Cliff White headed the Justice Department’s bankruptcy “watchdog” unit, the US Trustee Program, for 17 years prior to his retirement in 2022.
Millions of Americans and the national economy are affected each year by the bankruptcy system. Debtors receive a “fresh start” and creditors have a relatively efficient method for repayment. The system isn’t perfect, but it works. Unfortunately, there is a growing abuse that threatens its integrity and efficiency.
In large bankruptcy cases, there are often thousands of stakeholders, ranging from small business creditors to huge financial institutions. Each is entitled to a fair shake and an unbiased adjudication of their claim. That right is threatened when bankruptcy insiders and big corporate debtors manipulate the rules and get to freely choose the venue where the case is filed and dealt with.
Smaller creditors and employees especially are disenfranchised when their claims are heard by a court far way, selected by the debtor company whose lawyers are expert at picking debtor-friendly judges.
An ongoing judicial scandal is shining a spotlight on the problem. Last October, the Chief Judge of the US of the Court of Appeals for the Fifth Circuit found “probable cause” that a bankruptcy judge in Houston — who presided over a hugely disproportionate number of the most important corporate bankruptcies in the entire country — committed “ misconduct ” by failing to disclose or recuse himself from cases in which his live-in romantic interest or her law firm represented clients. The scope of the problem is breathtaking, but the Court of Appeals stopped its ethics investigation when the accused judge resigned.
The current poster child for venue abuse is the Sorrento Therapeutics case.
Under 28 U.S.C. section 1408, a company can file bankruptcy in any district where it has its domicile, principal place of business, or principal assets for 180 days prior to bankruptcy. But this seemingly straightforward provision has been twisted like a pretzel. Many large corporations have scores of subsidiaries. Some are active businesses, but some sit dormant as mere shell entities doing no business whatsoever. The latest gambit involves taking one of those dormant subsidiaries and giving it a business address in a favoured jurisdiction on the eve of bankruptcy. Voila, venue is manufactured out of whole cloth.
The US Justice Department characterised Sorrento’s conduct this way, with Alphaville’s emphasis in bold below:
This is a case of forum shopping and venue manipulation taken to a new and unprecedented extreme. It is undisputed that the only possible connection between the Debtors and the Southern District of Texas before the filing of these cases were two economically insignificant transactions . . . . the rental of a small UPS Mailbox that [affiliate] Scintilla admits was not used as its mailing address and a cash deposit into a New York chartered bank that maintained a non-depository, representative office in Houston — and it is based on these transactions alone that the Debtors contend venue is proper.
The scheme worked like this: Three days before the filing, Sorrento transferred $60,000 to a dormant affiliate which was otherwise without any assets. Then, a mere 10 hours before the bankruptcy filing, a company lawyer changed the address of the shell corporation to a post office box in Houston. Never mind that both the affiliate and Sorrento are incorporated in Delaware and registered in California.
Why all these shenanigans? Because a company can file bankruptcy in whatever district any one of its dormant shell company affiliates first files bankruptcy. And the affiliate can file anywhere where it has its domicile, principal place of business, or principal assets. In a case like Sorrento, not having any assets or business at all arguably relieves you of the 180-day requirement, too. Since the only asset of the Sorrento affiliate was a bank account created days before filing, that was enough.
Why did Sorrento want to file in Houston? There are approximately 350 highly capable bankruptcy judges sitting in 94 judicial districts across the country. Yet, a small number of judges hear most of the complex cases that have national economic impact . The two bankruptcy judges in Houston — who preside over all the mega-sized cases filed in their district — are popular with the handful of big law firms who file the most prominent business reorganisation cases in the country. Rightly or wrongly, this creates a clear appearance of an insider’s game and a perception of an uneven playing field.
When both a creditor and the US Justice Department cried foul, the debtor essentially said that is how the system works. The debtor explained its conduct very clearly:
[The affiliate Scintilla] had no other business, operations, assets, or activities until the bank account was opened. It was totally dormant and thus it arguably did not have a principal place of business anywhere until the account was opened. . . . So the principal place of business was located in Houston “for a longer portion” of the 180-day period than any other district, which satisfies section 1408.
