WEBVTT 00:00:00.000 --> 00:00:03.259 Welcome back to the Deep Dive. Today, we are 00:00:03.259 --> 00:00:06.700 going to talk about a word that I think for most 00:00:06.700 --> 00:00:09.080 people feels like the end of the world. Oh, yeah. 00:00:09.199 --> 00:00:11.179 It's got some serious weight to it. It really 00:00:11.179 --> 00:00:14.539 does. It summons these images of, you know, boarded 00:00:14.539 --> 00:00:16.980 up storefronts, everything must go signs, and 00:00:16.980 --> 00:00:19.379 maybe the Monopoly man turning out his empty 00:00:19.379 --> 00:00:22.109 pockets. With a frown on his face. It's the ultimate 00:00:22.109 --> 00:00:25.289 financial taboo. Exactly. Yeah. We were talking 00:00:25.289 --> 00:00:27.609 about bankruptcy. And usually when we hear that 00:00:27.609 --> 00:00:29.690 word, we think of failure. We think of ruin. 00:00:29.809 --> 00:00:33.130 We think game over. Right. But I've been reading 00:00:33.130 --> 00:00:35.869 through this whole stack of sources you sent 00:00:35.869 --> 00:00:39.189 over. We've got court cases, historical analysis, 00:00:39.469 --> 00:00:42.770 corporate strategy docs. And I have to say my 00:00:42.770 --> 00:00:45.649 brain is a little broken because the picture 00:00:45.649 --> 00:00:47.369 these sources paint is completely different. 00:00:47.789 --> 00:00:49.990 It usually is. I mean, if you look past the stigma, 00:00:50.030 --> 00:00:52.049 you start to realize that bankruptcy isn't just 00:00:52.049 --> 00:00:53.729 about running out of money. It's actually one 00:00:53.729 --> 00:00:57.450 of the most sophisticated, complex and powerful 00:00:57.450 --> 00:01:00.409 engines in the American economy. An engine. Right. 00:01:00.490 --> 00:01:03.750 Not a graveyard. Not a graveyard at all. The 00:01:03.750 --> 00:01:05.989 sources basically argue that it's not a funeral 00:01:05.989 --> 00:01:08.689 for a business or a person. It's a tool. It's 00:01:08.689 --> 00:01:11.450 a reset button. A reset button. And what really 00:01:11.450 --> 00:01:13.469 surprised me is how it's used as a strategic 00:01:13.469 --> 00:01:15.890 weapon. We're going to talk about how these massive 00:01:15.890 --> 00:01:18.730 corporations use the system not just to survive, 00:01:18.930 --> 00:01:21.290 but to actually make more money, to break contracts 00:01:21.290 --> 00:01:24.569 and even to dodge lawsuits. It is the safety 00:01:24.569 --> 00:01:26.750 valve of capitalism. That's probably the best 00:01:26.750 --> 00:01:29.209 way to frame it. Without this system, the gears 00:01:29.209 --> 00:01:31.629 of the economy would just they'd eventually grind 00:01:31.629 --> 00:01:34.969 to a total vault. So our mission today is to 00:01:34.969 --> 00:01:38.230 decode this bankruptcy code. We need to understand 00:01:38.230 --> 00:01:41.269 the difference between, say, liquidation and 00:01:41.269 --> 00:01:43.799 reorganization. And we need to figure out what 00:01:43.799 --> 00:01:47.079 a Texas two -step is. And spoiler alert, it's 00:01:47.079 --> 00:01:49.000 not a dance. Not a dance. And we need to answer 00:01:49.000 --> 00:01:51.560 a really hard question. Is this whole system 00:01:51.560 --> 00:01:55.000 designed to help people or is it, you know, rigged 00:01:55.000 --> 00:01:57.120 to save corporations? And to answer that, we 00:01:57.120 --> 00:01:58.780 have to start at the very beginning. And I don't 00:01:58.780 --> 00:02:01.140 mean the 1980s or even the 1920s. I mean the 00:02:01.140 --> 00:02:03.280 very foundation of the country. The Constitution. 00:02:04.099 --> 00:02:06.859 This was the first shocker for me. I always assumed 00:02:06.859 --> 00:02:09.759 bankruptcy laws were these, like modern regulations, 00:02:10.020 --> 00:02:12.319 maybe invented when credit cards became a thing. 00:02:12.599 --> 00:02:14.960 But it's right there in the original document. 00:02:15.199 --> 00:02:19.099 It is. Article 1, Section 8, Clause 4. It's wild. 00:02:19.439 --> 00:02:21.680 The founding fathers are sitting in Philadelphia, 00:02:21.860 --> 00:02:24.340 sweating in their wigs. They're drafting the 00:02:24.340 --> 00:02:26.400 blueprint for a new nation. They're writing about 00:02:26.400 --> 00:02:28.240 we the people. They're figuring out how to raise 00:02:28.240 --> 00:02:31.360 an army, coin money, declare war. All the big 00:02:31.360 --> 00:02:33.719 stuff. The big stuff. And in that exact same 00:02:33.719 --> 00:02:36.819 list of superpowers they give to Congress, they 00:02:36.819 --> 00:02:40.039 include the power to enact uniform laws on the 00:02:40.039 --> 00:02:42.379 subject of bankruptcies. It seems out of place, 00:02:42.520 --> 00:02:45.599 doesn't it? You have war, peace, currency and 00:02:45.599 --> 00:02:48.860 debt relief. Right. Why were Madison and Jefferson 00:02:48.860 --> 00:02:51.139 so obsessed with debt? Was the national credit 00:02:51.139 --> 00:02:53.340 card bill already that high? Well, you have to 00:02:53.340 --> 00:02:56.159 understand the context of the time. In the 18th 00:02:56.159 --> 00:02:58.120 century, especially in England and the early 00:02:58.120 --> 00:03:00.919 colonies, debt wasn't just a financial problem. 00:03:01.039 --> 00:03:04.020 It was seen as a moral failing, and it was a 00:03:04.020 --> 00:03:07.000 criminal offense. A criminal offense. Oh, yeah. 00:03:07.120 --> 00:03:09.240 If you couldn't pay your debts, you didn't just 00:03:09.240 --> 00:03:11.199 get a bad credit score and some annoying phone 00:03:11.199 --> 00:03:13.699 calls. You went to prison. Actual prison. Debtor's 00:03:13.699 --> 00:03:16.099 prison. And you would just, you'd rot in a cell 00:03:16.099 --> 00:03:18.319 until your family could scrape together the pennies 00:03:18.319 --> 00:03:20.979 to buy your freedom. It was a complete dead end. 00:03:21.060 --> 00:03:23.240 It took productive people out of the workforce 00:03:23.240 --> 00:03:24.979 and locked them away where they couldn't earn 00:03:24.979 --> 00:03:27.759 anything to pay back the debt anyway. It was 00:03:27.759 --> 00:03:29.840 totally illogical. It's a lose -lose situation. 00:03:30.219 --> 00:03:32.599 I mean, the creditor doesn't get paid and the 00:03:32.599 --> 00:03:35.460 debtor loses their liberty. Precisely. And the 00:03:35.460 --> 00:03:37.400 founders were building a commercial republic. 00:03:37.780 --> 00:03:39.819 They wanted to encourage enterprise. They wanted 00:03:39.819 --> 00:03:42.719 people to take risks, to borrow money, to build 00:03:42.719 --> 00:03:45.199 a ship or start a farm, open a trading post. 00:03:45.340 --> 00:03:47.919 But they knew human nature. If the punishment 00:03:47.919 --> 00:03:51.099 for failure is life in a cage, nobody is going 00:03:51.099 --> 00:03:53.340 to take that risk. You kill innovation before 00:03:53.340 --> 00:03:56.500 it even starts. You do. So they baked the concept 00:03:56.500 --> 00:03:58.819 of the fresh start right into the DNA of the 00:03:58.819 --> 00:04:01.879 United States. They authorized Congress to create 00:04:01.879 --> 00:04:03.800 a system where if things went wrong, you could 00:04:03.800 --> 00:04:06.599 wipe the slate clean and try again. OK, so let's 00:04:06.599 --> 00:04:08.919 unpack this first start concept. It sounds a 00:04:08.919 --> 00:04:11.860 bit like a marketing slogan, but legally, what 00:04:11.860 --> 00:04:14.139 does it actually mean? It is the philosophical 00:04:14.139 --> 00:04:17.540 heartbeat of U .S. bankruptcy law. The Supreme 00:04:17.540 --> 00:04:19.379 Court has actually weighed in on this multiple 00:04:19.379 --> 00:04:22.720 times. In one famous opinion, they described 00:04:22.720 --> 00:04:25.699 the purpose of bankruptcy as giving the honest 00:04:25.699 --> 00:04:28.399 but unfortunate debtor a new opportunity in life 00:04:28.399 --> 00:04:31.199 and a clear field for future effort. I love that 00:04:31.199 --> 00:04:34.120 phrasing. unhampered by the pressure and discouragement 00:04:34.120 --> 00:04:37.319 of pre -existing debt. It sounds almost, I don't 00:04:37.319 --> 00:04:39.899 know, religious, like being born again, but financially. 