug of war.
It's a balancing act between the need to show
mercy to the debtor so they can be productive
again versus, you know, the sanctity of contracts
and the rights of creditors to get what they
are owed. That makes sense. If you make bankruptcy
too easy, if anyone can just walk away from their
debts whenever they feel like it, well, nobody
will ever lend money again. Right. Interest rates
would skyrocket to 50 percent because the risks
would be astronomical. The economy would just
freeze. But if you make it too hard, you create
this permanent underclass of people just drowning
in debt, essentially serving a life sentence
of poverty. And that benefits no one. So the
code tries to walk this very fine line. And the
way it does that is through some very specific,
very powerful mechanics. Let's get into those
mechanics. I want to visualize this for the listener.
So let's say I'm drowning. My business is collapsing.
I've got creditors calling me day and night.
The bank is threatening to take my house. I go
down to the federal court and I file a bankruptcy
petition. Boom, I slide the paper across the
desk. What happens in that exact second? In that
exact second, you trigger one of the most powerful
injunctions in... All of American law. It's found
in 11 U .S .C. Section 362. It's called the automatic
stay. The automatic stay. I love this concept.
In my head, I picture it like a giant sci -fi
force field just slamming down around your house.
That is a surprisingly accurate analogy. Honestly,
think of it as a giant pause button that freezes
the entire universe of your debt. So let's play
this out. If a collection agency is dialing my
phone number at the exact moment I file. They
have to hang up. Immediately. If they say one
more word to you after they know you filed, they
are breaking federal law. What if there's a lawsuit?
Let's say I'm being sued for a million dollars
and the trial is scheduled for tomorrow morning.
The trial stops. The judge puts down the gavel.
The lawyers go home. Everything just freezes
in place. And what if the bank is auctioning
my house? Like the auctioneer is standing on
the front lawn, gavel in the air, about to say
sold. If you file that petition before he says
the word sold. The auction is canceled. The automatic
stay halts all foreclosure proceedings instantly.
That is an immense amount of power to give to
a person just by filing a single piece of paper.
Yeah. Why is the law so aggressive about this?
Why a total freeze? Well, it's not just to protect
you, the debtor. It's actually designed to protect
the creditors from each other. Wait, how does
freezing them protect them? That sounds backwards.
Think about a failing company. Let's use a nature
documentary analogy. A failing company is like
a dying buffalo on the savanna, and the creditors
are the lions. I was going to say vultures, but
sure, lions works. Lions, vultures, whatever.
If you don't have the automatic spay, you have
what lawyers call the race to the courthouse.
Paint the picture for me. OK, the first lion
to attack gets the best meat. The first creditor
to sue you and win a judgment grabs your bank
account. They take your car. They seize your
inventory. They get paid 100 cents on the dollar
because they were fast. And the second lion?
Maybe gets a bone. And the third, fourth, and
fifth lions? They starve. They get absolutely
nothing. It's chaotic. It's violent. And it's
fundamentally unfair because equal creditors
should be treated equally. The automatic state
just says stop. Nobody eat anything. Put your
forks down. We are going to assess what we have
and we are going to distribute it fairly and
in an orderly fashion. So it freezes the game
state. It forces everyone to take a breath so
the court can sort out the mess. Exactly. It
brings order to chaos. But is this force field
impenetrable? I mean, can a creditor ever break
through? They can try. It's called filing a motion
to lift the stay. And when would that happen?
Give me an example. Okay, let's say you file
for bankruptcy, but you're holding on to a luxury
asset, say a Ferrari. You owe the bank $200 ,000
on it, but the car is only worth $150 ,000 and
it's depreciating every single day. And you aren't
making payments. So I'm just joyriding in a car
I don't own and can't pay for. Right. The bank
can go to the judge and say... Your Honor, this
guy isn't reorganizing. He's just wasting our
asset. The car is losing value. Let us take it
back. They're arguing there's no equity cushion
and that their collateral is in danger. And the
judge might say, go get the Ferrari. Exactly.
