Bankruptcy protects fake people, brutalizes real ones

Debts that can’t be paid, won’t be paid.

A robotic hand wielding a gavel; the gavel is smashing the face of a terrified person.
Victor Bezrukov, CC BY 2.0 (modified) and Vitalik Radko/Deposit Photos, free license (modified)

Debts that can’t be paid, won’t be paid.” There, in eight simple words, we have Michael Hudson’s key insight into the role debt and debt cancellation plays in the rise and fall of human civilizations.

Debts are inescapable.

In order to provide a society with its necessities — food, shelter, energy — producers need the inputs (seed, fertilizer, materials, tools) before they have the means to buy them.

In order to produce, producers must borrow.

The earliest money we know of is debt: ancient Babylonian ledgers recording the debts owed by farmers, which they promised to repay after the harvest.

But what happens when there is no harvest? Foul weather, blight, pests, and other misfortune can wipe out the crops, and leave farmers unable to pay their debts. Farm long enough, and you will eventually fall prey to one of these disasters — thus, anyone who farms long enough will eventually become a debtor.

Societies inevitably fracture into two classes: creditors and debtors. If debtors have no way to escape their debts, then creditors will be able to command an ever larger segment of the workforce and its productive capacity.

The needs of the many — food, shelter, energy — will be sidelined by the whims of the few: gaudy baubles, ostentatious palaces, feasts and ornamental gardens.

That is why every known successful society has had some way for debtors to escape their creditors. In ancient times, we had jubilee, a festival where all debts were erased. Jubilees were announced by monarchs based on necessity, or were enacted to celebrate the ascension of a new ruler to the throne.

Creditors hated jubilee, just as modern creditors deplore its descendant, bankruptcy. Every state has had to balance the demands of creditors against the plight of debtors. It’s a hard balance to strike, because creditors are, by definition, wealthy and powerful, and they use that power to influence policy.

Sometimes, creditors get the upper hand and tip policy in their favor, insisting that even debts that can’t be paid must be paid. When this happens, the result isn’t repayment, it’s collapse.

From the fall of Rome to the collapse of Weimar Germany and the rise of fascism, the decision to protect creditors’ claims to unpayable debts leads to catastrophe, not repayment. After all: debts that can’t be paid, won’t be paid.

We don’t have jubilees anymore (not even close).

Biden’s student debt cancellation shows how hard it is to overcome the bureaucratic fetish for means-testing, despite the fact that these impossible-to-administer complexities always result in denying relief to the intended targets of these programs.

The closest we come to jubilee today is bankruptcy. But not all bankruptcy is created equal. In a new draft paper, “Fake and Real People in Bankruptcy” (forthcoming in Emory Bankruptcy Development Journal) UNC Law professor Melissa B. Jacoby makes a blazing case that bankruptcy exists to punish human beings and to insulate fake people (corporations) from accountability for a multitude of sins — even mass murder.

Jacoby starts by recounting the facts in Tamecki v. Frank, in which Ronald Tamecki was forced to sell off the home he built with his own hands because the trustee overseeing his bankruptcy — over $35,000 in credit-card debt —suspected that Tamecki might be engaged in a ruse to deny his soon-to-be-ex-wife a divorce settlement.

When a human being stands before a bankruptcy judge, they are required to prove that they are an “honest but unfortunate debtor,” and thus deserving of debt cancellation.

But this is a far cry from the treatment that fake people — that is, the immortal, transhuman colony-organisms that we sometimes call “limited liability companies” — receive when they can’t pay their debts.

When companies seek bankruptcy protection under Chapter 7 or Chapter 11, they enter into a process that seeks to give them a “fresh start,” despite the fact that we have no shortage of fake people.

As Jacoby writes,

There is an unlimited supply of [fake people], waiting to be born, via submission of a few forms and fees to the government. In Delaware alone, day in and day out, hundreds of additional LLCs are created.