00:04:40.120 --> 00:04:42.779 It is a form of economic redemption. And here's 00:04:42.779 --> 00:04:45.180 where we have to be critical. There is this massive 00:04:45.180 --> 00:04:47.959 tension inherent in that idea. Because for you 00:04:47.959 --> 00:04:50.220 to get your fresh start, someone else has to 00:04:50.220 --> 00:04:52.500 lose money. Right. The creditor. The person who 00:04:52.500 --> 00:04:54.819 lent you the cash in the first place. If I lend 00:04:54.819 --> 00:04:57.699 you $10 ,000 and you file for bankruptcy, I don't 00:04:57.699 --> 00:05:00.009 get that money back. I've been harmed. Exactly. 00:05:00.009 --> 00:05:02.310 You lent that money in good faith. You expected 00:05:02.310 --> 00:05:05.050 a return on it. So the entire history of the 00:05:05.050 --> 00:05:07.889 bankruptcy code is this constant tug of war. 00:05:08.250 --> 00:05:10.790 It's a balancing act between the need to show 00:05:10.790 --> 00:05:12.889 mercy to the debtor so they can be productive 00:05:12.889 --> 00:05:16.209 again versus, you know, the sanctity of contracts 00:05:16.209 --> 00:05:18.649 and the rights of creditors to get what they 00:05:18.649 --> 00:05:21.110 are owed. That makes sense. If you make bankruptcy 00:05:21.110 --> 00:05:23.629 too easy, if anyone can just walk away from their 00:05:23.629 --> 00:05:26.250 debts whenever they feel like it, well, nobody 00:05:26.250 --> 00:05:28.589 will ever lend money again. Right. Interest rates 00:05:28.589 --> 00:05:31.149 would skyrocket to 50 percent because the risks 00:05:31.149 --> 00:05:33.889 would be astronomical. The economy would just 00:05:33.889 --> 00:05:36.870 freeze. But if you make it too hard, you create 00:05:36.870 --> 00:05:39.370 this permanent underclass of people just drowning 00:05:39.370 --> 00:05:41.730 in debt, essentially serving a life sentence 00:05:41.730 --> 00:05:44.269 of poverty. And that benefits no one. So the 00:05:44.269 --> 00:05:47.050 code tries to walk this very fine line. And the 00:05:47.050 --> 00:05:49.170 way it does that is through some very specific, 00:05:49.329 --> 00:05:51.810 very powerful mechanics. Let's get into those 00:05:51.810 --> 00:05:53.850 mechanics. I want to visualize this for the listener. 00:05:54.269 --> 00:05:58.000 So let's say I'm drowning. My business is collapsing. 00:05:58.300 --> 00:06:00.399 I've got creditors calling me day and night. 00:06:00.459 --> 00:06:02.740 The bank is threatening to take my house. I go 00:06:02.740 --> 00:06:05.019 down to the federal court and I file a bankruptcy 00:06:05.019 --> 00:06:07.360 petition. Boom, I slide the paper across the 00:06:07.360 --> 00:06:10.439 desk. What happens in that exact second? In that 00:06:10.439 --> 00:06:13.000 exact second, you trigger one of the most powerful 00:06:13.000 --> 00:06:16.110 injunctions in... All of American law. It's found 00:06:16.110 --> 00:06:19.709 in 11 U .S .C. Section 362. It's called the automatic 00:06:19.709 --> 00:06:22.870 stay. The automatic stay. I love this concept. 00:06:22.949 --> 00:06:25.629 In my head, I picture it like a giant sci -fi 00:06:25.629 --> 00:06:28.069 force field just slamming down around your house. 00:06:28.170 --> 00:06:30.730 That is a surprisingly accurate analogy. Honestly, 00:06:30.889 --> 00:06:33.350 think of it as a giant pause button that freezes 00:06:33.350 --> 00:06:36.009 the entire universe of your debt. So let's play 00:06:36.009 --> 00:06:38.750 this out. If a collection agency is dialing my 00:06:38.750 --> 00:06:40.889 phone number at the exact moment I file. They 00:06:40.889 --> 00:06:43.350 have to hang up. Immediately. If they say one 00:06:43.350 --> 00:06:45.589 more word to you after they know you filed, they 00:06:45.589 --> 00:06:47.910 are breaking federal law. What if there's a lawsuit? 00:06:48.290 --> 00:06:50.189 Let's say I'm being sued for a million dollars 00:06:50.189 --> 00:06:51.810 and the trial is scheduled for tomorrow morning. 00:06:51.949 --> 00:06:54.589 The trial stops. The judge puts down the gavel. 00:06:54.709 --> 00:06:57.370 The lawyers go home. Everything just freezes 00:06:57.370 --> 00:06:59.790 in place. And what if the bank is auctioning 00:06:59.790 --> 00:07:02.490 my house? Like the auctioneer is standing on 00:07:02.490 --> 00:07:04.490 the front lawn, gavel in the air, about to say 00:07:04.490 --> 00:07:07.790 sold. If you file that petition before he says 00:07:07.790 --> 00:07:11.040 the word sold. The auction is canceled. The automatic 00:07:11.040 --> 00:07:14.199 stay halts all foreclosure proceedings instantly. 00:07:14.500 --> 00:07:16.920 That is an immense amount of power to give to 00:07:16.920 --> 00:07:19.680 a person just by filing a single piece of paper. 00:07:19.800 --> 00:07:22.360 Yeah. Why is the law so aggressive about this? 00:07:22.500 --> 00:07:25.759 Why a total freeze? Well, it's not just to protect 00:07:25.759 --> 00:07:28.540 you, the debtor. It's actually designed to protect 00:07:28.540 --> 00:07:31.139 the creditors from each other. Wait, how does 00:07:31.139 --> 00:07:33.300 freezing them protect them? That sounds backwards. 00:07:33.790 --> 00:07:36.730 Think about a failing company. Let's use a nature 00:07:36.730 --> 00:07:39.649 documentary analogy. A failing company is like 00:07:39.649 --> 00:07:42.990 a dying buffalo on the savanna, and the creditors 00:07:42.990 --> 00:07:44.930 are the lions. I was going to say vultures, but 00:07:44.930 --> 00:07:47.470 sure, lions works. Lions, vultures, whatever. 00:07:47.550 --> 00:07:49.509 If you don't have the automatic spay, you have 00:07:49.509 --> 00:07:51.629 what lawyers call the race to the courthouse. 00:07:51.810 --> 00:07:54.009 Paint the picture for me. OK, the first lion 00:07:54.009 --> 00:07:57.750 to attack gets the best meat. The first creditor 00:07:57.750 --> 00:08:00.029 to sue you and win a judgment grabs your bank 00:08:00.029 --> 00:08:02.170 account. They take your car. They seize your 00:08:02.170 --> 00:08:04.730 inventory. They get paid 100 cents on the dollar 00:08:04.730 --> 00:08:07.050 because they were fast. And the second lion? 00:08:07.230 --> 00:08:09.410 Maybe gets a bone. And the third, fourth, and 00:08:09.410 --> 00:08:12.189 fifth lions? They starve. They get absolutely 00:08:12.189 --> 00:08:15.250 nothing. It's chaotic. It's violent. And it's 00:08:15.250 --> 00:08:18.110 fundamentally unfair because equal creditors 00:08:18.110 --> 00:08:20.350 should be treated equally. The automatic state 00:08:20.350 --> 00:08:23.339 just says stop. Nobody eat anything. Put your 00:08:23.339 --> 00:08:26.060 forks down. We are going to assess what we have 00:08:26.060 --> 00:08:28.720 and we are going to distribute it fairly and 00:08:28.720 --> 00:08:31.439 in an orderly fashion. So it freezes the game 00:08:31.439 --> 00:08:33.360 state. It forces everyone to take a breath so 00:08:33.360 --> 00:08:35.820 the court can sort out the mess. Exactly. It 00:08:35.820 --> 00:08:38.620 brings order to chaos. But is this force field 00:08:38.620 --> 00:08:41.379 impenetrable? I mean, can a creditor ever break 00:08:41.379 --> 00:08:44.460 through? They can try. It's called filing a motion 00:08:44.460 --> 00:08:46.600 to lift the stay. And when would that happen? 