Asbestos and Mass Tort Claims

Despite the use of FCRs in most asbestos-related bankruptcies and the statutory requirement of an FCR's appointment under the Bankruptcy Code, in asbestos cases that seek to achieve a channeling injunction involving future claims, until recently there has been a dearth of case law and commentary on the qualifications and standards a court should employ in the process. The process ranges from the selection solely by the debtor to a consultation by the debtor with the asbestos claimants or asbestos committee in the case, with or without the involvement of the United States Trustee. In these scenarios, the standards used do not appear in reported or unreported decisions.

Congoleum

Recently, in the Congoleum Chapter 11 case, an asbestos prepackaged bankruptcy, the United States District Court for the District of New Jersey affirmed, on Aug. 2, 2004, the Bankruptcy Court's Feb. 17, 2004 decision appointing an FCR over strenuous objections by insurers, including what standard to employ, alleged conflicts of interest because of the prepetition appointment of the FCR and the payment by the debtors of the FCR's prepetiton fees and costs. In Congoleum, the FCR was selected by the debtor during the prepetition plan formulation period and significantly before the solicitation of Congoleum's prepackaged plan. After the filing of its bankruptcy petitions, Congoleum sought approval of the FCR it had selected prepetition. In its opinion, the Bankruptcy Court held:

” … although 524(g) indicates that the Court may appoint such a legal representative, it neither sets the standards nor qualifications for such an appointment, nor does it reference a specific Code section that does so. The Court must, therefore, look to the only similar provision in the Code that creates such standards, Section 327, and the standards it creates governing employment of professionals by the estate …

[T]he objectors have not pointed to any potential conflict of interest that could allow this Court to exercise its discretion to disqualify [the FCR]. Indeed, the focus seems to be on what happened prior to the filing, not on what is likely to happen to cause a conflict to arise in the future. The only issue raised that is based on a potential conflict arises from the indemnification provisions of the proposed Order of appointment, and that potential has been largely vitiated by the agreement reached with the U.S. Trustee.

This leaves us with the appearance of conflict, something that the Third Circuit has indicated cannot alone be the basis for disqualification for appointment under 327. The question is whether some higher standard applies for the future Claims Representatives because of the nature of that representation. The Legislative history indicates that a higher standard may be a possibility, but does not give any sort of guidance as to what that alternative standard might be …

In the absence of clear direction from either the statute or the Circuit, adoption of a more amorphous standard than that laid out in 327 and its interpretative cases seems, to this Court, a fairly capricious course of action. Since [the FCR] did not have an actual or potential conflict of interest and since the Court does not have the discretion to disqualify a proposed professional on the basis of a perceived conflict, the objections will be overruled … ”

In re Congoleum Corp., et al., Case No. 03-51524 (KCF), Transcript of Motion Decision Before the Honorable Kathryn C. Ferguson United States Bankruptcy Judge, Feb. 17, 2004, pgs. 6-8.

The District Court, in affirming the Bankruptcy Court, stated:

“The statutory provisions providing for the appointment of a future claims representative do not set forth any standards by which the court should evaluate the appointment of such an individual. All the statute says is that the court shall make such appointment.

[The Bankruptcy Court] clearly concluded that the most stringent appointment provisions of the Bankruptcy Code would be appropriate in this matter and she, therefore, looked to Section 327(a).

The Court concludes that, indeed, [the Bankruptcy Court] made the correct decision in the absence of any statutory direction provided by Congress, and in the absence of any binding or, indeed, nonbinding persuasive authority with regard to this issue, [the Bankruptcy Court] concluded that the stringent standards provided by Section 327(a) were appropriate.”

First State Ins. Co. et al. v. Congoleum Corp. et al. (In re Congoleum Corp. et al.), 04-cv-1517 (SRC) (D. N.J.), Hearing Transcript, Aug. 2, 2004, pg. 73.

