A New Dimension to Asbestos-Related Bankruptcies?

This preserved the understanding that the bargained-for relationship between policyholders and insurers regarding when an insurer's obligation to pay a claim matures would not be altered by a policyholder's bankruptcy. Third Circuit bankruptcy courts continue to follow Amatex. Except as discussed hereafter, asbestos-related plans of reorganization pending in Third Circuit bankruptcy courts provide that legal liability for asbestos related claims does not arise until the claim is allowed by the section 524(g) trust.

But the Seventh Circuit in the UNR case determined that confirmation of an asbestos debtor's plan of reorganization constituted a judgment of the debtor's liability for all present and future asbestos-related claims. UNR Indus., Inc. v. Continental Cas. Co., 942 F.2d 1101 (7th Cir. 1991), cert. denied, 503 U.S. 971 (1992). Ultimately the debtor's insurers were required to pay several hundred million dollars to reimburse it for its payments into the section 524(g) trust.

The Seventh Circuit reasoned that confirmation constituted a judgment. Because the underlying policies required the insurer to pay the amount of judgments or settlements covered under the policies, this judgment constituted a loss under applicable policies. Insurers were required to pay full amount of the loss up front, rather than when actual claims were allowed. Even though the UNR decision involves a number of unique facts, including, for example, that the insurers did not appear in the bankruptcy case, that the participation of a trade committee in plan negotiations led the court to conclude that the debtor's agreement with its asbestos-related claimants was not collusive, and that the debtor, not the asbestos trust, was the ultimate recipient of the insurance proceeds, none of these unique facts appear to limit UNR's application. In 1994, Congress enacted section 524(g) of the Bankruptcy Code. Section 524(g) requires that in connection with a plan of reorganization that seeks a section 524(g) channeling injunction, the court must determine that “the actual amounts, numbers, and timing of such future demands cannot be determined.” 11 U.S.C. ' 524(g)(2)(B)(ii)(II).

The Manville Trust

Asbestos trusts such as the Manville trust prove the wisdom of this subsection. Having been substantially incorrect on a number of estimates, it has steadily reduced claimant recovery. Now, in order to satisfy this subsection, a debtor must include in its plan a finding regarding its inability to determine the amount of future claims and must support this finding with testimony or other evidence at its confirmation hearing. If the debtor meets its burden and the requisite vote approving the plan is made, a section 524(g) trust to resolve debtor's asbestos liability will be formed. Proceeds from insurers will flow into the trust when liability under the policies is determined.

In 1998, Fuller-Austin filed a pre-packaged plan of reorganization, which sought to aggregate insurance payments. Specifically, it provided that confirmation constituted a judgment of liability in the estimated amount of asbestos-related claims. The debtor later amended the plan to remove any UNR provisions and to provide that confirmation did not alter the rights of insurers in ongoing coverage litigation. Judge Farnan confirmed the plan. In re Fuller-Austin Insulation, 1998 U.S. Dist. LEXIS 18340 (D. Del. Nov. 10, 1998).

A Landmark Ruling?

With a UNR result apparently avoided, the Fuller-Austin coverage litigation continued for several years. In February 2002, the Superior Court for the County of Los Angeles issued a ruling on summary judgment, which provided that the confirmation of Fuller-Austin's plan of reorganization constituted a judgment of liability for all future asbestos-related claims. Fuller-Austin Insulation Co. v. Fireman's Fund Ins. Co., et al., No. BC 116835 (Calif. Super., Los Angeles Co. (Chirlin, J.). This ruling did not even cite the Amatex case or section 524(g), both of which controlled the underlying bankruptcy case. The Fuller-Austin coverage litigation then proceeded to a jury trial on a number of issues, including the amount of future asbestos-related claims. The jury returned its verdict in favor of Fuller-Austin on May 2, 2003. The jury found that Fuller-Austin's asbestos-related liability to be nearly $1 billion, and if upheld on appeal, will require insurers to immediately pay approximately $200 million into the section 524(g) trust. The verdict is currently on appeal.

An asbestos-related debtor in the Third Circuit recently filed a plan that challenges Amatex. See In re Combustion Eng'g, Inc., Ch. 11 Case No. 03-10495 (JKF) (Bankr. D. Del.), at Docket Nos. 32 and 373. Combustion Engineering's January 19, 2003 pre-packaged plan of reorganization, provides that the number and amount of asbestos-related claims could not be determined, but did not address whether legal liability for such claims would arise at confirmation or at the time such claims are allowed by the section 524(g) trust. An April 1, 2003 plan amendment did. It provides that confirmation constitutes a judgment of liability for present and future asbestos-related claims. Subsequently, after strong insurer objection, the debtor removed this finding. See Docket No. 788, at '199.