00:08:46.720 --> 00:08:49.500 Give me an example. Okay, let's say you file 00:08:49.500 --> 00:08:51.820 for bankruptcy, but you're holding on to a luxury 00:08:51.820 --> 00:08:56.200 asset, say a Ferrari. You owe the bank $200 ,000 00:08:56.200 --> 00:08:59.279 on it, but the car is only worth $150 ,000 and 00:08:59.279 --> 00:09:02.519 it's depreciating every single day. And you aren't 00:09:02.519 --> 00:09:05.139 making payments. So I'm just joyriding in a car 00:09:05.139 --> 00:09:07.740 I don't own and can't pay for. Right. The bank 00:09:07.740 --> 00:09:09.940 can go to the judge and say... Your Honor, this 00:09:09.940 --> 00:09:12.120 guy isn't reorganizing. He's just wasting our 00:09:12.120 --> 00:09:14.399 asset. The car is losing value. Let us take it 00:09:14.399 --> 00:09:17.179 back. They're arguing there's no equity cushion 00:09:17.179 --> 00:09:19.779 and that their collateral is in danger. And the 00:09:19.779 --> 00:09:21.779 judge might say, go get the Ferrari. Exactly. 00:09:22.220 --> 00:09:25.580 But the key is they have to ask permission. They 00:09:25.580 --> 00:09:28.139 have to respect the court's authority. If they 00:09:28.139 --> 00:09:30.159 just came in the middle of the night and towed 00:09:30.159 --> 00:09:32.860 it without the judges say so, that's a willful 00:09:32.860 --> 00:09:35.039 violation of the automatic stay. And judges don't 00:09:35.039 --> 00:09:37.580 like that. They hate it. The court can slap the 00:09:37.580 --> 00:09:39.960 creditor with punitive damages. It's a very serious 00:09:39.960 --> 00:09:42.539 offense to ignore the force field. Okay, so the 00:09:42.539 --> 00:09:45.220 shield is up. The lions are sitting in a circle 00:09:45.220 --> 00:09:47.600 waiting to be fed. Now we have to look at the 00:09:47.600 --> 00:09:50.720 menu. Because the sources make it crystal clear 00:09:50.720 --> 00:09:53.960 that bankruptcy isn't just one flavor. There 00:09:53.960 --> 00:09:56.970 are chapters. Right. The bankruptcy cut is literally 00:09:56.970 --> 00:09:59.490 a book divided into chapters. And depending on 00:09:59.490 --> 00:10:01.129 who you are and what you want to achieve, you 00:10:01.129 --> 00:10:03.029 pick a different chapter. Let's walk through 00:10:03.029 --> 00:10:04.909 the big ones. Let's start with the one regular 00:10:04.909 --> 00:10:08.549 people know best, Chapter 7. Chapter 7 is liquidation. 00:10:08.889 --> 00:10:11.070 If you hear bankruptcy on the news regarding 00:10:11.070 --> 00:10:14.730 an individual, it's usually this. Roughly two 00:10:14.730 --> 00:10:18.330 -thirds of non -business filings are Chapter 00:10:18.330 --> 00:10:21.710 7. Think of this as the fire sale. Effectively, 00:10:21.710 --> 00:10:25.350 yes. The process is this. You file. A trustee 00:10:25.350 --> 00:10:27.909 is appointed. This is a government official whose 00:10:27.909 --> 00:10:30.029 job is to basically strip search your financial 00:10:30.029 --> 00:10:32.570 life. They step into your shoes. Their entire 00:10:32.570 --> 00:10:35.529 goal is to find assets they can sell to pay off 00:10:35.529 --> 00:10:37.529 your debts. But they don't take everything, right? 00:10:37.629 --> 00:10:39.230 I mean, we aren't leaving people naked in the 00:10:39.230 --> 00:10:42.350 street. No, no, absolutely not. We have moved 00:10:42.350 --> 00:10:45.570 past the Dickensian era, thankfully. The law 00:10:45.570 --> 00:10:49.289 defines exempt and non -exempt assets. Every 00:10:49.289 --> 00:10:52.250 state has a list of exemptions. Usually you can 00:10:52.250 --> 00:10:54.070 keep your clothes, your household furniture, 00:10:54.350 --> 00:10:56.970 tools you need for your trade, maybe a modest 00:10:56.970 --> 00:10:59.210 car and a certain amount of equity in your home. 00:10:59.370 --> 00:11:02.149 So if I'm just a normal guy living paycheck to 00:11:02.149 --> 00:11:04.690 paycheck, renting an apartment, driving a beat 00:11:04.690 --> 00:11:07.090 up Honda Civic. You probably have what's called 00:11:07.090 --> 00:11:10.269 a no asset case. The trustee looks at your stuff, 00:11:10.429 --> 00:11:12.570 does the math and says there is nothing here 00:11:12.570 --> 00:11:14.830 that isn't exempt. There is nothing for me to 00:11:14.830 --> 00:11:16.730 sell. And then what happens to my credit card 00:11:16.730 --> 00:11:19.820 debt? My medical bills. They're discharged. Boof. 00:11:19.940 --> 00:11:22.659 Gone. And the creditors get? Zero. That sounds 00:11:22.659 --> 00:11:24.860 like a pretty good deal for the debtor. Yeah. 00:11:25.000 --> 00:11:27.399 Maybe a little too good. That was exactly the 00:11:27.399 --> 00:11:29.620 argument made by the credit card lobby back in 00:11:29.620 --> 00:11:32.659 the early 2000s. They argued that Chapter 7 was 00:11:32.659 --> 00:11:34.919 being abused, that people who could afford to 00:11:34.919 --> 00:11:37.399 pay something were just walking away. Which brings 00:11:37.399 --> 00:11:40.019 us to the means test. The sources mentioned the 00:11:40.019 --> 00:11:43.980 BAPCPA Act of 2005. I want to circle back to 00:11:43.980 --> 00:11:46.269 the politics of that later, but just... Practically, 00:11:46.309 --> 00:11:48.889 how did it change the game? It made it much, 00:11:48.929 --> 00:11:51.769 much harder to file Chapter 7. It introduced 00:11:51.769 --> 00:11:54.789 a complicated math test. Before you can file, 00:11:54.889 --> 00:11:56.970 you have to compare your income to the median 00:11:56.970 --> 00:12:00.509 income in your state. So if I make, say, $100 00:12:00.509 --> 00:12:03.690 ,000 a year, but I've racked up $200 ,000 in 00:12:03.690 --> 00:12:06.419 debt. The court runs the numbers. they look at 00:12:06.419 --> 00:12:09.059 your income then they subtract a long list of 00:12:09.059 --> 00:12:12.440 allowable expenses rent food transportation taxes 00:12:12.440 --> 00:12:15.580 if the math says you have disposable income left 00:12:15.580 --> 00:12:17.580 over at the end of the month let's say five hundred 00:12:17.580 --> 00:12:20.559 dollars the law says stop you can't use chapter 00:12:20.559 --> 00:12:22.600 seven you have money you have to use chapter 00:12:22.600 --> 00:12:25.100 13. and that brings us to the next item on the 00:12:25.100 --> 00:12:28.480 menu chapter 13. the sources call this the wage 00:12:28.480 --> 00:12:31.340 earners plan think of chapter 13 as a form of 00:12:31.340 --> 00:12:34.090 financial purgatory In this scenario, you don't 00:12:34.090 --> 00:12:35.750 sell your assets. You get to keep the house, 00:12:35.789 --> 00:12:38.730 you keep the expensive car, but you have to sign 00:12:38.730 --> 00:12:40.950 over your future. What does that mean, sign over 00:12:40.950 --> 00:12:44.169 your future? You enter a court -approved repayment 00:12:44.169 --> 00:12:46.929 plan that lasts for three to five years. You 00:12:46.929 --> 00:12:49.909 and your lawyer sit down and say, okay, I will 00:12:49.909 --> 00:12:52.669 pay $800 a month to the trustee for the next 00:12:52.669 --> 00:12:56.309 60 months. The trustee takes that money and trickles 00:12:56.309 --> 00:12:59.110 it out to your creditors. You are living on a 00:12:59.110 --> 00:13:02.230 strict, court -monitored budget for half a decade. 