Although the decisions in Congoleum are on appeal to the Third Circuit Court of Appeals, they remain the most detailed analysis of any applicable standard for an FCR appointment. Professor Alan N. Resnick, in a June, 2000 law review article on bankruptcy and mass tort liability, is one of the few commentators that mention the issue, stating: “[t]he legal representative should be required to make the same kind of disclosure regarding possible conflicts of interest.” Resnick: Bankruptcy As a Vehicle for Resolving Enterprise-Threatening Mass Tort Liability. 148 U. Pa. L. Rev. 2045, 2078-79 (June, 2000). There is little other guidance in the bankruptcy context for the standard for appointment of FCRs.

As the Congoleum court stated, the Bankruptcy Code does not set forth any legal standard that a court should apply in considering such appointments. Thus, the court was forced to look to other provisions of the Code for guidance, including sections establishing standards with respect to the appointment of other fiduciaries in bankruptcy proceedings. Such sections include:

• section 101(14), defining who is a disinterested person;
• section 321, identifying who is eligible to serve as a trustee;
• section 327, establishing the standards for the employment of professionals who will serve the estate;
• section 701, providing for the appointment of an interim trustee in a Chapter 7 case;
• section 1103, establishing standards for the employment of professionals who will serve the official committee of unsecured creditors in a Chapter 11 case;
• section 1104, requiring that a trustee or examiner appointed in a Chapter 11 case be a “disinterested person”;
• section 1107, permitting a debtor-in-possession to serve as the functional equivalent of a trustee in Chapter 11 cases.

The over-arching theme is the person seeking court approval be free of any interest adverse to the principal he or she is seeking to serve.

Sectons 327 and 1103

Of these Bankruptcy Code provisions, sections 327 and 1103 (employment of debtors' and creditors' committee professionals) are analogous to the appointment of an FCR under section 524(g)(4)(B)(i) of the Bankruptcy Code. It appears consistent that an FCR, who plays a central role in any asbestos case, should be appointed under the same standards applicable to professionals in a bankruptcy case. See, e.g., Butler v. Indiano (In re Ponce Marine Farm, Inc.), 259 B.R. 484, 494 (D. P.R. 2001) (“A professional person is one who plays a central role in the administration of the bankruptcy estate and in the bankruptcy proceedings.”); see also In re That's Entertainment Marketing Group, Inc., 168 B.R. 226, 230 (N.D. Cal. 1994) (citing Matter of D'Lites of America, Inc., 108 B.R. 352 (Bankr. N.D. Ga. 1989)).

Section 327 of the Bankruptcy Code further requires that professionals retained by a trustee or debtor-in-possession be “disinterested.” 11 U.S.C. ' 327(a). Section 101(14) of the Bankruptcy Code prescribes five tests, two of which are applicable here, which, if satisfied, render a person disinterested. Section 101(14) provides that: “disinterested person means [a person] that: (A) is not a creditor, an equity security holder, or an insider; (B) is not and was not an investment banker for any outstanding security of the debtor; (C) has not been, within 3 years before the date of the filing of the petition, an investment banker for a security of the debtor, or an attorney for such an investment banker in connection with the offer, sale, or issuance of a security of the debtor; (D) is not and was not, within two years before the date of the filing of the petition a director, officer or employee of the debtor or of an investment banker specified in subparagraph (B) or (C) of this paragraph; and (E) does not have an interests materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to connection with, or interest in, the debtor or an investment banker specified in subparagraph (B) or (C) of this paragraph, or for any other reason. 11 U.S.C. ' 101(14).

An FCR owes a fiduciary duty to one constituency. To ensure that the subject professional will adequately serve the interests of that constituency, both sections 327 and 1103 of the Bankruptcy Code require the individual selected satisfy the court that he or she is free of any adverse interests. See 11 U.S.C. ' 327(a) (the trustee or debtor-in-possession, “with the court's approval, may employ [professionals] that do not hold or represent an interest adverse to the estat …”); see also 11 U.S.C. ' 1103(b) (a professional retained by the creditors' committee may not, while employed by such committee, represent any other entity having an adverse interest in connection with the case”).

