Originally posted on SSRN.

Abstract

Logic and equity would seem to demand that when administrative agencies are creditors to a bankrupt debtor, they should have the same status as other creditors. But a creditor agency retains its regulatory authority over the debtor, permitting it to continue with agency business such as conducting enforcement proceedings and awarding licenses. As a result, though bankruptcy law and policy both strongly support equal distribution of the estate, administrative agencies have been able to circumvent these goals through the use of “shapeshifting” behaviors. This Article evaluates two dangerous shapeshifting scenarios:

(1) where the agency avoids the limitations of creditor status by piercing the corporate veil and bringing its claims against the debtor's individual stakeholders; and

(2) where the agency operates in two distinct roles within a single proceeding, such as its dual identity as creditor and regulator under the Second Thursday doctrine. Through these behaviors, agencies take advantage of deferential judicial review to prioritize the debts they are owed over other creditors.

This Article concludes that, when administrative agencies maintain a self-interested position in bankruptcy litigation, the balance must shift away from traditional judicial deference to offer stronger protections to other creditors and to maintain the separation of powers. To begin the work of remedying shapeshifting behavior, this Article proposes two modest solutions. First, existing Bankruptcy Code provisions suggest that Congress may favor a statutory amendment that enhances the scrutiny of shapeshifting agencies. This could be accomplished through a statutory bar on creditor veil piercing or, at minimum, the imposition of a notice and hearing requirement. Second, shapeshifting behavior, once recognized, should be afforded only Skidmore deference.

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