00:13:02.639 --> 00:13:05.379 That sounds miserable. Why would anyone choose 00:13:05.379 --> 00:13:07.940 that over the quick rip the band -aid off of 00:13:07.940 --> 00:13:11.039 Chapter 7? Two main reasons. One, the means test 00:13:11.039 --> 00:13:13.000 forced you to. You'd just make too much money 00:13:13.000 --> 00:13:15.419 for Chapter 7. Or two, and this is the big one, 00:13:15.539 --> 00:13:17.980 you want to save your home. Okay, how does Chapter 00:13:17.980 --> 00:13:21.480 13 help with the house? This is a really crucial 00:13:21.480 --> 00:13:23.960 distinction. In Chapter 7, if you are behind 00:13:23.960 --> 00:13:26.440 on your mortgage, the bank will eventually take 00:13:26.440 --> 00:13:29.080 the house. Chapter 7 wipes out your personal 00:13:29.080 --> 00:13:31.179 liability for the debt, but the lien on the house 00:13:31.179 --> 00:13:33.759 stays. If you don't pay, they foreclose. But 00:13:33.759 --> 00:13:35.860 Chapter 13 is different. Chapter 13 is like a 00:13:35.860 --> 00:13:38.080 time machine for your mortgage. It allows you 00:13:38.080 --> 00:13:40.059 to take those missed payments, what lawyers call 00:13:40.059 --> 00:13:43.000 the arrears, and spread them out over the three 00:13:43.000 --> 00:13:45.759 to five years of the plan. It stops the foreclosure 00:13:45.759 --> 00:13:47.960 dead in its tracks and gives you a chance to 00:13:47.960 --> 00:13:50.669 catch up. I see. So chapter seven is basically 00:13:50.669 --> 00:13:54.529 take my stuff, wipe my debt. And chapter 13 is 00:13:54.529 --> 00:13:57.610 take my income, save my stuff. That is a perfect 00:13:57.610 --> 00:14:00.330 summary. OK, so that covers individuals for the 00:14:00.330 --> 00:14:03.230 most part. Now I want to shift gears to the heavyweight 00:14:03.230 --> 00:14:05.570 division, the stuff we see on the front page 00:14:05.570 --> 00:14:08.549 of The Wall Street Journal. Chapter 11. The corporate 00:14:08.549 --> 00:14:10.789 playbook. This is the one that confuses people 00:14:10.789 --> 00:14:13.409 the most, I think, because we see these huge 00:14:13.409 --> 00:14:16.419 companies file for bankruptcy. And then they 00:14:16.419 --> 00:14:18.700 just keep running. You can buy a ticket on an 00:14:18.700 --> 00:14:21.240 airline that is currently in Chapter 11. You 00:14:21.240 --> 00:14:23.460 can shop at a department store that is in Chapter 00:14:23.460 --> 00:14:26.299 11. How is that possible? Because the goal of 00:14:26.299 --> 00:14:29.220 Chapter 11 is reorganization, not liquidation. 00:14:29.690 --> 00:14:32.190 The fundamental economic theory here is that 00:14:32.190 --> 00:14:34.129 a functioning business is usually worth more 00:14:34.129 --> 00:14:36.610 than a pile of dead parts. Right, the going concern 00:14:36.610 --> 00:14:39.330 value. Exactly. Yeah. If you shut down an airline, 00:14:39.590 --> 00:14:41.789 you fire all the pilots, and you sell the planes 00:14:41.789 --> 00:14:43.610 for scrap metal, you get pennies on the dollar. 00:14:44.149 --> 00:14:46.590 But if you can fix the balance sheet, reduce 00:14:46.590 --> 00:14:49.370 the debt, and keep the planes flying, that company 00:14:49.370 --> 00:14:51.669 might be worth billions again. But here's the 00:14:51.669 --> 00:14:54.049 thing that shocks me. If I run my local bakery 00:14:54.049 --> 00:14:57.179 into the ground, I lose my bakery. A trustee 00:14:57.179 --> 00:14:59.919 takes over. But in Chapter 11, the sources say 00:14:59.919 --> 00:15:02.279 the CEO who flew the plane into the mountain 00:15:02.279 --> 00:15:05.039 often gets to stay in the cockpit. It's called 00:15:05.039 --> 00:15:07.879 being a debtor in possession or D .I .P. for 00:15:07.879 --> 00:15:11.480 short. D .I .P. Yes. The bankruptcy kite actually 00:15:11.480 --> 00:15:13.980 has a presumption that allows the existing management 00:15:13.980 --> 00:15:16.399 to stay in control of the company during the 00:15:16.399 --> 00:15:18.720 bankruptcy. Isn't it just letting the fox guard 00:15:18.720 --> 00:15:20.759 the henhouse? I mean, these are the guys who 00:15:20.759 --> 00:15:22.899 broke the company. Why on earth are we trusting 00:15:22.899 --> 00:15:25.500 them to fix it? It feels counterintuitive, doesn't 00:15:25.500 --> 00:15:27.529 it? But think about the practical alternative. 00:15:27.950 --> 00:15:29.710 Let's say General Motors files for bankruptcy. 00:15:30.110 --> 00:15:33.649 Do you want to fire the CEO and the entire board 00:15:33.649 --> 00:15:37.129 of directors and bring in a court appointed trustee 00:15:37.129 --> 00:15:39.950 who knows absolutely nothing about automotive 00:15:39.950 --> 00:15:43.389 supply chains, union contracts or how to manufacture 00:15:43.389 --> 00:15:45.659 a car? They'd probably crash it even harder. 00:15:45.779 --> 00:15:47.259 I mean, they don't know where the bathroom keys 00:15:47.259 --> 00:15:50.179 are, let alone how to run the business. Exactly. 00:15:50.179 --> 00:15:52.919 The institutional knowledge is incredibly valuable. 00:15:53.279 --> 00:15:55.779 So the court lets them stay, but they are on 00:15:55.779 --> 00:15:57.980 a very, very short leash. They have to report 00:15:57.980 --> 00:16:00.440 everything to the court, to the U .S. trustee's 00:16:00.440 --> 00:16:04.059 office. And usually the creditors form a committee, 00:16:04.200 --> 00:16:06.720 the Committee of Unsecured Creditors, to watch 00:16:06.720 --> 00:16:08.899 their every move and make sure they aren't just 00:16:08.899 --> 00:16:12.389 burning cash. So the CEO stays. What are they 00:16:12.389 --> 00:16:14.429 actually doing during Chapter 11? They aren't 00:16:14.429 --> 00:16:17.450 just selling widgets day to day. They are negotiating. 00:16:17.590 --> 00:16:20.230 It's a high stakes poker game. The company gets 00:16:20.230 --> 00:16:22.549 what's called a period of exclusivity, usually 00:16:22.549 --> 00:16:26.789 about 120 days, to propose a plan of reorganization. 00:16:26.950 --> 00:16:29.509 And what's in this plan? Usually a lot of pain. 00:16:29.590 --> 00:16:31.990 The plan basically says, OK, creditors, we owe 00:16:31.990 --> 00:16:34.169 a billion dollars, but the company is only worth 00:16:34.169 --> 00:16:37.419 600 million. So Bank of America, instead of the 00:16:37.419 --> 00:16:40.159 100 million we owe you, you're getting 60 million 00:16:40.159 --> 00:16:43.080 and maybe 5 % of the new stock. Bondholders, 00:16:43.299 --> 00:16:45.159 you're getting 20 cents on the dollar. And the 00:16:45.159 --> 00:16:46.720 creditors have to agree to this. They have to 00:16:46.720 --> 00:16:49.039 accept the haircut. They vote. They are divided 00:16:49.039 --> 00:16:52.159 into classes based on the type of debt they hold. 00:16:52.440 --> 00:16:55.279 Class A might be the senior lenders. Class B 00:16:55.279 --> 00:16:58.379 might be junior lenders. Class C might be suppliers. 00:16:58.820 --> 00:17:01.340 They all vote on the plan. What happens if they 00:17:01.340 --> 00:17:04.319 say no? No, we hate this plan. Pay us in full. 00:17:04.640 --> 00:17:06.700 Then the company can pull out the heavy artillery. 00:17:07.119 --> 00:17:09.880 The cram down. I love legal terms that sound 00:17:09.880 --> 00:17:12.859 violent. The cram down. It is aggressive. If 00:17:12.859 --> 00:17:15.859 the plan meets certain strict legal standards, 00:17:16.140 --> 00:17:18.759 specifically that it is fair and equitable and 00:17:18.759 --> 00:17:21.500 doesn't discriminate unfairly, the judge can 00:17:21.500 --> 00:17:23.680 approve the plan over the objection of a dissent 00:17:23.680 --> 00:17:26.200 in class. He literally crams the plan down their 00:17:26.200 --> 00:17:29.259 throats. That is immense power for a judge. But 00:17:29.259 --> 00:17:32.309 fair is a subjective word. How does a judge decide 00:17:32.309 --> 00:17:34.609 what's fair in a billion dollar fight? They use 00:17:34.609 --> 00:17:36.869 the absolute priority rule. OK, let's unpack 00:17:36.869 --> 00:17:39.829 that. Absolute priority. It sounds like a medieval 00:17:39.829 --> 00:17:43.150 hierarchy and it kind of is. Imagine a waterfall 00:17:43.150 --> 00:17:46.769 of money, the rule says. The people at the top, 00:17:46.910 --> 00:17:49.769 the senior secured creditors, must fill their 00:17:49.769 --> 00:17:52.670 buckets completely before a single drop flows 00:17:52.670 --> 00:17:55.170 down to the next level, the junior creditors. 00:17:55.470 --> 00:17:57.990 And the junior creditors must be paid in full 00:17:57.990 --> 00:18:00.250 before a drop hits the people at the very bottom. 