Conclusion

Until there is clear statutory guidance in the Bankruptcy Code, it appears that the application of the standard pronounced in section 327 of the Bankruptcy Code, the strictest of all standards respecting the retention of professionals, is the most logical source of guidance in evaluating the proposed appointment of an FCR under section 524(g)(4)(B)(i) of the Bankruptcy Code.

Asbestos-related bankruptcies are prevalent for various reasons, including expense of traditional tort litigation, lack of either state or federal procedures to handle mass litigation, disputes between insurer and insured, and need for many companies' creditors and shareholders to achieve certainty with large current and contingent asbestos liabilities. Bankruptcy remains an attractive alternative and sometimes last resort because section 524(g) of the Bankruptcy Code provides a mechanism for companies faced with overwhelming asbestos liability to resolve current and future asbestos claims by channeling them to a trust, thereby allowing the effected company to avoid what could result in an inevitable liquidation. One necessary component of this channeling mechanism is section 524(g)(4)(B)(i) of the Bankruptcy Code which requires the Bankruptcy Court appoint “a legal representative for the purpose of protecting the rights of persons that might subsequently assert [asbestos claims] …” 11 U.S.C. ' 524(g)(4)(B)(i), commonly referred to as a future claimants' representative (FCR).

Future Asbestos or Mass Tort Claims

Since the enactment of section 524(g) of the Bankruptcy Code, courts in numerous jurisdictions have appointed representatives for future asbestos or mass tort claimants. Specifically, FCRs have been appointed in, inter alia, the Chapter 11 cases of Combustion Engineering, Inc., Owens Corning, et al., Armstrong World Industries, Inc., Pittsburgh Corning Corp., J.T. Thorpe, Shook and Fletcher, Federal-Mogul Global Inc., T&N Limited, et al., Fuller-Austin Insulation Co., Babcock and Wilcox, Congoleum Corporation and Mid-Valley, Inc. Prior to the codification of the channeling mechanisms and the appointment of an FCR, courts faced with mass-tort bankruptcies recognized the need for an FCR. See, e.g., In re Johns-Manville Corp., 36 B.R. 743, 748-49 (Bankr. S.D.N.Y. 1984), aff'd, 52 B.R. 940 (S.D.N.Y. 1985) (holding that the interests of future asbestos claimants are affected by the bankruptcy so as to entitle them to party-in-interest status and a separate representative), quoted in In re Amatex Corp., 755 F.2d 1034, 1042-43 (3d Cir. 1985) (reversing lower court's denial of debtor's application to appoint futures representative for future asbestos victims, concluding that future claimants are sufficiently affected by reorganization proceedings to require a voice through their own representative, given adverse interests of other parties); see also In re UNR Indus., Inc. 46 B.R. 671, 675 (Bankr. Ill. 1995) (court granted application because such claimants have a stake in the outcome of the cases entitling them to party-in-interest status); In re Eagle-Picher Indus., 144 B.R. 69, 71 (Bankr. S.D. Ohio 1992) (“In mass tort cases, to have a meaningful reorganization from which a viable entity emerges, it has come to be accepted that someone serve as a guardian, a representative of future claimants”).

Despite the use of FCRs in most asbestos-related bankruptcies and the statutory requirement of an FCR's appointment under the Bankruptcy Code, in asbestos cases that seek to achieve a channeling injunction involving future claims, until recently there has been a dearth of case law and commentary on the qualifications and standards a court should employ in the process. The process ranges from the selection solely by the debtor to a consultation by the debtor with the asbestos claimants or asbestos committee in the case, with or without the involvement of the United States Trustee. In these scenarios, the standards used do not appear in reported or unreported decisions.