But the key is they have to ask permission. They
have to respect the court's authority. If they
just came in the middle of the night and towed
it without the judges say so, that's a willful
violation of the automatic stay. And judges don't
like that. They hate it. The court can slap the
creditor with punitive damages. It's a very serious
offense to ignore the force field. Okay, so the
shield is up. The lions are sitting in a circle
waiting to be fed. Now we have to look at the
menu. Because the sources make it crystal clear
that bankruptcy isn't just one flavor. There
are chapters. Right. The bankruptcy cut is literally
a book divided into chapters. And depending on
who you are and what you want to achieve, you
pick a different chapter. Let's walk through
the big ones. Let's start with the one regular
people know best, Chapter 7. Chapter 7 is liquidation.
If you hear bankruptcy on the news regarding
an individual, it's usually this. Roughly two
-thirds of non -business filings are Chapter
7. Think of this as the fire sale. Effectively,
yes. The process is this. You file. A trustee
is appointed. This is a government official whose
job is to basically strip search your financial
life. They step into your shoes. Their entire
goal is to find assets they can sell to pay off
your debts. But they don't take everything, right?
I mean, we aren't leaving people naked in the
street. No, no, absolutely not. We have moved
past the Dickensian era, thankfully. The law
defines exempt and non -exempt assets. Every
state has a list of exemptions. Usually you can
keep your clothes, your household furniture,
tools you need for your trade, maybe a modest
car and a certain amount of equity in your home.
So if I'm just a normal guy living paycheck to
paycheck, renting an apartment, driving a beat
up Honda Civic. You probably have what's called
a no asset case. The trustee looks at your stuff,
does the math and says there is nothing here
that isn't exempt. There is nothing for me to
sell. And then what happens to my credit card
debt? My medical bills. They're discharged. Boof.
Gone. And the creditors get? Zero. That sounds
like a pretty good deal for the debtor. Yeah.
Maybe a little too good. That was exactly the
argument made by the credit card lobby back in
the early 2000s. They argued that Chapter 7 was
being abused, that people who could afford to
pay something were just walking away. Which brings
us to the means test. The sources mentioned the
BAPCPA Act of 2005. I want to circle back to
the politics of that later, but just... Practically,
how did it change the game? It made it much,
much harder to file Chapter 7. It introduced
a complicated math test. Before you can file,
you have to compare your income to the median
income in your state. So if I make, say, $100
,000 a year, but I've racked up $200 ,000 in
debt. The court runs the numbers. they look at
your income then they subtract a long list of
allowable expenses rent food transportation taxes
if the math says you have disposable income left
over at the end of the month let's say five hundred
dollars the law says stop you can't use chapter
seven you have money you have to use chapter
13. and that brings us to the next item on the
menu chapter 13. the sources call this the wage
earners plan think of chapter 13 as a form of
financial purgatory In this scenario, you don't
sell your assets. You get to keep the house,
you keep the expensive car, but you have to sign
over your future. What does that mean, sign over
your future? You enter a court -approved repayment
plan that lasts for three to five years. You
and your lawyer sit down and say, okay, I will
pay $800 a month to the trustee for the next
60 months. The trustee takes that money and trickles
it out to your creditors. You are living on a
strict, court -monitored budget for half a decade.
That sounds miserable. Why would anyone choose
that over the quick rip the band -aid off of
Chapter 7? Two main reasons. One, the means test
forced you to. You'd just make too much money
for Chapter 7. Or two, and this is the big one,
you want to save your home. Okay, how does Chapter
13 help with the house? This is a really crucial
distinction. In Chapter 7, if you are behind
on your mortgage, the bank will eventually take
the house. Chapter 7 wipes out your personal
liability for the debt, but the lien on the house
stays. If you don't pay, they foreclose. But
Chapter 13 is different. Chapter 13 is like a
time machine for your mortgage. It allows you
to take those missed payments, what lawyers call
the arrears, and spread them out over the three
to five years of the plan. It stops the foreclosure
dead in its tracks and gives you a chance to
catch up. I see. So chapter seven is basically
take my stuff, wipe my debt. And chapter 13 is
take my income, save my stuff. That is a perfect
summary. OK, so that covers individuals for the
most part. Now I want to shift gears to the heavyweight
division, the stuff we see on the front page
of The Wall Street Journal. Chapter 11. The corporate
playbook. This is the one that confuses people
the most, I think, because we see these huge
companies file for bankruptcy. And then they
just keep running. You can buy a ticket on an
airline that is currently in Chapter 11. You
can shop at a department store that is in Chapter
11. How is that possible? Because the goal of
Chapter 11 is reorganization, not liquidation.