In deciding two separate challenges to Sorrento’s venue, the presiding bankruptcy judge denied the motions on timeliness grounds and also seemed to agree that the law allows the debtor’s machinations anyway.
Sadly, the Sorrento case isn’t unique. Just this month, the well-known Vancouver-based fitness company BowFlex filed for bankruptcy in a judicial district that is almost 3,000 miles away from its headquarters.
The notorious Purdue Pharma case was also selectively filed in a one-judge venue in an apparent attempt to benefit from the presiding judge’s previous rulings in other cases that would allow the Sackler family, which owned the debtor, to shelter their family fortune from opioid victim lawsuits.
As Georgetown Law’s Adam Levitin testified to Congress in 2021:
When Purdue Pharma filed for bankruptcy, it did not file in Connecticut, where it is headquartered, or in Rhode Island or North Carolina, where it has substantial manufacturing operations. Nor did it file in Delaware, where most of its entities are incorporated. Instead, it filed in the Southern District of New York, claiming that venue by virtue of the fact that the non-equity general partner in some of its entities partnerships was a New York corporation.
Forum shopping has long been a problem in bankruptcy, but Purdue did not merely forum shop into the district of its choice. It also hand-picked its judge: Robert D. Drain, the only bankruptcy judge sitting in the White Plains Division of the Bankruptcy Court for the Southern District of New York. Even before Purdue filed, it knew its case would be assigned to Judge Drain. The pleadings Purdue filed immediately after it filed its petition contain a blank for the case number, but already have Judge Drain’s initials in the caption box.
How did Purdue know that it was getting Judge Drain? Because the court’s implementation of the Case Management/Electronic Case Filing system automatically assigned to Judge Drain any case where the debtor indicated that the White Plains division was appropriate. Under the local bankruptcy rules of the Southern District of New York, cases are supposed to be assigned to the White Plains division if the debtor’s address — excluding post office boxes — on the bankruptcy petition is in Westchester or Rockland Counties. Other cases are randomly assigned among the seven judges sitting in Manhattan.
The address on Purdue’s petition was in Stamford, Connecticut. So why did Purdue claim that the White Plains division was appropriate? Because 198 days before filing for bankruptcy (just outside the 180 day requirement under the bankruptcy venue statute), Purdue changed the service of process address for its non-equity general partner to an address in Westchester County, New York. Purdue has never conducted any business at that address, making it little more than a post office box.
In scores of cases every year, sophisticated law firms “forum shop” their cases to a small number of districts where they think their clients will receive more favourable treatment. That’s not the way the system ought to work.
Congress has considered many fixes over the years. Regardless of the precise solution, venue should be limited to judicial districts with bona fide connections to the debtor. Manufacturing venue by opening up a post office box on the eve of bankruptcy simply shouldn’t be allowed.
There is a crisis of confidence in the bankruptcy system caused by the twin problems of the scandal in Houston and blatant abuse by debtors such as Sorrento which choose their bankruptcy court and judge. The legitimacy of all judicial systems relies on the fact and appearance of fairness and transparency. Cynical manipulation of venue rules — and parties choosing their own courts and even judges — undermines the very foundation of that legitimacy.
There is hope. In the past, about 200 bankruptcy judges, law professors, and professional organisations — including the National Association of Attorneys General (NAAG) — have endorsed bipartisan legislation to fix this.
In endorsing venue reform legislation in 2021 , NAAG noted that there is seldom a practical ability to appeal bankruptcy court decisions in usually fast-paced bankruptcy proceedings:
The ability of debtors to limit their filings to a few chosen venues and/or judges is even more significant than in ordinary litigation in that bankruptcy cases have a national effect, yet the binding precedent in the large cases may only issue from a very few courts so there is no ability to assess differing views on the issues or to have those debates rise to higher levels on appeal
. . . As such, the forum shopping process can result in debtors being able to pick not only the initial, but also, in many cases, the final arbiter of their fate.
More recently, 5th Circuit Court of Appeals judge James Ho noted that the “ serious concerns that have been voiced about ” venue shopping in bankruptcy. It’s time for Congress to act now and pass bankruptcy venue reform.