00:18:00.700 --> 00:18:02.940 And who is at the bottom of the waterfall? The 00:18:02.940 --> 00:18:05.259 shareholders, the owners of the company. This 00:18:05.259 --> 00:18:07.960 explains why when a company goes bankrupt, the 00:18:07.960 --> 00:18:10.839 stock usually goes to zero. Right. By the time 00:18:10.839 --> 00:18:12.420 the water gets down to the shareholder bucket, 00:18:12.579 --> 00:18:15.079 the river is dry. The creditors usually end up 00:18:15.079 --> 00:18:17.099 owning the new company. The old owners are wiped 00:18:17.099 --> 00:18:19.460 out. That's the rule. But wait, I feel like I've 00:18:19.460 --> 00:18:22.160 seen cases where the old owners still end up 00:18:22.160 --> 00:18:24.779 with something or the senior guys give a little 00:18:24.779 --> 00:18:26.599 bit to the little guys just to make things go 00:18:26.599 --> 00:18:28.930 smoothly. That happens all the time. It's called 00:18:28.930 --> 00:18:32.230 a gift plan or a carve out. Sometimes senior 00:18:32.230 --> 00:18:34.730 creditors will say, look, we are entitled to 00:18:34.730 --> 00:18:36.809 everything. But if we fight this out in court 00:18:36.809 --> 00:18:38.450 for two years, the lawyers will take all the 00:18:38.450 --> 00:18:42.269 money and fees. So we will gift some of our recovery 00:18:42.269 --> 00:18:44.690 to the junior creditors just to get them to vote 00:18:44.690 --> 00:18:47.650 yes and end this thing. It's practical, even 00:18:47.650 --> 00:18:50.920 if it bends the strict hierarchy. If Chapter 00:18:50.920 --> 00:18:53.319 11 is just about rearranging the deck chairs 00:18:53.319 --> 00:18:55.640 on the Titanic and stiffing the shareholders, 00:18:55.980 --> 00:18:59.019 why do companies rush to do it? The sources suggest 00:18:59.019 --> 00:19:01.339 there is something more strategic going on. Oh, 00:19:01.380 --> 00:19:03.319 it's extremely strategic, especially when it 00:19:03.319 --> 00:19:05.180 comes to something called executory contracts. 00:19:05.500 --> 00:19:08.160 Define that for us. An executory contract is 00:19:08.160 --> 00:19:10.920 just an ongoing agreement where both sides still 00:19:10.920 --> 00:19:13.680 have duties to perform. A lease on a building, 00:19:13.839 --> 00:19:18.480 a long -term contract to buy fuel, or... a collective 00:19:18.480 --> 00:19:20.500 bargaining agreement with a labor union. Ah, 00:19:20.799 --> 00:19:23.099 now we're getting into the real friction. Chapter 00:19:23.099 --> 00:19:25.519 11 gives companies a superpower, the power to 00:19:25.519 --> 00:19:27.700 reject contracts. They can just tear them up. 00:19:27.960 --> 00:19:31.000 Effectively, yes. Section 365 of the code. The 00:19:31.000 --> 00:19:33.799 company can go to the judge and say, this contract 00:19:33.799 --> 00:19:36.859 is burdensome. It's dragging us down. If we keep 00:19:36.859 --> 00:19:38.920 paying these rates, we will die. We want to reject 00:19:38.920 --> 00:19:41.829 it. Let's look at a specific industry to see 00:19:41.829 --> 00:19:44.329 how this plays out in the real world. The sources 00:19:44.329 --> 00:19:47.009 mention the airlines. It seems like since 2002, 00:19:47.250 --> 00:19:49.710 practically every major U .S. airline has filed 00:19:49.710 --> 00:19:52.190 Chapter 11 at some point. It's true. United, 00:19:52.589 --> 00:19:55.910 Delta, American, Northwest. They all went through 00:19:55.910 --> 00:19:57.890 what they called the car wash of Chapter 11. 00:19:58.130 --> 00:20:00.170 And the sources suggest this wasn't just about, 00:20:00.250 --> 00:20:03.450 oops, we ran out of cash. It was strategic. It 00:20:03.450 --> 00:20:05.329 absolutely was. You have to look at the landscape 00:20:05.329 --> 00:20:08.049 in the early 2000s. You had the shock of 9 -11. 00:20:08.210 --> 00:20:11.769 You had rising fuel prices. But the biggest problem 00:20:11.769 --> 00:20:14.250 for the legacy carriers was their legacy costs. 00:20:14.430 --> 00:20:16.890 Pensions. Pensions and union contracts. They 00:20:16.890 --> 00:20:18.829 had negotiated these very generous deals in the 00:20:18.829 --> 00:20:21.009 70s and 80s when they were highly regulated and 00:20:21.009 --> 00:20:23.750 profitable. But then low -cost carriers like 00:20:23.750 --> 00:20:26.230 Southwest and JetBlue came along. They were younger. 00:20:26.349 --> 00:20:28.529 They didn't have thousands of retirees to pay. 00:20:28.670 --> 00:20:31.170 And their labor costs were dramatically lower. 00:20:31.390 --> 00:20:33.430 So the big guys couldn't compete. on ticket price 00:20:33.430 --> 00:20:36.450 because they were dragging this massive anchor 00:20:36.450 --> 00:20:40.539 of labor costs. Exactly. So one by one, they 00:20:40.539 --> 00:20:43.640 use Chapter 11. They filed for bankruptcy. They 00:20:43.640 --> 00:20:45.740 went to the pilots union and the machinists union 00:20:45.740 --> 00:20:48.400 and said, look, we are bankrupt. The judge is 00:20:48.400 --> 00:20:50.460 going to let us reject your contract. If that 00:20:50.460 --> 00:20:53.019 happens, you get nothing. No job, no pension. 00:20:53.180 --> 00:20:56.099 Or you can agree to a 30 percent pay cut. We 00:20:56.099 --> 00:20:58.920 freeze the pension and you keep your job. That's 00:20:58.920 --> 00:21:01.519 brutal. It's negotiation with a gun to your head. 00:21:01.660 --> 00:21:04.200 It is. The expert commentary in the sources puts 00:21:04.200 --> 00:21:07.400 it this way. This turned bankrupt. from a shield 00:21:07.400 --> 00:21:09.900 against death into a strategic business tool. 00:21:10.319 --> 00:21:13.299 Companies were remodeling the plane while flying 00:21:13.299 --> 00:21:15.619 it. But the people paying for the remodel were 00:21:15.619 --> 00:21:18.000 the employees, their pensions, their salaries. 00:21:18.299 --> 00:21:23.490 Correct. So what? For the economy. Once one airline 00:21:23.490 --> 00:21:25.210 did it, the others had to follow suit. Because 00:21:25.210 --> 00:21:27.430 of competition. Right, right. If United Airlines 00:21:27.430 --> 00:21:30.529 uses bankruptcy to slash its labor costs by 30%, 00:21:30.529 --> 00:21:33.630 they can lower their ticket prices. Now American 00:21:33.630 --> 00:21:35.789 Airlines is looking at their books saying, we 00:21:35.789 --> 00:21:37.950 can't match those prices unless we slash our 00:21:37.950 --> 00:21:41.940 costs too. So they file. It triggered a domino 00:21:41.940 --> 00:21:44.180 effect across the entire industry. It really 00:21:44.180 --> 00:21:46.859 highlights how Chapter 11 is about the survival 00:21:46.859 --> 00:21:50.119 of the entity, the corporation itself. The logo 00:21:50.119 --> 00:21:52.319 on the tail of the plane survives. The flight 00:21:52.319 --> 00:21:54.940 routes survive. But the promises made to the 00:21:54.940 --> 00:21:57.079 people who work there, those get left behind 00:21:57.079 --> 00:21:59.740 in court. That is the tradeoff. We save the business. 00:21:59.779 --> 00:22:02.440 We sacrifice the contract. OK, speaking of sacrificing 00:22:02.440 --> 00:22:04.859 contracts and dodging promises. Right. Let's 00:22:04.859 --> 00:22:06.980 get into what you call the dark arts of bankruptcy. 00:22:07.140 --> 00:22:09.599 The loopholes, the tricks, the things that make 00:22:09.599 --> 00:22:11.559 people. look at lawyers and just shake their 00:22:11.559 --> 00:22:13.859 heads. Well, every system has its edges. Let's 00:22:13.859 --> 00:22:16.180 talk about avoidance actions. Avoidance. It sounds 00:22:16.180 --> 00:22:18.920 like me trying to get out of doing dishes. But 00:22:18.920 --> 00:22:21.480 in court, this means the trustee has superpowers, 00:22:21.599 --> 00:22:24.019 right? They do. The trustee can actually travel 00:22:24.019 --> 00:22:27.220 back in time, legally speaking, and undo transactions 00:22:27.220 --> 00:22:30.279 that happened before the bankruptcy filing. These 00:22:30.279 --> 00:22:32.740 are called clawbacks. OK, give me the classic 00:22:32.740 --> 00:22:34.579 brother -in -law example. I saw that in the notes. 