The fundamental economic theory here is that
a functioning business is usually worth more
than a pile of dead parts. Right, the going concern
value. Exactly. Yeah. If you shut down an airline,
you fire all the pilots, and you sell the planes
for scrap metal, you get pennies on the dollar.
But if you can fix the balance sheet, reduce
the debt, and keep the planes flying, that company
might be worth billions again. But here's the
thing that shocks me. If I run my local bakery
into the ground, I lose my bakery. A trustee
takes over. But in Chapter 11, the sources say
the CEO who flew the plane into the mountain
often gets to stay in the cockpit. It's called
being a debtor in possession or D .I .P. for
short. D .I .P. Yes. The bankruptcy kite actually
has a presumption that allows the existing management
to stay in control of the company during the
bankruptcy. Isn't it just letting the fox guard
the henhouse? I mean, these are the guys who
broke the company. Why on earth are we trusting
them to fix it? It feels counterintuitive, doesn't
it? But think about the practical alternative.
Let's say General Motors files for bankruptcy.
Do you want to fire the CEO and the entire board
of directors and bring in a court appointed trustee
who knows absolutely nothing about automotive
supply chains, union contracts or how to manufacture
a car? They'd probably crash it even harder.
I mean, they don't know where the bathroom keys
are, let alone how to run the business. Exactly.
The institutional knowledge is incredibly valuable.
So the court lets them stay, but they are on
a very, very short leash. They have to report
everything to the court, to the U .S. trustee's
office. And usually the creditors form a committee,
the Committee of Unsecured Creditors, to watch
their every move and make sure they aren't just
burning cash. So the CEO stays. What are they
actually doing during Chapter 11? They aren't
just selling widgets day to day. They are negotiating.
It's a high stakes poker game. The company gets
what's called a period of exclusivity, usually
about 120 days, to propose a plan of reorganization.
And what's in this plan? Usually a lot of pain.
The plan basically says, OK, creditors, we owe
a billion dollars, but the company is only worth
600 million. So Bank of America, instead of the
100 million we owe you, you're getting 60 million
and maybe 5 % of the new stock. Bondholders,
you're getting 20 cents on the dollar. And the
creditors have to agree to this. They have to
accept the haircut. They vote. They are divided
into classes based on the type of debt they hold.
Class A might be the senior lenders. Class B
might be junior lenders. Class C might be suppliers.
They all vote on the plan. What happens if they
say no? No, we hate this plan. Pay us in full.
Then the company can pull out the heavy artillery.
The cram down. I love legal terms that sound
violent. The cram down. It is aggressive. If
the plan meets certain strict legal standards,
specifically that it is fair and equitable and
doesn't discriminate unfairly, the judge can
approve the plan over the objection of a dissent
in class. He literally crams the plan down their
throats. That is immense power for a judge. But
fair is a subjective word. How does a judge decide
what's fair in a billion dollar fight? They use
the absolute priority rule. OK, let's unpack
that. Absolute priority. It sounds like a medieval
hierarchy and it kind of is. Imagine a waterfall
of money, the rule says. The people at the top,
the senior secured creditors, must fill their
buckets completely before a single drop flows
down to the next level, the junior creditors.
And the junior creditors must be paid in full
before a drop hits the people at the very bottom.