Fake people don’t have to prove that they are either “honest” or “unfortunate.” Indeed, fake people can use bankruptcy to wipe away liabilities they incurred for being dishonest.

One recent, spectacular example of bankruptcy being used to escape liability for corporate crimes is Johnson & Johnson, who used bankruptcy to duck responsibility for years of knowingly advising women to dust their vulvas with asbestos-laced talcum powder. This resulted in waves of deaths and grotesque maimings.

Likewise, there’s the bankruptcy manipulations of the Sackler family and their Purdue Pharma, the instigators (through their vastly profitable drug Oxycontin) of the opioid epidemic. Purdue and its owners played the bankruptcy system and walked away with billions in blood-money, while their victims made do with pennies on the dollar.

Apologists for this system will say that fake people shouldn’t be punished in bankruptcy because they can’t commit bad acts on their own. When a fake person murders a real person by poisoning their vulva or tricking them into becoming an opioid addict, the blame lies with the executive who directed this conduct, not the company that employed that executive.

But — Jacoby points out — there are plenty of offenses that fake people commit that we hold them to account for, even though the ultimate blame for those offenses lies with a real person. When a company engages in criminal conduct, or violates the US Constitution, or breaks employment law, or cheats on its taxes, we hold the company to account, separate from the people who directed the company.

What’s more, the favorable treatment for fake people under bankruptcy law renders all those other laws toothless. What’s the point of fining a company for employment discrimination or tax cheating if it can slip free of the fine by declaring itself bankrupt?

A human seeking bankruptcy protection must prove that they are “honest but unfortunate.” But a fake person seeking the same protection must only prove that holding them accountable would create “undesirable uncertainty” for its investors, making it harder for that company to reorganize and carry on doing the business (even if that business included illegal acts, including those that resulted in mass deaths).

As Jacoby writes, “There is nothing inherently preferable about reorganization of a fake person over its liquidation.”

Corporate bankruptcy law does have some safeguards that are supposed to prevent impunity for genuinely egregious acts. However, canny corporate bankruptcy lawyers have developed “sophisticated approaches” (AKA, “scams”) that fend these off.

The wildest of these scams is to run your business so chaotically, to squander so much of its money, sell off so many of its assets (through “going concern” sales) and bring it so close to liquidation, that it can’t afford to go through the complex procedures needed to demonstrate that it is acting in good faith.

When that happens, all bets are off. Corporate lawyers use their clients’ frail conditions to demand that the bankruptcy code be bent beyond recognition by judges. As bankruptcy judge Alan Jaroslovsky said (while presiding over In re Humboldt Creamery, LLC):

[A judge] might as well leave his or her signature stamp with the debtor’s counsel or go on vacation or shift attention to consumer cases where the law may still mean something.

If you are a real human being and find yourself in bankruptcy proceedings, you will likely find yourself required to pay for a privately administered “financial education packages.” Unsurprisingly, given that all the people who buy these are under a court order to do so, the companies that run these programs are provide extremely poor value for money.

You will pay a large sum — perhaps even going into further debt to do so — to receive a very cursory “financial education” indeed. The legal requirement to take a course like this does not turn on whether you lacked financial literacy, or whether financial illiteracy can be linked to your indebtedness.

(And, of course, “financial education” is basically useless.)

Compare that with bankruptcy for fake people.

A fake person who lands in bankruptcy due to bad financial choices doesn’t have to sign up the company — or even just its CFO — for financial education courses. And even moreso: when a company faces bankruptcy due to its bad ethical choices (say, murdering thousands of its customers due to negligence), no one makes the CEO or the company’s managers enroll in “ethical education” programs.

For every way in which bankruptcy is rigged against real people, it is rigged for fake people. When you face bankruptcy, you can’t spin off a separate company that just holds your liabilities, as J&J did, when it created “LTL Management” (“LTL” stands for “Legacy Talc Litigation”) and insisted that its debts all landed in the new, bankrupt company, while its assets remained safely on Johnson & Johnson’s balance-sheet.