00:22:34.720 --> 00:22:37.779 This is the classic preference action. Let's 00:22:37.779 --> 00:22:39.599 say your business is failing. You know you're 00:22:39.599 --> 00:22:42.299 going to file bankruptcy next week. But you owe 00:22:42.299 --> 00:22:45.160 your brother -in -law $10 ,000 and you owe Visa 00:22:45.160 --> 00:22:47.940 $10 ,000. I want to keep peace at the Thanksgiving 00:22:47.940 --> 00:22:50.759 table, so I play my brother -in -law. You write 00:22:50.759 --> 00:22:53.279 him a check for the full $10 ,000. Then on Monday, 00:22:53.460 --> 00:22:56.619 you file Chapter 7. You tell Visa, sorry, I'm 00:22:56.619 --> 00:22:59.720 broke. No money left. Seems smart. I mean, unethical 00:22:59.720 --> 00:23:02.640 maybe, but smart. The bankruptcy code says no. 00:23:03.150 --> 00:23:05.529 That is a preference. You preferred one creditor 00:23:05.529 --> 00:23:08.829 over another, an insider creditor. The trustee 00:23:08.829 --> 00:23:10.890 looks at that transaction. If it happened within 00:23:10.890 --> 00:23:13.710 90 days of filing, or one full year if it's an 00:23:13.710 --> 00:23:16.750 insider, like a relative, the trustee can sue 00:23:16.750 --> 00:23:18.750 your brother -in -law. They sue him for the money 00:23:18.750 --> 00:23:22.829 I paid him. Yes. They file a lawsuit to avoid 00:23:22.829 --> 00:23:25.269 the preference and force him to cough it up. 00:23:25.549 --> 00:23:28.529 That $10 ,000 goes back into the pot to be shared 00:23:28.529 --> 00:23:32.119 equally among all the creditors. Man. Thanksgiving 00:23:32.119 --> 00:23:34.720 dinner is gonna be incredibly awkward. Very. 00:23:34.940 --> 00:23:37.920 But the principle is equality of distribution. 00:23:38.650 --> 00:23:40.369 You shouldn't be allowed to pick winners and 00:23:40.369 --> 00:23:42.730 losers right before the ship sinks. That makes 00:23:42.730 --> 00:23:44.869 sense. It prevents people from looting the ship 00:23:44.869 --> 00:23:47.390 before it goes under. But what about fraudulent 00:23:47.390 --> 00:23:50.089 transfers? That sounds more malicious. That is 00:23:50.089 --> 00:23:52.210 when you are actively trying to hide assets. 00:23:52.509 --> 00:23:55.230 The classic example is selling your house to 00:23:55.230 --> 00:23:58.170 your best friend for $1. Here's the deed. Just 00:23:58.170 --> 00:23:59.789 give it back to me when this all blows over. 00:23:59.950 --> 00:24:02.730 Exactly. The court sees right through that. They 00:24:02.730 --> 00:24:05.490 will undo that sale in a heartbeat. But there 00:24:05.490 --> 00:24:07.309 is also something called constructive fraud. 00:24:07.879 --> 00:24:09.779 That's where you didn't intend to be evil, but 00:24:09.779 --> 00:24:11.900 you were insolvent and you sold something for 00:24:11.900 --> 00:24:14.960 way less than it was worth. The court essentially 00:24:14.960 --> 00:24:17.880 says you were too broke to be giving away value 00:24:17.880 --> 00:24:20.720 like that, and they reverse it. Okay, those seem 00:24:20.720 --> 00:24:23.019 like standard policing of the rules. Keeping 00:24:23.019 --> 00:24:26.279 the game fair. But then there is the Texas two 00:24:26.279 --> 00:24:30.700 -step. This one feels different. This feels less 00:24:30.700 --> 00:24:33.140 like policing the rules and more like inventing 00:24:33.140 --> 00:24:35.650 a whole new game. This is a highly controversial 00:24:35.650 --> 00:24:38.609 modern strategy. It involves something called 00:24:38.609 --> 00:24:41.049 a divisional merger, which is permitted under 00:24:41.049 --> 00:24:44.049 Texas state law. The sources bring up Johnson 00:24:44.049 --> 00:24:46.309 & Johnson here. Walk us through what happened 00:24:46.309 --> 00:24:48.829 because this involves baby powder, cancer, and 00:24:48.829 --> 00:24:51.619 some very, very creative lawyering. Right. So 00:24:51.619 --> 00:24:54.599 Johnson & Johnson was facing roughly 40 ,000 00:24:54.599 --> 00:24:57.119 lawsuits alleging that their talc -based baby 00:24:57.119 --> 00:24:59.680 powder caused ovarian cancer. We are talking 00:24:59.680 --> 00:25:01.940 billions and billions of dollars in potential 00:25:01.940 --> 00:25:04.700 liability. A massive cloud hanging over the whole 00:25:04.700 --> 00:25:07.000 company. If they lose those suits, it could cripple 00:25:07.000 --> 00:25:10.140 them. Yes. So they used this specific Texas law 00:25:10.140 --> 00:25:12.599 to perform a corporate split. They took the original 00:25:12.599 --> 00:25:14.519 company and split it into two new companies. 00:25:14.740 --> 00:25:17.619 Let's call them Good Co. and Bad Co. for simplicity. 00:25:17.940 --> 00:25:20.670 I'm with you. Goodco gets all the profitable 00:25:20.670 --> 00:25:24.190 assets, the Tylenol, the Band -Aids, the Listerine, 00:25:24.289 --> 00:25:27.369 all the cash flow, the factories. Badco, a new 00:25:27.369 --> 00:25:31.509 entity, gets the lawsuits, all 40 ,000 of them. 00:25:31.529 --> 00:25:33.410 Wait, wait, they just shoveled the cancer lawsuits 00:25:33.410 --> 00:25:36.490 into a separate box? Exactly. They allocated 00:25:36.490 --> 00:25:39.049 the talc -related liabilities to this new, smaller 00:25:39.049 --> 00:25:42.509 entity, and then almost immediately, Badco files 00:25:42.509 --> 00:25:45.009 for Chapter 11 bankruptcy. And because of the 00:25:45.009 --> 00:25:47.569 automatic stay? All those lawsuits stop. The 00:25:47.569 --> 00:25:50.369 litigation is paused. The 40 ,000 victims are 00:25:50.369 --> 00:25:53.250 told, sorry, you can't sue Johnson & Johnson 00:25:53.250 --> 00:25:56.390 anymore. Your claim is now against Badco, and 00:25:56.390 --> 00:25:59.269 Badco is bankrupt. Meanwhile, Goodco, the one 00:25:59.269 --> 00:26:01.589 with all the actual money, is out there doing 00:26:01.589 --> 00:26:04.180 business, paying dividends. totally unaffected. 00:26:04.200 --> 00:26:06.940 That is the strategy. Now, J &J argues it's an 00:26:06.940 --> 00:26:08.920 efficient way to settle mass tort claims. They 00:26:08.920 --> 00:26:11.119 say, we will put a bunch of money into the bad 00:26:11.119 --> 00:26:13.160 copot and the victims can divide it up there. 00:26:13.220 --> 00:26:15.599 It saves everyone legal fees and time. But the 00:26:15.599 --> 00:26:18.140 victims lose their right to a jury trial against 00:26:18.140 --> 00:26:20.819 the actual company that sold the powder. Correct. 00:26:21.019 --> 00:26:23.720 And that's the heart of the controversy. Critics 00:26:23.720 --> 00:26:26.480 call it a gross manipulation of the system. They 00:26:26.480 --> 00:26:29.359 say it's a fraudulent transfer on a massive scale. 00:26:29.539 --> 00:26:32.359 It insulates the wealthy parent company from 00:26:32.359 --> 00:26:35.099 the consequences of its products. It really tests 00:26:35.099 --> 00:26:37.180 the limits of what bankruptcy is supposed to 00:26:37.180 --> 00:26:40.200 be for. Is it a fresh start for an honest but 00:26:40.200 --> 00:26:43.400 unfortunate debtor? Or is it a getaway car for 00:26:43.400 --> 00:26:46.140 a wealthy corporation? That is the billion dollar 00:26:46.140 --> 00:26:48.779 question being litigated right now. Courts are 00:26:48.779 --> 00:26:50.859 struggling with whether this was filed in good 00:26:50.859 --> 00:26:53.180 faith, which is a requirement for bankruptcy. 00:26:53.599 --> 00:26:55.720 I'm pretty sure Madison wasn't thinking about 00:26:55.720 --> 00:26:57.920 divisional mergers when he wrote the Constitution. 00:26:58.299 --> 00:27:00.079 Definitely not. The world has gotten a lot more 00:27:00.079 --> 00:27:02.079 complicated. Okay, let's zoom out a bit. We've 00:27:02.079 --> 00:27:04.980 been talking about in -court bankruptcy. But 00:27:04.980 --> 00:27:07.299 the sources mention restructuring as a broader 00:27:07.299 --> 00:27:10.140 concept. This can happen outside of a courtroom, 00:27:10.299 --> 00:27:13.529 right? Yes. In fact, most companies prefer to 00:27:13.529 --> 00:27:16.029 solve their problems out of court if they can. 00:27:16.150 --> 00:27:18.829 It's cheaper, it's quieter, and it's much faster. 