Litigating Complex Environmental Cases

Section 502(e)(1)(B) requires disallowance of a claim by a creditor if each of the following three elements is met: 1) the claim is for reimbursement or contribution; 2) the claim is “contingent” at the time of its allowance or disallowance; and 3) the creditor asserting the claim is “liable with the debtor” on the claim of a third party. The policy underlying section 502(e)(1)(B) is principally to prevent “double-dipping” or redundant recoveries by holders of the same underlying claim against the estate. See In re Hemingway Transport, Inc., 993 F.2d 915, 923 (1st Cir. 1993); see also In re GCO, LLC, 324 B.R. 459, 465 (Bankr. S.D.N.Y. 2005). Section 502(e)(1)(B) thus represents an exception to the general principle of recognition of contingent claims in bankruptcy and can be a trap for the unwary.

The various issues that arise in the application of section 502(e)(1)(B) were analyzed in a pair of decisions by bankruptcy judge Robert E. Gerber in the Southern District of New York. In In re Lyondell Chemical Co. (Lyondell), 442 B.R. 236 (Bankr. S.D.N.Y. 2011) and In re Chemtura Corp. (Chemtura), 443 B.R. 601 (Bankr. S.D.N.Y. 2011), the court disallowed claims for contribution for environmental remediation costs under CERCLA. Judge Gerber in turn relied in part on the earlier decision of Bankruptcy Judge Burton R. Lifland in In re Alper Holdings USA, Inc. (Alper), No. 07-12148, 2008 Bankr. LEXIS 2634 (Bankr. S.D.N.Y. Sept. 10, 2008), in which Judge Lifland applied section 502(e)(1)(B) to disallow claims by creditors for indemnification for future defense costs and potential liability in defending against personal injury and property damage claims allegedly caused by environmental contamination, as asserted by multiple plaintiffs in the underlying litigation. These three decisions served to clarify the scope of section 502(e)(1)(B), particularly because, as noted by courts and commentators, the terms used in 502(e)(1)(B), including “contribution,” “reimbursement,” “contingent,” or “liable with the debtor,” are not defined in the Code, nor does the Code set forth standards for their application. See Lyondell, 442 B.R. at 243-44.

Lyondell and Chemtura both dealt with claims by “potentially responsible parties” (PRPs) that are liable for remediating pollution under CERCLA. PRPs that fund remediation actions can seek contribution from other PRPs “during or following any civil action” instituted under CERCLA. In addition, CERCLA permits “private parties” to seek contribution after they settle their liability with the Environmental Protection Agency (EPA).

The Contingency Requirement

Judge Gerber in his decisions first addressed the “contingency” element of section 502(e)(1)(B). In this regard, certain of the creditors argued that their claims were not contingent in the sense that their liability for remediation costs had already accrued, although the amount of the costs was not yet fixed. Judge Gerber found that that the Second Circuit decisions in In re Chateaugay Corp., 944 F.2d 997 (2d Cir. 1991) and Olin Corp. v. Riverwood Int'l Corp. (In re Manville Forest Products Corp.), 209 F.3d 125 (2d Cir. 2000), although not directly holding that claims are contingent until costs for remediation work are actually expended or paid, supported that proposition. The court observed that the Second Circuit “described those claims as contingent because the scope, amount, and form of the environmental liability was undetermined.” Chemtura, 443 B.R. at 617.

Furthermore, Judge Gerber relied on the holding of Judge Lifland in Alper, in which Judge Lifland found that future defense costs and indemnification of any liability resulting from the underlying environmental tort litigation were “contingent” claims since “the amounts and ultimate liability are presently unknown.” Chemtura, 443 B.R. at 617 and Lyondell, 442 B.R. at 248 (citing Alper, 2008 Bankr. LEXIS 2634, 2008 WL 4186333, *6-7).

