Stuffing the Chapter 11 Ballot Box with "Junk" Claims

A recent, disturbing, and truly scandalous development in Chapter 11 mass tort cases is the phenomenon of debtors trying to stuff the ballot box with "junk" claims, that is claims that should by all lights be disallowed as unenforceable and therefore ineligible to vote on a plan. Debtors have recognized that they can strategically co-opt part of the mass tort bar to push through plans:  debtors offer small payments to claims that ought to be disallowed (and thus to the attorneys representing those claims on contingency fee) in order to get those claimants to vote in favor of a plan that forces a low-ball payment on the legitimate tort claimants. While debtors have to pay a bit for the "junk" claims' votes, they come out ahead in the end because by flooding the electorate with the junk claims, they can overwhelm the voting power of the legitimate claims and stick the legitimate claimants with a much lower payment than otherwise.  

The specter of spurious claims has always loomed in any sort of mass tort case; when claims are resolved en masse, the resolution is likely to be either over- or under-inclusive (or both), meaning that it will either always cover either some non-meritorious claims or fail to compensate some meritorious claims. None of that changes with mass torts moving over to the bankruptcy arena. Instead, the typical bankruptcy treatment of mass torts is to estimate the aggregate mass tort liability for plan confirmation purposes and then to fund a trust to which all of the mass tort claims are channeled. The issue of claim allowance is punted in the bankruptcy, with allowance being decided as a matter of the trust's distribution procedures. It's not a perfect system: some claims that will ultimately be disallowed are permitted to vote on the plan (as claims are presumed allowed until they are disallowed), but everyone understands that the perfect cannot be the enemy of the good and that the bankruptcy court cannot sort through the thousands of individual claims (and indeed it is legally prohibited from doing so for personal injury and wrongful death claims). Instead, it's just easier to handle claim allowance administratively through the trust structure.

What is new in bankruptcy, however, is how debtors have begun to weaponize spurious claims for their benefit. In bankruptcy, unlike in class actions or MDLs, claimants have a vote. The debtor is typically the plan proponent, so it is eager to get enough votes in favor of its plan to push it through and force it on other creditors (who lack an opt-out right, unlike with a class action settlement). And that's exactly what we've seen happen.

(1) Boy Scouts' Attempt to Stuff the Ballot Box with No-Look Payments to Time-Barred Claims

In Boy Scouts of America, there were numerous sex abuse claims. Some were time-barred, while others were not, often based on the differences in statutes of limitations among states. Rather than moving to disallow all of the time-barred claims, BSA proposed a plan that had a no-look quick pay option paying around $3,000 per claim. That would have paid around $1,000/claim to the attorneys with time-barred "inventory," even though none of these claims should have received a penny in a bankruptcy distribution. (To be clear, I am not suggesting that there was not abuse, only that the statute of limitations interposed.) That was enough to get a lot of attorneys with substantial time-barred inventory to recommend that their clients support the plan, even though the plan was overall a low-ball proposal. The BSA proposal got derailed for reasons not germane here, but it created a template for debtors to co-opt friendly plaintiffs' firms with payments for unenforceable claims. Basically, the debtors were buying the votes for "junk" claims in order to confirm a plan under which they would pay less in aggregate.

To be clear: this isn't the usual situation of a debtor obtaining votes by offering to pay more on allowed claims. That's how bankruptcy is supposed to work: sweeten the pot enough to get creditor consent. The phenomenon I'm describing is different. The ballot box stuffing problem is one in which the debtor offers to pay an attorney something in exchange for the attorney filing a client's claim that will be voted for the plan when the attorney would not otherwise have even thought of filing a claim in the bankruptcy. Described that way, it strikes me as within the ambit of 18 U.S.C. § 152(6). 

(2) J&J's Attempt to Stuff the Ballot Box with Claims Based on Cancers Not Linked to Talc in LTL 2.0

The ballot box stuffing strategy didn't exactly work in Boy Scouts (although the final plan does something not so dissimilar on account of it not always being so clear what claims are in fact time-barred), but the case inspired Johnson & Johnson's strategy in LTL 2.0.