Ronald Tamecki lost the house he built with his own hands because his court-appointed trustee accused him of bad faith. Big businesses entering bankruptcy rarely have to contend with these trustees. Chapter 11 bankruptcies do have other measures that are supposed to ensure the integrity of a bankruptcy, but these are easily evaded: “If chapter 11 debtors have no money to pay for the integrity-promoting parts of the process, those elements get dropped in favor of salvaging value.”

Maybe you’re thinking that you should become a fake person. Many freelancers create LLCs as “pass-through” companies that let them write off the business expenses they incur as a result of being self-employed.

Perhaps if you had an LLC, you could use it as a shield against your creditors, capitalizing on the special privileges that the largest fake people have carved out of the US bankruptcy system?

Sorry, nope. “Small” fake people are treated roughly the same as real people: “From 2005 and 2020, the Bankruptcy Code reflected distrust toward the all-too-human smallest businesses that tried to reorganize in chapter 11, imposing hurdles that probably decreased the odds of reorganization.”

Letting fake people off the hook in bankruptcy also lets the worst real people escape culpability. When large companies enter into bankruptcy proceedings, they disappear behind an opaque veil, as judges rubber-stamp requests to seal documents (or make access to court documents conditional on non-disclosure obligations).

To illustrate this, Jacoby analyzes the bankruptcy of The Weinstein Company (TWC), the large, powerful firm that Harvey Weinstein wielded against the women whom he sexually assaulted.

Despite its size and power, TWC was chaotically managed (“TWC was unable to even locate H. Weinstein’s personnel file”). As the CEO of Lantern Capital said, on acquiring TWC, “The Weinstein Co. was one of the worst-managed companies I’ve ever seen. They had no financial controls, no legal controls. … It was an ‘inmates ran the asylum’ type of scenario.”

TWC’s chaos let it continue to shamble on even as Harvey Weinstein committed his crimes — and it let the officers of the company escape liability for their failure to oversee the company as Weinstein used it to harm his victims. The Weinstein Company’s board was stuffed with billionaires, all of whom were given a full legal release by the bankruptcy court, ensuring that Weinstein’s victims couldn’t hold them to account.

And still: debts that can’t be paid, won’t be paid.

For 40 years, wages have stagnated, and consumer spending has relied on debt (credit cards, reverse-mortgages, payday loans ) to keep the economy afloat.

These debts can’t be paid, so they won’t be paid. Long before most of us land in bankruptcy court, we will encounter digital arm-breakers: cars with ignition-locks that repossess themselves if you miss a payment; “smart meters” that turn off your power if you skip a bill; mobile phones that delete your favorite apps if you can’t afford a monthly payment.

The computer-haunted Internet of Things brings the mafia loan-shark into a bloodless modern form. The tough guy who breaks your arm because you can’t make your payment to the neighborhood bookie knows that you’ll never make good on all your debt (you can’t —like student debt, it’s designed to balloon every time you miss a payment), but he wants to encourage you to take every conceivable measure before he lets you off the hook.

Ordinarily, you might not secretly remortgage your house, or sell your wedding ring, or cash in your kid’s college savings. But if the consequences for failing to do so are sufficiently ghastly, you might be convinced, and the arm-breaker’s boss thus enriched.

The goal is to ensure that you pay as much as can be conceivably extracted before you reach a save haven (bankruptcy court, the grave, or the prison cell you’re condemned to for stealing catalytic converters to make your monthly payment).

Keep that in mind as you ponder the difference between the treatment of real people and fake people in our bankruptcy system: not only does the real person get far worse treatment, but that real person arrives in court having been abused in every available way by fake people.

And should those fake people land in court — say, because they can’t pay the damages they owe for so brutally abusing real people — they will be greeted with a red carpet and the gentlest of kid gloves.