In particular, the creditors in Chemtura and Lyondell, in arguing that their claims were not contingent, relied on Judge Christopher S. Sontchi's decision in RNI Wind Down Corp., 369 B.R. 174 (Bankr. D. Del. 2007), in which he drew a distinction between contingent and unliquidated costs in ruling that the debtor was liable for payment of future defense costs to a corporate director who was a defendant in the underlying security fraud litigation giving rise to the claim. Both Judge Gerber and Judge Lifland, however, read RNI Wind Down narrowly, as applying to a fixed right to “advancement” of defense costs as opposed to “reimbursement.” See Alper, 2008 Bankr. LEXIS 2634, at *21; Chemtura, 443 B.R. at 619.

Accordingly, Judge Gerber applied a bright-line rule, holding that “until and unless amounts are actually paid, the claims for reimbursement or contribution with respect to those amounts remain contingent for 502(e)(1)(B) purposes.” Lyondell, 442 B.R. at 248 (emphasis in original). Thus, in Lyondell and Chemtura, the claimants could only recover for their respective costs of remediation that were both incurred and actually paid.

Judge Gerber further justified his holding with respect to the contingency prong of 502(e)(1)(B) by pointing out the practical uncertainty as to whether the PRP “might or might not wind up making the payment for which it then would be seeking reimbursement or contribution.” Lyondell, 442 B.R. at 249-50; Chemtura, 443 B.R. at 618-19.

In the case of an indemnification claim with respect to ongoing environmental litigation, it could be argued that exposure to future defense costs is a virtual certainty, although the unpredictability of litigation, including whether a case will be dismissed at the pleading stage or after a motion for summary judgment, as well as potential appeals, can make cost estimation difficult. Under Judge Gerber's analysis in the CERCLA context, however, “the fact that the amount of future costs is known or fixed does not render the claim non-contingent where the costs have not yet been incurred and paid by the claimant.” Chemtura, 443 B.R. at 620.

Judge Gerber also noted that his ruling was supported not just by bankruptcy policy, but also advanced CERCLA's policy goal of encouraging expeditious cleanup, “because claimants are encouraged to remediate promptly by the threat of disallowance of claims that have not been fixed.” Lyondell, 442 B.R. at 251; Chemtura, 443 B.R. at 619.

The Co-Liability Requirement

The second element of section 502(e)(1)(B) analyzed by the court in Lyondell and Chemtura in the CERCLA context, and in connection with common-law claims for indemnification in Alper, is the requirement of “co-liability.” In Lyondell, Judge Gerber applied 502(e)(1)(B) to exclude not only statutory contribution claims under section 113(f) of CERCLA, but also claims arising under section 107(a), which the Supreme Court held in U.S. v. Atlantic Research, 551 U.S. 128 (2007) permits private parties to recover from another PRP without establishing liability to a third party.

Nevertheless, for purposes of section 502(e)(1)(B), Judge Gerber focused on whether the actual bankruptcy claim was predicated on some form of shared or co-liability for remediation costs. The court observed that the statutory language is broad and there is no requirement under section 502(e)(1)(B) “that the debtor and the party asserting the claim be liable on the claim of the third party in the same action, under a common statute, or on the same legal theory.” Lyondell, 442 B.R. at 244 n.10.

Thus, Judge Gerber reasoned that although a claim under section 107(a) need not be based on co-liability to a third party, Atlantic Research did not hold that a claim under section 107(a) cannot be based on co-liability. Lyondell, 442 B.R. at 252. In this instance, where the claimant and the debtors had both been designated as PRPs by the EPA, and had a shared statutory obligation, the court found that the bankruptcy claims were in substance claims predicated on co-liability since they relied on the theory that if the debtors paid less than their share of clean up costs, the claimants would have to pay more, so as to bar recovery under section 502(e)(1)(B). Lyondell, 442 B.R. at 253.

The court also rejected those cases adopting the use of a trust into which claims could be paid to be expended on remediation of the waste sites on the ground that this would not avoid the possibility of redundant payments under section 502(e)(1)(B). See Chemtura, 443 B.R. at 622-23; Lyondell, 442 B.R. at 254-55.