Congoleum

Recently, in the Congoleum Chapter 11 case, an asbestos prepackaged bankruptcy, the United States District Court for the District of New Jersey affirmed, on Aug. 2, 2004, the Bankruptcy Court's Feb. 17, 2004 decision appointing an FCR over strenuous objections by insurers, including what standard to employ, alleged conflicts of interest because of the prepetition appointment of the FCR and the payment by the debtors of the FCR's prepetiton fees and costs. In Congoleum, the FCR was selected by the debtor during the prepetition plan formulation period and significantly before the solicitation of Congoleum's prepackaged plan. After the filing of its bankruptcy petitions, Congoleum sought approval of the FCR it had selected prepetition. In its opinion, the Bankruptcy Court held:

” … although 524(g) indicates that the Court may appoint such a legal representative, it neither sets the standards nor qualifications for such an appointment, nor does it reference a specific Code section that does so. The Court must, therefore, look to the only similar provision in the Code that creates such standards, Section 327, and the standards it creates governing employment of professionals by the estate …

[T]he objectors have not pointed to any potential conflict of interest that could allow this Court to exercise its discretion to disqualify [the FCR]. Indeed, the focus seems to be on what happened prior to the filing, not on what is likely to happen to cause a conflict to arise in the future. The only issue raised that is based on a potential conflict arises from the indemnification provisions of the proposed Order of appointment, and that potential has been largely vitiated by the agreement reached with the U.S. Trustee.

This leaves us with the appearance of conflict, something that the Third Circuit has indicated cannot alone be the basis for disqualification for appointment under 327. The question is whether some higher standard applies for the future Claims Representatives because of the nature of that representation. The Legislative history indicates that a higher standard may be a possibility, but does not give any sort of guidance as to what that alternative standard might be …

In the absence of clear direction from either the statute or the Circuit, adoption of a more amorphous standard than that laid out in 327 and its interpretative cases seems, to this Court, a fairly capricious course of action. Since [the FCR] did not have an actual or potential conflict of interest and since the Court does not have the discretion to disqualify a proposed professional on the basis of a perceived conflict, the objections will be overruled … ”

In re Congoleum Corp., et al., Case No. 03-51524 (KCF), Transcript of Motion Decision Before the Honorable Kathryn C. Ferguson United States Bankruptcy Judge, Feb. 17, 2004, pgs. 6-8.

The District Court, in affirming the Bankruptcy Court, stated:

“The statutory provisions providing for the appointment of a future claims representative do not set forth any standards by which the court should evaluate the appointment of such an individual. All the statute says is that the court shall make such appointment.

[The Bankruptcy Court] clearly concluded that the most stringent appointment provisions of the Bankruptcy Code would be appropriate in this matter and she, therefore, looked to Section 327(a).

The Court concludes that, indeed, [the Bankruptcy Court] made the correct decision in the absence of any statutory direction provided by Congress, and in the absence of any binding or, indeed, nonbinding persuasive authority with regard to this issue, [the Bankruptcy Court] concluded that the stringent standards provided by Section 327(a) were appropriate.”

First State Ins. Co. et al. v. Congoleum Corp. et al. (In re Congoleum Corp. et al.), 04-cv-1517 (SRC) (D. N.J.), Hearing Transcript, Aug. 2, 2004, pg. 73.

Although the decisions in Congoleum are on appeal to the Third Circuit Court of Appeals, they remain the most detailed analysis of any applicable standard for an FCR appointment. Professor Alan N. Resnick, in a June, 2000 law review article on bankruptcy and mass tort liability, is one of the few commentators that mention the issue, stating: “[t]he legal representative should be required to make the same kind of disclosure regarding possible conflicts of interest.” Resnick: Bankruptcy As a Vehicle for Resolving Enterprise-Threatening Mass Tort Liability. 148 U. Pa. L. Rev. 2045, 2078-79 (June, 2000). There is little other guidance in the bankruptcy context for the standard for appointment of FCRs.