And who is at the bottom of the waterfall? The
shareholders, the owners of the company. This
explains why when a company goes bankrupt, the
stock usually goes to zero. Right. By the time
the water gets down to the shareholder bucket,
the river is dry. The creditors usually end up
owning the new company. The old owners are wiped
out. That's the rule. But wait, I feel like I've
seen cases where the old owners still end up
with something or the senior guys give a little
bit to the little guys just to make things go
smoothly. That happens all the time. It's called
a gift plan or a carve out. Sometimes senior
creditors will say, look, we are entitled to
everything. But if we fight this out in court
for two years, the lawyers will take all the
money and fees. So we will gift some of our recovery
to the junior creditors just to get them to vote
yes and end this thing. It's practical, even
if it bends the strict hierarchy. If Chapter
11 is just about rearranging the deck chairs
on the Titanic and stiffing the shareholders,
why do companies rush to do it? The sources suggest
there is something more strategic going on. Oh,
it's extremely strategic, especially when it
comes to something called executory contracts.
Define that for us. An executory contract is
just an ongoing agreement where both sides still
have duties to perform. A lease on a building,
a long -term contract to buy fuel, or... a collective
bargaining agreement with a labor union. Ah,
now we're getting into the real friction. Chapter
11 gives companies a superpower, the power to
reject contracts. They can just tear them up.
Effectively, yes. Section 365 of the code. The
company can go to the judge and say, this contract
is burdensome. It's dragging us down. If we keep
paying these rates, we will die. We want to reject
it. Let's look at a specific industry to see
how this plays out in the real world. The sources
mention the airlines. It seems like since 2002,
practically every major U .S. airline has filed
Chapter 11 at some point. It's true. United,
Delta, American, Northwest. They all went through
what they called the car wash of Chapter 11.
And the sources suggest this wasn't just about,
oops, we ran out of cash. It was strategic. It
absolutely was. You have to look at the landscape
in the early 2000s. You had the shock of 9 -11.
You had rising fuel prices. But the biggest problem
for the legacy carriers was their legacy costs.
Pensions. Pensions and union contracts. They
had negotiated these very generous deals in the
70s and 80s when they were highly regulated and
profitable. But then low -cost carriers like
Southwest and JetBlue came along. They were younger.
They didn't have thousands of retirees to pay.
And their labor costs were dramatically lower.
So the big guys couldn't compete. on ticket price
because they were dragging this massive anchor
of labor costs. Exactly. So one by one, they
use Chapter 11. They filed for bankruptcy. They
went to the pilots union and the machinists union
and said, look, we are bankrupt. The judge is
going to let us reject your contract. If that
happens, you get nothing. No job, no pension.
Or you can agree to a 30 percent pay cut. We
freeze the pension and you keep your job. That's
brutal. It's negotiation with a gun to your head.
It is. The expert commentary in the sources puts
it this way. This turned bankrupt. from a shield
against death into a strategic business tool.
Companies were remodeling the plane while flying
it. But the people paying for the remodel were
the employees, their pensions, their salaries.
Correct. So what? For the economy. Once one airline
did it, the others had to follow suit. Because
of competition. Right, right. If United Airlines
uses bankruptcy to slash its labor costs by 30%,
they can lower their ticket prices. Now American
Airlines is looking at their books saying, we
can't match those prices unless we slash our
costs too. So they file. It triggered a domino
effect across the entire industry. It really
highlights how Chapter 11 is about the survival
of the entity, the corporation itself. The logo
on the tail of the plane survives. The flight
routes survive. But the promises made to the
people who work there, those get left behind
in court. That is the tradeoff. We save the business.
We sacrifice the contract. OK, speaking of sacrificing
contracts and dodging promises. Right. Let's
get into what you call the dark arts of bankruptcy.
The loopholes, the tricks, the things that make
people. look at lawyers and just shake their
heads. Well, every system has its edges. Let's
talk about avoidance actions. Avoidance. It sounds
like me trying to get out of doing dishes. But
in court, this means the trustee has superpowers,
right? They do. The trustee can actually travel
back in time, legally speaking, and undo transactions
that happened before the bankruptcy filing. These
are called clawbacks. OK, give me the classic
brother -in -law example. I saw that in the notes.