00:27:19.009 --> 00:27:22.509 This is like a workout. Exactly. A workout. The 00:27:22.509 --> 00:27:24.890 company calls its major creditors into a room 00:27:24.890 --> 00:27:27.230 and says, look, we can't pay you. If we file 00:27:27.230 --> 00:27:30.029 for bankruptcy, you'll lose a lot on legal fees 00:27:30.029 --> 00:27:33.170 and delays, and it will be a mess. Let's make 00:27:33.170 --> 00:27:35.970 a deal right now. And what kind of deals are 00:27:35.970 --> 00:27:38.009 we talking about? You might do a debt for equity 00:27:38.009 --> 00:27:41.420 swap. The creditors forgive the debt and in exchange 00:27:41.420 --> 00:27:43.839 they get ownership, they get stock in the company, 00:27:43.940 --> 00:27:48.460 or you might agree to a haircut. A haircut? That's 00:27:48.460 --> 00:27:50.599 when creditors agree to take less than they are 00:27:50.599 --> 00:27:52.740 owed. Maybe you get 70 cents on the dollar just 00:27:52.740 --> 00:27:55.440 to get paid something now instead of maybe nothing 00:27:55.440 --> 00:27:57.480 in two years. Better a bird in the hand than 00:27:57.480 --> 00:28:00.140 two in the bankruptcy court? Precisely. But whether 00:28:00.140 --> 00:28:02.859 it is in court or out of court, everything hinges 00:28:02.859 --> 00:28:07.049 on one massive contentious debate. Valuation. 00:28:07.069 --> 00:28:09.710 How much the company is actually worth. It sounds 00:28:09.710 --> 00:28:13.289 boring, but it is the valuation war. Think about 00:28:13.289 --> 00:28:15.589 it. If you say the company is worth $1 billion, 00:28:15.910 --> 00:28:17.990 there might be enough value to pay the banks 00:28:17.990 --> 00:28:19.849 and maybe have something left for the shareholders. 00:28:20.269 --> 00:28:22.829 If you say it's worth only $500 million, the 00:28:22.829 --> 00:28:24.829 shareholders get wiped out and the banks take 00:28:24.829 --> 00:28:27.890 a loss. So who decides? Who puts the price tag 00:28:27.890 --> 00:28:31.049 on the company? Experts. Investment bankers. 00:28:31.480 --> 00:28:33.960 They come in with these complex financial models 00:28:33.960 --> 00:28:37.319 and spreadsheets and they fight it out. And because 00:28:37.319 --> 00:28:39.859 it is so subjective, you see these massive battles. 00:28:40.160 --> 00:28:43.059 The senior creditors, interestingly, want the 00:28:43.059 --> 00:28:46.619 valuation to be low. Why low? Usually people 00:28:46.619 --> 00:28:48.599 want their stuff to be worth a lot. In bankruptcy, 00:28:48.779 --> 00:28:50.920 if the value is low, the senior creditors can 00:28:50.920 --> 00:28:52.819 say, look, there isn't enough money for anyone 00:28:52.819 --> 00:28:55.039 else. The company is broke. So we should get 00:28:55.039 --> 00:28:57.619 100 percent of the equity in the new company. 00:28:58.329 --> 00:29:00.410 If the value is high, they have to share that 00:29:00.410 --> 00:29:02.609 equity with the junior creditors. So the banks 00:29:02.609 --> 00:29:04.609 are arguing this company is trash. Give it all 00:29:04.609 --> 00:29:06.390 to us. And the shareholders are arguing, no, 00:29:06.470 --> 00:29:08.670 it's a goldmine. Don't wipe us out. That's the 00:29:08.670 --> 00:29:11.069 fight in a nutshell. And the players in this 00:29:11.069 --> 00:29:13.390 game have really changed. The sources mention 00:29:13.390 --> 00:29:17.089 the London approach. Historically, in Europe, 00:29:17.210 --> 00:29:19.369 banks would work together. They were gentle. 00:29:19.529 --> 00:29:21.950 They tried to support the company to avoid write 00:29:21.950 --> 00:29:24.490 -offs. It was a gentleman's agreement. Today, 00:29:24.569 --> 00:29:27.720 we have hedge funds. Distressed debt traders. 00:29:28.019 --> 00:29:30.779 These are investors who specifically buy the 00:29:30.779 --> 00:29:33.079 debt of failing companies for pennies on the 00:29:33.079 --> 00:29:36.700 dollar specifically to take control. They aren't 00:29:36.700 --> 00:29:38.859 interested in a gentleman's agreement. They are 00:29:38.859 --> 00:29:40.779 interested in aggressive enforcement of their 00:29:40.779 --> 00:29:44.079 rights, often pushing for liquidation. It has 00:29:44.079 --> 00:29:46.759 made the restructuring world much more litigious 00:29:46.759 --> 00:29:49.339 and sharp elbowed. It's a shark tank. It is. 00:29:49.380 --> 00:29:51.960 I want to pivot now. We've been talking about 00:29:51.960 --> 00:29:54.500 billions of dollars, corporate maneuvering, and 00:29:54.500 --> 00:29:57.559 hedge funds. But the outline highlights the human 00:29:57.559 --> 00:30:00.880 cost, the social factors. Because behind all 00:30:00.880 --> 00:30:03.559 these statues and legal battles are real people. 00:30:04.190 --> 00:30:06.789 And the data in our sources is honestly startling. 00:30:06.849 --> 00:30:08.910 It is. This is where the rubber meets the road. 00:30:09.049 --> 00:30:11.230 We often think of bankruptcy as a failure of 00:30:11.230 --> 00:30:13.930 character, a moral failing. But the data suggests 00:30:13.930 --> 00:30:16.269 it's usually a failure of luck. The statistic 00:30:16.269 --> 00:30:17.849 that just jumped off the page at me was about 00:30:17.849 --> 00:30:19.710 medical bankruptcy. It is the leading cause, 00:30:19.869 --> 00:30:23.009 by far. The sources cite data from 2020 showing 00:30:23.009 --> 00:30:26.690 that 66 .5 % of individual bankruptcies were 00:30:26.690 --> 00:30:29.730 tied to medical issues. 66 .5%. That is huge. 00:30:30.170 --> 00:30:32.289 That means two -thirds of the people standing 00:30:32.289 --> 00:30:34.990 in front of a bankruptcy judge aren't there because 00:30:34.990 --> 00:30:37.049 they bought too many fancy dinners or went on 00:30:37.049 --> 00:30:39.390 vacations they couldn't afford. They are there 00:30:39.390 --> 00:30:41.329 because they got sick. Or they lost their job 00:30:41.329 --> 00:30:43.230 because they got sick and couldn't work. Exactly. 00:30:43.369 --> 00:30:46.210 It's often both. The medical bills themselves 00:30:46.210 --> 00:30:49.430 and the lost income from the illness. The American 00:30:49.430 --> 00:30:52.430 Journal of Medicine backs this up. Over three 00:30:52.430 --> 00:30:55.170 out of five personal bankruptcies are due to 00:30:55.170 --> 00:30:58.549 medical debt. It highlights a unique feature 00:30:58.549 --> 00:31:01.509 of the American system. We don't have a robust 00:31:01.509 --> 00:31:04.029 safety net for health shocks, so the bankruptcy 00:31:04.029 --> 00:31:06.329 court becomes the safety net. It's the emergency 00:31:06.329 --> 00:31:08.630 room for your finances after the actual emergency 00:31:08.630 --> 00:31:10.930 room bankrupts you. That's a very powerful way 00:31:10.930 --> 00:31:12.430 to put it. And then there is the student loan 00:31:12.430 --> 00:31:15.210 issue. We hear about this constantly. Can you 00:31:15.210 --> 00:31:17.849 discharge student loans in bankruptcy? Generally, 00:31:17.849 --> 00:31:20.789 no. And that is a huge controversial exception 00:31:20.789 --> 00:31:23.910 in the code. Most debt credit cards, medical 00:31:23.910 --> 00:31:27.480 bills, personal loans... can be wiped out. But 00:31:27.480 --> 00:31:30.559 student loans have this special protection. Why? 00:31:31.220 --> 00:31:34.160 I mean, you can discharge gambling debt. You 00:31:34.160 --> 00:31:36.460 can discharge credit card debt from buying luxury 00:31:36.460 --> 00:31:39.059 clothes. But you can't discharge the loan you 00:31:39.059 --> 00:31:41.720 took to get an education. It seems backwards. 