Book Review: "Unjust Debts: How Our Bankruptcy System Makes America More Unequal" by Melissa B. Jacoby

This article is forthcoming in the Journal of Economic Literature as 'Book review by Anat R. Admati (Stanford University) on "Unjust Debts: How Our Bankruptcy System Makes America More Unequal" by Melissa B. Jacoby'. 

My local utility, Pacific Gas and Electric (PG&E), filed for Chapter 11 bankruptcy in early 2019 to preempt lawsuits related to multiple wildfires involving its aged equipment. Shortly after it emerged from bankruptcy in July 2020, a 2017 fire victim who had previously sued PG&E for damages and became an “unsecured creditor” in the bankruptcy told me about the opaque court process and the outcomes it produced. I was flabbergasted. Tens of thousands of victims seeking to recover from the devastation of the fires ended up with claims against a trust that owned 25 percent of PG&E shares, inefficiently bearing non-diversifiable risks. Other creditors, including insurance companies, and all lawyers, were paid in cash. The hedge funds that controlled PG&E through bankruptcy and played key roles in the process dumped their shares quickly and moved on. The process and outcome seemed disturbingly flawed[1].

“Unjust debt” refers to injustices produced by US bankruptcy law and to Jacoby’s suggestion that bankruptcy should return to its original “just debt” intent to apply just to contractual (debt) promises. Prevailing narratives hold that bankruptcy can “reduce suffering and promote innovation” (p. 4), but instead its application is uneven and often problematic. Powerful parties transformed bankruptcy into “a legal Swiss army knife” that undermines civil justice and can rob people of their legal rights without consent even when debtors’ obligations are due to bad behavior.

The first two chapters describe personal bankruptcy, explaining how Chapter 7, which provides immediate debt relief (with key exceptions such as student debt and fines), and Chapter 13, where relief is conditional on successful completion of a court-supervised repayment plan, work. An individual in bankruptcy has little control over the process, or privacy. About two thirds of Chapter 13 filers—disproportionately Black—never receive any relief. A 2005 law made personal bankruptcy less debtor friendly, causing delays in filing that further benefit lenders[2]. Differential outcomes “pile on” existing inequality[3].

The remaining chapters, drawing stark and thought-provoking contrasts, focus on what Jacoby refers to as “fake people,” also known as “legal persons,” entities like corporations, nonprofits, and municipalities that are separate from all “real people” (humans) and created entirely by law. “The system perceives lawyers and their clients’ financial problems in profoundly different ways, depending on whether their clients are real or fake people” (p. 64). Unlike humans, “enterprises that can persuade a majority of their creditors and a court to support their Chapter 11 plans can cancel almost everything, even debts arising from willful or malicious injury or fraud” (p. 67).

Chapter 11 bankruptcy allows managers of bankrupt corporations to continue controlling information and decisions, does not require government-appointed trustees, and provides final relief from obligations, sometimes also releasing third parties not in bankruptcy from liability, upon the approval of a plan rather than after debtors fulfill promises they made in the plan. Those involved in the process, including judges, have no duty or true incentives to promote societal objectives like deterring corporate misconduct. Does it always make sense to allow companies that persistently engage in pollution, wage theft, reckless endangerment, or fraud to get a fresh start (and possibly thrive later) and never pay fully for the harm they caused?

The book discusses (in chapter 4) the history of municipal bankruptcies and key examples, particularly Detroit. Cities in bankruptcy may be able to reduce prior obligations to victims of civil rights violations, such as police brutality, where remedies may not be only monetary.

Similar issues arose in the bankruptcy of gunmaker Remmington in 2020, discussed in chapter 5 (“My Money, My Rules”). Families of Sandy Hook school shooting suing Remmington wanted information about its marketing of deadly weapons to prevent future harm. This chapter explains the history of Chapter 11 bankruptcy and how it enables corporations to insulate themselves from obligations. One approach, used by Remmington in 2020, is proposing a quick and “essential” sale of the company that requires certain liabilities to be cancelled.

Chapters 5 and 6 cover more examples of the use of bankruptcy for noncontractual liabilities, starting with asbestos in the 1980s and including Bikram Yoga, Weinstein Company, and Purdue Pharma. In the Purdue case, after this book went to print the Supreme Court blocked the bankruptcy plan that provided permanent releases from all litigation to Sackler family owners, some bearing significant responsibility for the massive opioid crisis but considered third parties in the corporate bankruptcy of Purdue.