Important Considerations

Fuller-Austin could create a race to section 524(g) trusts and encourage the filing of marginal claims. Some debtors have attempted to use Chapter 11 to challenge the validity of asbestos-related claims. Such a strategy is risky. Rather, the use of pre-packaged plans to shed asbestos-related liabilities, similar to Combustion Engineering's plan, has gained momentum. The ultimate success for an asbestos debtor is the preservation of its equity interests.

Common to either strategy is the assignment of insurance proceeds to the section 524(g) trust. Because typical insurance policies include anti-assignment provisions, such assignment is arguably unlawful. In addition, debtors will include in their plans proposed findings regarding insurance issues which may be pending in ongoing coverage litigation and which are more appropriated resolved in a declaration judgment action, rather than a confirmation hearing. For example, debtors may seek findings that the plan negotiations did not violate consent to settlement or duty to cooperate provisions of underlying policies. With Combustion Engineering, a debtor, buoyed by Fuller-Austin, it is seeking a UNR result.

Associated Risks

The risks associated with Fuller-Austin have created an enormous amount of collateral litigation in connection with asbestos-related bankruptcy cases. Some insurers have followed a litigation strategy to avoid a UNR result. Others have taken the ongoing litigation strategy one step further. In re JT Thorpe Co., Ch. 11 Case No. 02-41487-H5 (Bankr. S.D. Tex.). In In re JT Thorpe Co., the debtor, certain insurers, and the Official Committee of Asbestos Claimants arrived at a stipulation that governed the issue. The stipulation was entered by both the bankruptcy judge presiding over the bankruptcy case and the federal district court judge presiding over the insurance coverage litigation. Pursuant to the stipulation, the parties agreed that nothing in the debtor's Chapter 11 proceeding would preclude the insurers' rights to contest liability under the policies and the insurers reserved their rights to assert or contest that confirmation of the debtor's reorganization plan is not a covered loss under the policies, notwithstanding the UNR and Fuller-Austin cases.

The parties also agreed that no finding made in connection with the reorganization plan, disclosure statement, the section 524(g) trust or any other related action would have a res judicata or collateral estoppel effect on any claim, defense, right or cause of action already asserted by the parties or that may be asserted in the future in the coverage action. It is too early to determine whether the JT Thorpe stipulation will serve as a model for resolving complicated insurance issues in asbestos bankruptcy cases, including the UNR and Fuller Austin issues. However, it certainly is the most comprehensive effort to directly address the pitfalls created by UNR and Fuller Austin. Finally, insurers in one instance have taken a different, but no less creative, approach to preventing a UNR result. See In re The Muralo Co., Inc., Ch. 11 Case No. 03-26723 (Bankr. D.N.J.). In Muralo, certain insurers agreed to fund the debtor's successor liability litigation against its plaintiffs. As part of such funding agreement, the debtor and insurers agreed that the debtor would only file a plan with mutually acceptable claims allowance procedures and that did not require aggregated payments up front. The success of such an approach remains to be seen.

Conclusion

Future fallout from the Fuller-Austin decision and jury verdict is not clear. Since the case is under appeal, the full impact of Fuller-Austin remains uncertain. However, if Combustion Engineering and Muralo provide any guidance, this issue has significant momentum and is likely to be a flash point in future asbestos-related and mass tort bankruptcy cases.

Mark D. Taylor and Jennifer D. Larkin are partner and associate, respectively, in the Washington, DC offices of Arent Fox Kintner Plotkin & Kahn, PLLC. Mr. Taylor has extensive experience representing insurers, committees and defendants in connection with mass tort and asbestos-related bankruptcy issues.

A recent jury verdict in California threatens to break wide open the uneasy issue of aggregated insurance payments in asbestos litigation. Fuller-Austin Insulation Co. v. Fireman's Fund Ins. Co., et al., No. BC 116835 (Calif. Super. Los Angeles Co.). Its ramifications, however, reach far beyond insurance coverage litigation into every asbestos-related or mass tort bankruptcy.