00:31:42.299 --> 00:31:44.920 The policy logic dating back to the 70s was to 00:31:44.920 --> 00:31:48.460 prevent strategic defaults. Lawmakers were afraid 00:31:48.460 --> 00:31:50.519 that students would graduate from Harvard Medical 00:31:50.519 --> 00:31:53.279 School, immediately file bankruptcy to wipe their 00:31:53.279 --> 00:31:55.799 debt and then go on to make millions. But does 00:31:55.799 --> 00:31:58.160 that actually happen? Did that ever happen? There 00:31:58.160 --> 00:32:00.619 was very little evidence of it then, and there 00:32:00.619 --> 00:32:03.980 is almost none now. But the law stuck. To get 00:32:03.980 --> 00:32:06.119 rid of student loans and bankruptcy, you have 00:32:06.119 --> 00:32:09.079 to prove undue hardship. And the sources say 00:32:09.079 --> 00:32:11.720 that is very, very hard to prove. Extremely. 00:32:11.720 --> 00:32:14.119 In most courts, you have to pass something called 00:32:14.119 --> 00:32:16.619 the Brunner test. You effectively have to prove 00:32:16.619 --> 00:32:19.039 that you can't maintain a minimal standard of 00:32:19.039 --> 00:32:21.279 living, that the situation is likely to persist 00:32:21.279 --> 00:32:23.980 for a huge portion of the repayment period, and 00:32:23.980 --> 00:32:25.859 that you made good faith efforts to pay in the 00:32:25.859 --> 00:32:28.769 past. It's a very high. And you have to sue the 00:32:28.769 --> 00:32:30.970 lender to prove it. Yes, in what's called an 00:32:30.970 --> 00:32:34.089 adversary proceeding, which costs money for a 00:32:34.089 --> 00:32:36.170 lawyer. So you have to be rich enough to hire 00:32:36.170 --> 00:32:38.970 a lawyer to prove you're too poor to pay your 00:32:38.970 --> 00:32:41.470 loans. It's a cruel paradox. It traps people 00:32:41.470 --> 00:32:44.329 in this debt for decades, sometimes for life. 00:32:44.630 --> 00:32:46.430 The sources also mentioned racial disparities. 00:32:47.099 --> 00:32:49.940 This is disturbing to read. It is. Data shows 00:32:49.940 --> 00:32:52.160 that minority debtors have an approximately 40 00:32:52.160 --> 00:32:54.579 % decreased chance of receiving a discharge in 00:32:54.579 --> 00:32:57.960 Chapter 13 compared to white debtors. 40%. That 00:32:57.960 --> 00:33:00.690 is a massive gap. Why? What's driving that? The 00:33:00.690 --> 00:33:02.390 sources link it to a combination of factors, 00:33:02.509 --> 00:33:04.869 but a big one is legal representation and what 00:33:04.869 --> 00:33:07.950 some call steering. It seems minority filers 00:33:07.950 --> 00:33:10.750 are often steered towards Chapter 13, which requires 00:33:10.750 --> 00:33:13.710 that rigorous five -year payment plan rather 00:33:13.710 --> 00:33:16.829 than Chapter 7, which is the quick, clean discharge. 00:33:17.109 --> 00:33:19.470 And Chapter 13 is just... Really hard to finish. 00:33:19.549 --> 00:33:22.390 Very hard. Life happens. If you miss a few payments 00:33:22.390 --> 00:33:24.470 in year three because your car breaks down, you 00:33:24.470 --> 00:33:26.329 can get kicked out of the program. Your case 00:33:26.329 --> 00:33:28.569 is dismissed, you're back at square one, and 00:33:28.569 --> 00:33:31.410 you still owe all the debt plus interest. Chapter 00:33:31.410 --> 00:33:34.230 seven is a quick, fresh start. So if one group 00:33:34.230 --> 00:33:36.450 is disproportionately pushed into the five -year 00:33:36.450 --> 00:33:39.089 penalty box, that just exacerbates wealth inequality 00:33:39.089 --> 00:33:41.750 over time. So the system works differently depending 00:33:41.750 --> 00:33:44.509 on who you are, who represents you, and whether 00:33:44.509 --> 00:33:47.150 you are a corporation or a person. That brings 00:33:47.150 --> 00:33:51.950 us back to that 2005 law, BAPCPA, the moral hazard 00:33:51.950 --> 00:33:54.769 debate. The argument was that people were abusing 00:33:54.769 --> 00:33:56.690 the system, right? That was the narrative pushed 00:33:56.690 --> 00:33:59.150 by the credit card lobby. They spent millions 00:33:59.150 --> 00:34:01.549 arguing that bankruptcy was too easy, that it 00:34:01.549 --> 00:34:03.950 created a moral hazard encouraging reckless spending. 00:34:04.230 --> 00:34:06.670 They promised Congress that if we made bankruptcy 00:34:06.670 --> 00:34:09.369 harder with the means test, it would reduce their 00:34:09.369 --> 00:34:11.750 losses and they would pass those savings on to 00:34:11.750 --> 00:34:13.690 consumers in the form of lower interest rates. 00:34:13.909 --> 00:34:16.150 And did they? Did my credit card rate go down 00:34:16.150 --> 00:34:20.010 after 2005? The data suggests no. Credit card 00:34:20.010 --> 00:34:22.929 company losses did go down significantly, but 00:34:22.929 --> 00:34:25.369 their profits went up. And costs to consumers, 00:34:25.690 --> 00:34:29.090 interest rates, late fees, overlimit fees, they 00:34:29.090 --> 00:34:31.210 didn't necessarily drop. In many cases, they 00:34:31.210 --> 00:34:33.829 went up. So the law helped the corporate creditors, 00:34:33.829 --> 00:34:35.610 but it didn't really help the consumers it was 00:34:35.610 --> 00:34:37.730 promised to protect. It's a classic case of shifting 00:34:37.730 --> 00:34:40.630 the balance of power. The 2005 act tilted the 00:34:40.630 --> 00:34:42.750 playing field significantly in favor of the lenders. 00:34:42.949 --> 00:34:45.159 So let's bring this all home. We've covered a 00:34:45.159 --> 00:34:48.400 lot of ground, constitutional roots, sci -fi 00:34:48.400 --> 00:34:51.940 force fields, cram downs, airlines breaking unions, 00:34:52.320 --> 00:34:55.480 the Texas two -step, and the just crushing weight 00:34:55.480 --> 00:34:58.440 of medical debt. If we boil this all down, what 00:34:58.440 --> 00:35:00.639 are the big takeaways for our listeners? I think 00:35:00.639 --> 00:35:02.380 there are three main points to walk away with. 00:35:10.400 --> 00:35:33.610 Okay. Second. And third. balancing act. It tries 00:35:33.610 --> 00:35:35.829 to balance the fresh start for the honest debtor 00:35:35.829 --> 00:35:38.449 against fairness for creditors. But as we've 00:35:38.449 --> 00:35:40.829 seen with the Texas two -step, the medical debt 00:35:40.829 --> 00:35:43.389 stats, and the student loan rules, that balance 00:35:43.389 --> 00:35:46.449 is often tested and, you could argue, often tilted. 00:35:46.690 --> 00:35:48.969 It really feels like the system is designed to 00:35:48.969 --> 00:35:52.489 save the business, this abstract legal entity, 00:35:52.690 --> 00:35:55.090 sometimes at the expense of the people inside 00:35:55.090 --> 00:35:57.789 it or the people hurt by it. That is the final 00:35:57.789 --> 00:36:00.579 provocative thought I would leave you with. We 00:36:00.579 --> 00:36:03.320 have created a system that is incredibly sophisticated 00:36:03.320 --> 00:36:06.420 and good at preserving corporate life. We can 00:36:06.420 --> 00:36:08.860 split companies, we can shed contracts, we can 00:36:08.860 --> 00:36:11.980 pause lawsuits, all to keep the going concern 00:36:11.980 --> 00:36:16.360 alive. But when 66 % of personal filings are 00:36:16.360 --> 00:36:19.380 families crushed by medical bills, or when cancer 00:36:19.380 --> 00:36:21.739 victims are trapped in a bad company spinoff, 00:36:22.380 --> 00:36:25.039 you have to ask a really hard question. Does 00:36:25.039 --> 00:36:28.400 the current bankruptcy code prioritize the survival 00:36:28.400 --> 00:36:31.159 of the corporation over the well -being of the 00:36:31.159 --> 00:36:33.300 individual? And is it time for a fresh start 00:36:33.300 --> 00:36:35.800 for the bankruptcy code itself? That is a huge 00:36:35.800 --> 00:36:37.679 question to chew on. Thanks for taking this deep 00:36:37.679 --> 00:36:40.119 dive with us into the murky but fascinating waters 00:36:40.119 --> 00:36:41.820 of bankruptcy. It was a pleasure. Thanks for 00:36:41.820 --> 00:36:43.340 having me. We'll see you next time on The Deep 00:36:43.340 --> 00:36:43.579 Dive.