This is the classic preference action. Let's
say your business is failing. You know you're
going to file bankruptcy next week. But you owe
your brother -in -law $10 ,000 and you owe Visa
$10 ,000. I want to keep peace at the Thanksgiving
table, so I play my brother -in -law. You write
him a check for the full $10 ,000. Then on Monday,
you file Chapter 7. You tell Visa, sorry, I'm
broke. No money left. Seems smart. I mean, unethical
maybe, but smart. The bankruptcy code says no.
That is a preference. You preferred one creditor
over another, an insider creditor. The trustee
looks at that transaction. If it happened within
90 days of filing, or one full year if it's an
insider, like a relative, the trustee can sue
your brother -in -law. They sue him for the money
I paid him. Yes. They file a lawsuit to avoid
the preference and force him to cough it up.
That $10 ,000 goes back into the pot to be shared
equally among all the creditors. Man. Thanksgiving
dinner is gonna be incredibly awkward. Very.
But the principle is equality of distribution.
You shouldn't be allowed to pick winners and
losers right before the ship sinks. That makes
sense. It prevents people from looting the ship
before it goes under. But what about fraudulent
transfers? That sounds more malicious. That is
when you are actively trying to hide assets.
The classic example is selling your house to
your best friend for $1. Here's the deed. Just
give it back to me when this all blows over.
Exactly. The court sees right through that. They
will undo that sale in a heartbeat. But there
is also something called constructive fraud.
That's where you didn't intend to be evil, but
you were insolvent and you sold something for
way less than it was worth. The court essentially
says you were too broke to be giving away value
like that, and they reverse it. Okay, those seem
like standard policing of the rules. Keeping
the game fair. But then there is the Texas two
-step. This one feels different. This feels less
like policing the rules and more like inventing
a whole new game. This is a highly controversial
modern strategy. It involves something called
a divisional merger, which is permitted under
Texas state law. The sources bring up Johnson
& Johnson here. Walk us through what happened
because this involves baby powder, cancer, and
some very, very creative lawyering. Right. So
Johnson & Johnson was facing roughly 40 ,000
lawsuits alleging that their talc -based baby
powder caused ovarian cancer. We are talking
billions and billions of dollars in potential
liability. A massive cloud hanging over the whole
company. If they lose those suits, it could cripple
them. Yes. So they used this specific Texas law
to perform a corporate split. They took the original
company and split it into two new companies.
Let's call them Good Co. and Bad Co. for simplicity.
I'm with you. Goodco gets all the profitable
assets, the Tylenol, the Band -Aids, the Listerine,
all the cash flow, the factories. Badco, a new
entity, gets the lawsuits, all 40 ,000 of them.
Wait, wait, they just shoveled the cancer lawsuits
into a separate box? Exactly. They allocated
the talc -related liabilities to this new, smaller
entity, and then almost immediately, Badco files
for Chapter 11 bankruptcy. And because of the
automatic stay? All those lawsuits stop. The
litigation is paused. The 40 ,000 victims are
told, sorry, you can't sue Johnson & Johnson
anymore. Your claim is now against Badco, and
Badco is bankrupt. Meanwhile, Goodco, the one
with all the actual money, is out there doing
business, paying dividends. totally unaffected.
That is the strategy. Now, J &J argues it's an
efficient way to settle mass tort claims. They
say, we will put a bunch of money into the bad
copot and the victims can divide it up there.
It saves everyone legal fees and time. But the
victims lose their right to a jury trial against
the actual company that sold the powder. Correct.
And that's the heart of the controversy. Critics
call it a gross manipulation of the system. They
say it's a fraudulent transfer on a massive scale.
It insulates the wealthy parent company from
the consequences of its products. It really tests
the limits of what bankruptcy is supposed to
be for. Is it a fresh start for an honest but
unfortunate debtor? Or is it a getaway car for
a wealthy corporation? That is the billion dollar
question being litigated right now. Courts are
struggling with whether this was filed in good
faith, which is a requirement for bankruptcy.
I'm pretty sure Madison wasn't thinking about
divisional mergers when he wrote the Constitution.
Definitely not. The world has gotten a lot more
complicated. Okay, let's zoom out a bit. We've
been talking about in -court bankruptcy. But
the sources mention restructuring as a broader
concept. This can happen outside of a courtroom,
right? Yes. In fact, most companies prefer to
solve their problems out of court if they can.