Fuller-Austin

Handling insurance and asbestos-related claims in a bankruptcy case has always been controversial. In 1989, a Pennsylvania bankruptcy court applied the still accepted principle that bankruptcy courts lack authority to alter material terms of contractual relationships in the context of bankruptcy cases. In re Amatex, 97 B.R. 220 (Bankr. E.D. Pa. 1989), aff'd sub nom., Amatex Corp. v. Stonewall Ins. Co. , 102 B.R. 411 (E.D. Pa. 1989), aff'd, 908 F.2d 964 (3rd Cir. 1990. In ruling that Amatex could not use the Bankruptcy Code to alter material terms of contractual relationships, the court denied Amatex's request to require its insurers to make lump sum payouts to the debtor for distribution to all present and future asbestos-related claims.

This preserved the understanding that the bargained-for relationship between policyholders and insurers regarding when an insurer's obligation to pay a claim matures would not be altered by a policyholder's bankruptcy. Third Circuit bankruptcy courts continue to follow Amatex. Except as discussed hereafter, asbestos-related plans of reorganization pending in Third Circuit bankruptcy courts provide that legal liability for asbestos related claims does not arise until the claim is allowed by the section 524(g) trust.

But the Seventh Circuit in the UNR case determined that confirmation of an asbestos debtor's plan of reorganization constituted a judgment of the debtor's liability for all present and future asbestos-related claims. UNR Indus., Inc. v. Continental Cas. Co. , 942 F.2d 1101 (7th Cir. 1991), cert. denied, 503 U.S. 971 (1992). Ultimately the debtor's insurers were required to pay several hundred million dollars to reimburse it for its payments into the section 524(g) trust.

The Seventh Circuit reasoned that confirmation constituted a judgment. Because the underlying policies required the insurer to pay the amount of judgments or settlements covered under the policies, this judgment constituted a loss under applicable policies. Insurers were required to pay full amount of the loss up front, rather than when actual claims were allowed. Even though the UNR decision involves a number of unique facts, including, for example, that the insurers did not appear in the bankruptcy case, that the participation of a trade committee in plan negotiations led the court to conclude that the debtor's agreement with its asbestos-related claimants was not collusive, and that the debtor, not the asbestos trust, was the ultimate recipient of the insurance proceeds, none of these unique facts appear to limit UNR's application. In 1994, Congress enacted section 524(g) of the Bankruptcy Code. Section 524(g) requires that in connection with a plan of reorganization that seeks a section 524(g) channeling injunction, the court must determine that “the actual amounts, numbers, and timing of such future demands cannot be determined.” 11 U.S.C. ' 524(g)(2)(B)(ii)(II).

The Manville Trust

Asbestos trusts such as the Manville trust prove the wisdom of this subsection. Having been substantially incorrect on a number of estimates, it has steadily reduced claimant recovery. Now, in order to satisfy this subsection, a debtor must include in its plan a finding regarding its inability to determine the amount of future claims and must support this finding with testimony or other evidence at its confirmation hearing. If the debtor meets its burden and the requisite vote approving the plan is made, a section 524(g) trust to resolve debtor's asbestos liability will be formed. Proceeds from insurers will flow into the trust when liability under the policies is determined.

In 1998, Fuller-Austin filed a pre-packaged plan of reorganization, which sought to aggregate insurance payments. Specifically, it provided that confirmation constituted a judgment of liability in the estimated amount of asbestos-related claims. The debtor later amended the plan to remove any UNR provisions and to provide that confirmation did not alter the rights of insurers in ongoing coverage litigation. Judge Farnan confirmed the plan. In re Fuller-Austin Insulation, 1998 U.S. Dist. LEXIS 18340 (D. Del. Nov. 10, 1998).

A Landmark Ruling?

With a UNR result apparently avoided, the Fuller-Austin coverage litigation continued for several years. In February 2002, the Superior Court for the County of Los Angeles issued a ruling on summary judgment, which provided that the confirmation of Fuller-Austin's plan of reorganization constituted a judgment of liability for all future asbestos-related claims. Fuller-Austin Insulation Co. v. Fireman's Fund Ins. Co., et al., No. BC 116835 (Calif. Super., Los Angeles Co. (Chirlin, J.). This ruling did not even cite the Amatex case or section 524(g), both of which controlled the underlying bankruptcy case. The Fuller-Austin coverage litigation then proceeded to a jury trial on a number of issues, including the amount of future asbestos-related claims. The jury returned its verdict in favor of Fuller-Austin on May 2, 2003. The jury found that Fuller-Austin's asbestos-related liability to be nearly $1 billion, and if upheld on appeal, will require insurers to immediately pay approximately $200 million into the section 524(g) trust. The verdict is currently on appeal.