As the Congoleum court stated, the Bankruptcy Code does not set forth any legal standard that a court should apply in considering such appointments. Thus, the court was forced to look to other provisions of the Code for guidance, including sections establishing standards with respect to the appointment of other fiduciaries in bankruptcy proceedings. Such sections include:

• section 101(14), defining who is a disinterested person;
• section 321, identifying who is eligible to serve as a trustee;
• section 327, establishing the standards for the employment of professionals who will serve the estate;
• section 701, providing for the appointment of an interim trustee in a Chapter 7 case;
• section 1103, establishing standards for the employment of professionals who will serve the official committee of unsecured creditors in a Chapter 11 case;
• section 1104, requiring that a trustee or examiner appointed in a Chapter 11 case be a “disinterested person”;
• section 1107, permitting a debtor-in-possession to serve as the functional equivalent of a trustee in Chapter 11 cases.

The over-arching theme is the person seeking court approval be free of any interest adverse to the principal he or she is seeking to serve.

Sectons 327 and 1103

Of these Bankruptcy Code provisions, sections 327 and 1103 (employment of debtors' and creditors' committee professionals) are analogous to the appointment of an FCR under section 524(g)(4)(B)(i) of the Bankruptcy Code. It appears consistent that an FCR, who plays a central role in any asbestos case, should be appointed under the same standards applicable to professionals in a bankruptcy case. See, e.g., Butler v. Indiano (In re Ponce Marine Farm, Inc.), 259 B.R. 484, 494 (D. P.R. 2001) (“A professional person is one who plays a central role in the administration of the bankruptcy estate and in the bankruptcy proceedings.”); see also In re That's Entertainment Marketing Group, Inc., 168 B.R. 226, 230 (N.D. Cal. 1994) (citing Matter of D'Lites of America, Inc., 108 B.R. 352 (Bankr. N.D. Ga. 1989)).

Section 327 of the Bankruptcy Code further requires that professionals retained by a trustee or debtor-in-possession be “disinterested.” 11 U.S.C. ' 327(a). Section 101(14) of the Bankruptcy Code prescribes five tests, two of which are applicable here, which, if satisfied, render a person disinterested. Section 101(14) provides that: “disinterested person means [a person] that: (A) is not a creditor, an equity security holder, or an insider; (B) is not and was not an investment banker for any outstanding security of the debtor; (C) has not been, within 3 years before the date of the filing of the petition, an investment banker for a security of the debtor, or an attorney for such an investment banker in connection with the offer, sale, or issuance of a security of the debtor; (D) is not and was not, within two years before the date of the filing of the petition a director, officer or employee of the debtor or of an investment banker specified in subparagraph (B) or (C) of this paragraph; and (E) does not have an interests materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to connection with, or interest in, the debtor or an investment banker specified in subparagraph (B) or (C) of this paragraph, or for any other reason. 11 U.S.C. ' 101(14).

An FCR owes a fiduciary duty to one constituency. To ensure that the subject professional will adequately serve the interests of that constituency, both sections 327 and 1103 of the Bankruptcy Code require the individual selected satisfy the court that he or she is free of any adverse interests. See 11 U.S.C. ' 327(a) (the trustee or debtor-in-possession, “with the court's approval, may employ [professionals] that do not hold or represent an interest adverse to the estat …”); see also 11 U.S.C. ' 1103(b) (a professional retained by the creditors' committee may not, while employed by such committee, represent any other entity having an adverse interest in connection with the case”).

Conclusion

Until there is clear statutory guidance in the Bankruptcy Code, it appears that the application of the standard pronounced in section 327 of the Bankruptcy Code, the strictest of all standards respecting the retention of professionals, is the most logical source of guidance in evaluating the proposed appointment of an FCR under section 524(g)(4)(B)(i) of the Bankruptcy Code.