It's cheaper, it's quieter, and it's much faster.
This is like a workout. Exactly. A workout. The
company calls its major creditors into a room
and says, look, we can't pay you. If we file
for bankruptcy, you'll lose a lot on legal fees
and delays, and it will be a mess. Let's make
a deal right now. And what kind of deals are
we talking about? You might do a debt for equity
swap. The creditors forgive the debt and in exchange
they get ownership, they get stock in the company,
or you might agree to a haircut. A haircut? That's
when creditors agree to take less than they are
owed. Maybe you get 70 cents on the dollar just
to get paid something now instead of maybe nothing
in two years. Better a bird in the hand than
two in the bankruptcy court? Precisely. But whether
it is in court or out of court, everything hinges
on one massive contentious debate. Valuation.
How much the company is actually worth. It sounds
boring, but it is the valuation war. Think about
it. If you say the company is worth $1 billion,
there might be enough value to pay the banks
and maybe have something left for the shareholders.
If you say it's worth only $500 million, the
shareholders get wiped out and the banks take
a loss. So who decides? Who puts the price tag
on the company? Experts. Investment bankers.
They come in with these complex financial models
and spreadsheets and they fight it out. And because
it is so subjective, you see these massive battles.
The senior creditors, interestingly, want the
valuation to be low. Why low? Usually people
want their stuff to be worth a lot. In bankruptcy,
if the value is low, the senior creditors can
say, look, there isn't enough money for anyone
else. The company is broke. So we should get
100 percent of the equity in the new company.
If the value is high, they have to share that
equity with the junior creditors. So the banks
are arguing this company is trash. Give it all
to us. And the shareholders are arguing, no,
it's a goldmine. Don't wipe us out. That's the
fight in a nutshell. And the players in this
game have really changed. The sources mention
the London approach. Historically, in Europe,
banks would work together. They were gentle.
They tried to support the company to avoid write
-offs. It was a gentleman's agreement. Today,
we have hedge funds. Distressed debt traders.
These are investors who specifically buy the
debt of failing companies for pennies on the
dollar specifically to take control. They aren't
interested in a gentleman's agreement. They are
interested in aggressive enforcement of their
rights, often pushing for liquidation. It has
made the restructuring world much more litigious
and sharp elbowed. It's a shark tank. It is.
I want to pivot now. We've been talking about
billions of dollars, corporate maneuvering, and
hedge funds. But the outline highlights the human
cost, the social factors. Because behind all
these statues and legal battles are real people.
And the data in our sources is honestly startling.
It is. This is where the rubber meets the road.
We often think of bankruptcy as a failure of
character, a moral failing. But the data suggests
it's usually a failure of luck. The statistic
that just jumped off the page at me was about
medical bankruptcy. It is the leading cause,
by far. The sources cite data from 2020 showing
that 66 .5 % of individual bankruptcies were
tied to medical issues. 66 .5%. That is huge.
That means two -thirds of the people standing
in front of a bankruptcy judge aren't there because
they bought too many fancy dinners or went on
vacations they couldn't afford. They are there
because they got sick. Or they lost their job
because they got sick and couldn't work. Exactly.
It's often both. The medical bills themselves
and the lost income from the illness. The American
Journal of Medicine backs this up. Over three
out of five personal bankruptcies are due to
medical debt. It highlights a unique feature
of the American system. We don't have a robust
safety net for health shocks, so the bankruptcy
court becomes the safety net. It's the emergency
room for your finances after the actual emergency
room bankrupts you. That's a very powerful way
to put it. And then there is the student loan
issue. We hear about this constantly. Can you
discharge student loans in bankruptcy? Generally,
no. And that is a huge controversial exception
in the code. Most debt credit cards, medical
bills, personal loans... can be wiped out. But
student loans have this special protection. Why?
I mean, you can discharge gambling debt. You
can discharge credit card debt from buying luxury
clothes. But you can't discharge the loan you
took to get an education. It seems backwards.