An asbestos-related debtor in the Third Circuit recently filed a plan that challenges Amatex. See In re Combustion Eng'g, Inc., Ch. 11 Case No. 03-10495 (JKF) (Bankr. D. Del.), at Docket Nos. 32 and 373. Combustion Engineering's January 19, 2003 pre-packaged plan of reorganization, provides that the number and amount of asbestos-related claims could not be determined, but did not address whether legal liability for such claims would arise at confirmation or at the time such claims are allowed by the section 524(g) trust. An April 1, 2003 plan amendment did. It provides that confirmation constitutes a judgment of liability for present and future asbestos-related claims. Subsequently, after strong insurer objection, the debtor removed this finding. See Docket No. 788, at '199.

Important Considerations

Fuller-Austin could create a race to section 524(g) trusts and encourage the filing of marginal claims. Some debtors have attempted to use Chapter 11 to challenge the validity of asbestos-related claims. Such a strategy is risky. Rather, the use of pre-packaged plans to shed asbestos-related liabilities, similar to Combustion Engineering's plan, has gained momentum. The ultimate success for an asbestos debtor is the preservation of its equity interests.

Common to either strategy is the assignment of insurance proceeds to the section 524(g) trust. Because typical insurance policies include anti-assignment provisions, such assignment is arguably unlawful. In addition, debtors will include in their plans proposed findings regarding insurance issues which may be pending in ongoing coverage litigation and which are more appropriated resolved in a declaration judgment action, rather than a confirmation hearing. For example, debtors may seek findings that the plan negotiations did not violate consent to settlement or duty to cooperate provisions of underlying policies. With Combustion Engineering, a debtor, buoyed by Fuller-Austin, it is seeking a UNR result.

Associated Risks

The risks associated with Fuller-Austin have created an enormous amount of collateral litigation in connection with asbestos-related bankruptcy cases. Some insurers have followed a litigation strategy to avoid a UNR result. Others have taken the ongoing litigation strategy one step further. In re JT Thorpe Co., Ch. 11 Case No. 02-41487-H5 (Bankr. S.D. Tex.). In In re JT Thorpe Co., the debtor, certain insurers, and the Official Committee of Asbestos Claimants arrived at a stipulation that governed the issue. The stipulation was entered by both the bankruptcy judge presiding over the bankruptcy case and the federal district court judge presiding over the insurance coverage litigation. Pursuant to the stipulation, the parties agreed that nothing in the debtor's Chapter 11 proceeding would preclude the insurers' rights to contest liability under the policies and the insurers reserved their rights to assert or contest that confirmation of the debtor's reorganization plan is not a covered loss under the policies, notwithstanding the UNR and Fuller-Austin cases.

The parties also agreed that no finding made in connection with the reorganization plan, disclosure statement, the section 524(g) trust or any other related action would have a res judicata or collateral estoppel effect on any claim, defense, right or cause of action already asserted by the parties or that may be asserted in the future in the coverage action. It is too early to determine whether the JT Thorpe stipulation will serve as a model for resolving complicated insurance issues in asbestos bankruptcy cases, including the UNR and Fuller Austin issues. However, it certainly is the most comprehensive effort to directly address the pitfalls created by UNR and Fuller Austin. Finally, insurers in one instance have taken a different, but no less creative, approach to preventing a UNR result. See In re The Muralo Co., Inc., Ch. 11 Case No. 03-26723 (Bankr. D.N.J.). In Muralo, certain insurers agreed to fund the debtor's successor liability litigation against its plaintiffs. As part of such funding agreement, the debtor and insurers agreed that the debtor would only file a plan with mutually acceptable claims allowance procedures and that did not require aggregated payments up front. The success of such an approach remains to be seen.

Conclusion

Future fallout from the Fuller-Austin decision and jury verdict is not clear. Since the case is under appeal, the full impact of Fuller-Austin remains uncertain. However, if Combustion Engineering and Muralo provide any guidance, this issue has significant momentum and is likely to be a flash point in future asbestos-related and mass tort bankruptcy cases.

Mark D. Taylor and Jennifer D. Larkin are partner and associate, respectively, in the Washington, DC offices of Arent Fox Kintner Plotkin & Kahn, PLLC. Mr. Taylor has extensive experience representing insurers, committees and defendants in connection with mass tort and asbestos-related bankruptcy issues.