Optimal Trust Design in Mass Tort Bankruptcy

Abstract:     
Many firms have filed for bankruptcy to manage liabilities stemming from mass tort claims, most notably asbestos producers. This paper develops a model of an optimal bankruptcy procedure that balances the need to provide liquidity to the present claimants already injured with the need to set aside funds for the uncertain number of future claimants who may develop injury or illness at a later date. We also consider the appropriate division of value and risk between tort claimants and pre-existing contractual creditors of the firm. Our model suggests several significant improvements to current practice. In particular, we find that future claimants should receive greater awards in expectation than present claimants, due to precautionary savings motives. Comparing claimants and creditors, we find that allocating a greater share of the firm's value to contractual creditors makes an earlier bankruptcy filing more likely, which may increase overall welfare. We also find that optimal risk-sharing implies that creditors should receive this value through an equity claim in the trust fund, with tort claimants receiving senior claims resembling debt.

Keywords: Bankruptcy, mass tort, future claimants, asbestos

JEL Classification: G32, G33, K00, K13

Accepted Paper Series