The policy logic dating back to the 70s was to
prevent strategic defaults. Lawmakers were afraid
that students would graduate from Harvard Medical
School, immediately file bankruptcy to wipe their
debt and then go on to make millions. But does
that actually happen? Did that ever happen? There
was very little evidence of it then, and there
is almost none now. But the law stuck. To get
rid of student loans and bankruptcy, you have
to prove undue hardship. And the sources say
that is very, very hard to prove. Extremely.
In most courts, you have to pass something called
the Brunner test. You effectively have to prove
that you can't maintain a minimal standard of
living, that the situation is likely to persist
for a huge portion of the repayment period, and
that you made good faith efforts to pay in the
past. It's a very high. And you have to sue the
lender to prove it. Yes, in what's called an
adversary proceeding, which costs money for a
lawyer. So you have to be rich enough to hire
a lawyer to prove you're too poor to pay your
loans. It's a cruel paradox. It traps people
in this debt for decades, sometimes for life.
The sources also mentioned racial disparities.
This is disturbing to read. It is. Data shows
that minority debtors have an approximately 40
% decreased chance of receiving a discharge in
Chapter 13 compared to white debtors. 40%. That
is a massive gap. Why? What's driving that? The
sources link it to a combination of factors,
but a big one is legal representation and what
some call steering. It seems minority filers
are often steered towards Chapter 13, which requires
that rigorous five -year payment plan rather
than Chapter 7, which is the quick, clean discharge.
And Chapter 13 is just... Really hard to finish.
Very hard. Life happens. If you miss a few payments
in year three because your car breaks down, you
can get kicked out of the program. Your case
is dismissed, you're back at square one, and
you still owe all the debt plus interest. Chapter
seven is a quick, fresh start. So if one group
is disproportionately pushed into the five -year
penalty box, that just exacerbates wealth inequality
over time. So the system works differently depending
on who you are, who represents you, and whether
you are a corporation or a person. That brings
us back to that 2005 law, BAPCPA, the moral hazard
debate. The argument was that people were abusing
the system, right? That was the narrative pushed
by the credit card lobby. They spent millions
arguing that bankruptcy was too easy, that it
created a moral hazard encouraging reckless spending.
They promised Congress that if we made bankruptcy
harder with the means test, it would reduce their
losses and they would pass those savings on to
consumers in the form of lower interest rates.
And did they? Did my credit card rate go down
after 2005? The data suggests no. Credit card
company losses did go down significantly, but
their profits went up. And costs to consumers,
interest rates, late fees, overlimit fees, they
didn't necessarily drop. In many cases, they
went up. So the law helped the corporate creditors,
but it didn't really help the consumers it was
promised to protect. It's a classic case of shifting
the balance of power. The 2005 act tilted the
playing field significantly in favor of the lenders.
So let's bring this all home. We've covered a
lot of ground, constitutional roots, sci -fi
force fields, cram downs, airlines breaking unions,
the Texas two -step, and the just crushing weight
of medical debt. If we boil this all down, what
are the big takeaways for our listeners? I think
there are three main points to walk away with.
Okay. Second. And third. balancing act. It tries
to balance the fresh start for the honest debtor
against fairness for creditors. But as we've
seen with the Texas two -step, the medical debt
stats, and the student loan rules, that balance
is often tested and, you could argue, often tilted.
It really feels like the system is designed to
save the business, this abstract legal entity,
sometimes at the expense of the people inside
it or the people hurt by it. That is the final
provocative thought I would leave you with. We
have created a system that is incredibly sophisticated
and good at preserving corporate life. We can
split companies, we can shed contracts, we can
pause lawsuits, all to keep the going concern
alive. But when 66 % of personal filings are
families crushed by medical bills, or when cancer
victims are trapped in a bad company spinoff,
you have to ask a really hard question. Does
the current bankruptcy code prioritize the survival
of the corporation over the well -being of the
individual? And is it time for a fresh start
for the bankruptcy code itself? That is a huge
question to chew on. Thanks for taking this deep
dive with us into the murky but fascinating waters
of bankruptcy. It was a pleasure. Thanks for
having me. We'll see you next time on The Deep
Dive.