In LTL 1.0, there were approximately 35,000 ovarian cancer claims (or more specifically epithelial ovarian cancer, fallopian tube cancer, and primary peritoneal cancer) and a few hundred mesothelioma claims. Those numbers are consistent with the number of claims in the bankruptcy of Imerys, J&J's talc supplier, and in the long-running talc MDL. Yet When LTL 2.0 was filed (less than 24 hours after LTL 1.0 was dismissed), J&J claimed to have a plan support agreement backed attorneys representing over 60,000 current claimants. Most of those supposed 60,000 current claimants whose attorneys signed onto the plan support agreement had never filed claims in LTL 1.0, Imerys, or the talc MDL. Somehow, those tens of thousands of claims about which no one ever had heard of before emerged magically in time for LTL 2.0.

Moreover, it seems that many of these newfound talc claimants were not claiming to have ovarian cancer or mesothelioma—the only two conditions for which there is a connection to talc that is currently supported by medical evidence—and judgments. Instead, they claimed various other gynecological cancers (cervical, vaginal, uterine, endometrial) or even non-gynecological cancers, none of which have ever been connected to talc previously. 

J&J has itself considered these claims worthless. In LTL 2.0, J&J testified that it has never paid a judgment or even a settlement on any non-ovarian gynecological cancer to date. Yet J&J had no compunctions about entering into a plan support agreement based on these claims that it considers "non-compensable."  

J&J's gambit in LTL 2.0 was to flood the bankruptcy electorate with non-compensable "junk" claims who would vote in favor of a plan that would provide for a low-ball distribution to talc claimants. In other words, J&J was buying the votes of "junk" claimants in order to force a rotten deal on legitimate talc victims, who would have held out for a higher settlement.

J&J was frustrated in its LTL 2.0 gambit because of the Third Circuit's ruling in LTL 1.0; Bankruptcy Judge Kaplan simply didn't have the room to maneuver around the Third Circuit ruling, as much as he might have wanted otherwise.

(3) J&J's Pending Attempt to Stuff the Ballot Box with "Junk" Claims in LTL 3.0 and Short-Circuit Judicial Scrutiny of Votes with a Prepack

Now we're hearing rumbles of an LTL 3.0, with a "Texas Three-Step," as LTL has redomesticated from North Carolina to Texas and changed its name to LLT Management LLC. It appears that J&J is going to try the same maneuver that failed in Trenton in a Houston court that is going to be eager to show that it is still a premier filing destination. And it looks as if LTL 3.0 is going to be run as a pre-packaged plan, with solicitations expected soon.

An LTL 3.0 that is premised on plan support by junk claims is going to tee up a fight about whether it's permissible for junk claims to get to vote on a plan that would pay them something. These are claims to which the debtor in possession should, by all rights, as an estate fiduciary object. But there's zero chance LTL will object because it needs these votes to push through a low-dollar plan. We'll have to see how this plays out, but the issue of claim allowance really needs to be decided before ballots are distributed, otherwise the court will have effectively determined that the junk claims are permitted to contaminate the bankruptcy electorate. And that's one reason why LTL is supposedly proceeding with a pre-packaged plan, so it can show up in court on day one and say "here are the votes, let's go straight to a confirmation hearing" and try to side-step judicial consideration of whether it stuffed the ballot box with the votes of ineligible voters holding non-compensable claims. It's not clear to me if this gets fought out on allowance, on estimation, on classification, or possibly on good faith grounds (or maybe something else), but I'd expect this issue to be front and center in an LTL 3.0 case. 

I don't know how all of this will play out, but if LTL is able to buy an electoral majority by paying a smidgen on junk claims, you can bet that it is going to be a strategy that gets copied right and left in mass tort cases. And if that happens, it will not be a good thing for the bankruptcy system.