Explaining accessibly the cynical use of bankruptcy as “litigation tool” to evade accountability and deprive people of legal rights (as in the PG&E case, not discussed in the book) is the most significant contribution of this important book. A common trick illustrated in the case of Boy Scouts of America, which filed for bankruptcy to deal with a pervasive sexual harassment scandal, is to include as many victims as possible in a bankruptcy “class,” each getting equal voting right. Victims with strong cases that would have succeeded in civil courts might be outvoted by others who would have been unable to get any compensation elsewhere. A broader problem (for all laws), seen in Purdue’s case, is the ability to remove money out of reach of legal jurisdictions.

Basic corporate finance textbooks calculate the tax “shield” corporations gain by borrowing. They rarely ask why tax laws reward excessive use of debt funding by corporations that makes bankruptcies more likely, and the discussion entirely ignores the use of corporate bankruptcy as a shield from non-debt liabilities. Law schools teach future lawyers how to use all tools and shape laws to benefit corporate clients.

Economists seem remarkably blind to the fact that firms are separate legal (“fake”) persons and the significant impact this separateness can have on economic outcomes. In reviewing Steven Shavel’s Foundations of Economic Analysis of Law, Posner (2006) lamented that “the ‘law’ that Shavell analyzes is an abstract or stylized—a simplified—version of actual law; it is law minus detail and texture, law trimmed to fit the economic model.” Unjust Debt explains the detail, texture, and political economy of US bankruptcy law in a highly readable form and illustrates how they matter. It also shows that the power to shape laws and enforcement, including through deceptive narratives, matters greatly too[4].

This book offers new research directions for economists related to bankruptcy and much beyond. Studying the detail, texture, implementation, and political economy of laws as they apply to real people and to “fake” people, also across jurisdictions, is important. Such explorations can help address distortions in the system and improve outcomes.

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NOTES
[1] Blunt (2022) describes PG&E-related events through 2021. Among other things, PG&E was convicted by a jury in 2016 of five counts of federal crimes related to 2010 explosions of its poorly maintained gas pipes, and it pleaded guilty to 84 manslaughter charges in 2020, both with minimal consequences for PG&E as a corporation and with no PG&E employees or executives implicated.

[2] White (2007) discusses the 2005 law and argues that such policy change should be accompanied by ensuring that lenders who supply too much credit or charge excessively high interest rates and fees are constrained by other rules aimed to protect individuals and small businesses from predatory loans. Such rules and their enforcement routinely face political challenges.

[3] On the root causes of racial inequality that determine individuals’ initial conditions and thus their likelihood of bankruptcy, see Rothstein (2017) and Story and Reed (2024). Mitchell (2022) describes the related history of the student debt crisis. In a case involving a corporate bankruptcy, for-profit college ITT Technical Institute (hereafter, ITT) filed for Chapter 11 bankruptcy in 2016. Beyond not getting the promised education, ITT students were saddled with heavy student loans. Because ITT and some lenders engaged in massive fraud, students ultimately received some relief, first from predatory private loans in 2020 (State of California Department of Justice Office of the Attorney General 2020) and finally in late 2023 from remaining government loans (Office of Communications Outreach 2023).

[4] For more on the issues and other examples, see Admati (2017, 2021), Admati and Hellwig (2024), and Pistor (2019).

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REFERENCES
1. Admati, Anat R. 2017. “A Skeptical View of Financialized Corporate Governance.” Journal of Economic Perspectives 31 (3): 131–50.
2. Admati, Anat R. 2021. “Capitalism, Laws, and the Need for Trustworthy Institutions.” Oxford Review of Economic Policy37 (4): 678–89.
3. Admati, Anat R., and Martin Hellwig. 2024. The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It. Princeton University Press.
4. Blunt, Katherine. 2022. California Burning: The Fall of Pacific Gas and Electric–and What It Means for America's Power Grid. Penguin Random House.
5. Mitchell, Josh. 2022. The Debt Trap: How Student Loans Became a National Catastrophe. Simon and Schuster.
6. Pistor, Katharina. 2019. The Code of Capital: How the Law Creates Wealth and Inequality. Princeton University Press.
7. Rothstein, Richard. 2017. The Color of Law: A Forgotten History of How Our Government Segregated America. Liveright.
8. State of California Department of Justice Office of the Attorney General. 2020. September 15. “Attorney General Becerra Announces Multistate $330 Million Settlement with ITT Tech Lender for Defrauding Students.” 
9. Story, Louis, and Ebony Reed. 2024. Fifteen Cents on the Dollar: How Americans Made the Black-White Wealth Gap. Harper. US Department of Education, October 31. 
10. Office of Communications Outreach. 2023. “Education Department Approves $3.9 Billion Group Discharge for 208,000 Borrowers Who Attended ITT Technical Institute.” 
11. White, Michelle J. 2007. “Bankruptcy Reform and Credit Cards.” Journal of Economic Perspectives 21 (4): 175–200.

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By Anat R. Admati (Stanford University)

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