In Alper, Judge Lifland also construed the co-liability requirement broadly in the context of potential liability among co-defendants in environmental tort litigation. The court in Alper addressed co-liability under state statutory and common law principles, in this case the law of Tennessee, which governed the underlying tort claims. The court reaffirmed that the co-liability requirement is determined by reference to the complaint in the underlying third-party action and whether “'the causes of action in the underlying lawsuit assert claims upon which, if proven, the debtor could be liable absent the automatic stay.'” Alper, 2008 Bankr. LEXIS 2634, at *22 (quoting In re GCO, LLC, 324 B.R. at 465). Thus, notwithstanding that the bankruptcy court had expunged the bankruptcy claims of the plaintiffs in the underlying tort litigation, Judge Lifland rejected the argument that the claimant could not be co-liable with Alper because the allegations as to co-liability remained pending in the underlying actions.

Furthermore, Judge Lifland found that the claimant's argument that the co-liability requirement could not be satisfied because Tennessee had statutorily abolished the common-law doctrine of joint and several liability was also without merit. In this regard, the court focused on the theory of liability pled in the underlying actions, which asserted liability against the claimant based on successor liability in contrast to subsequent, independent negligent conduct. Accordingly, under the rationale of Alper, claims based on various theories of successor, vicarious or alter ego liability fall within the ambit of section 502(e)(1)(B) because such claims could encompass co-liability of the debtor with its corporate successor or parent entities. Alper, 2008 Bankr. LEXIS 2634, at *24-25.

Judge Gerber in Lyondell addressed a similar argument that CERCLA does not always require joint and several liability for superfund sites, and therefore section 502(e)(1)(B) should not apply, but found this argument flawed since if liability was apportioned separately among the potential claimants, there would be no claim against the debtor in the first place. Lyondell, 442 B.R. at 255. While the court's reasoning applies to contribution claims, it would not necessarily preclude a bankruptcy claim based on a contractual indemnification clause that shifted liability arising out of the operation of the site. In this regard, indemnification clauses may be broadly worded to extend beyond damages that are proximately caused by the indemnifying party or may provide for indemnification of even negligent conduct, absent gross negligence or fraud.

In considering the co-liability element of section 502(e)(1)(B) with respect to common-law claims for contribution or indemnity, bankruptcy courts will therefore need to evaluate the nature of the claims in the underlying litigation and whether those claims are based on successor or joint and several liability. Moreover, even when the applicable state law follows the traditional common law rule of joint and several liability for tort claims, such as under New York law, the court could be faced with the issue of whether the alleged tortious conduct in the underlying litigation constituted independent or supervening negligence so as to exclude joint and several liability. These issues in turn raise the question of whether the court in appropriate cases should conduct an inquiry into the factual basis for generalized allegations of liability contained in the underlying complaint giving rise to a claim for indemnification against the debtor.

Strategic Considerations Under Section 502(e)(1)(B)

The broad application of section 502(e)(1)(B) in these decisions raises a number of strategic considerations for both insolvent (or potentially insolvent) defendants and solvent co-defendants in complex environmental litigation, particularly where liability is based on a chain of ownership or operation of the site at issue over many years. In theory, the same policy considerations that would encourage PRPs to promptly establish their liability for remediation costs so as to avoid disallowance of their claims should also incentivize joint defendants facing expensive and protracted litigation to settle sooner so as to fix the amount of their claims. In practice, however, this may prove difficult to achieve depending on the demands of the plaintiffs, the time required for potentially dispositive motion practice, and complex issues as to causation and allocation of damages. Nevertheless, in situations where one or more of the primary defendants or indemnifying parties has filed for bankruptcy, depending on the percentage of recovery that can be expected, the parties will have an incentive to achieve a settlement so as to fix their respective claims in the bankruptcy.

In this multi-party environmental litigation scenario, a defendant who is facing substantial exposure to litigation claims will have a strong incentive to file for bankruptcy protection sooner than it might otherwise to protect itself not only against claims by plaintiffs under the automatic stay, but also to avoid claims for contribution and indemnification by co-defendants. The creditors holding such claims will also need to consider whether they can effectively challenge the bankruptcy filing as “premature” given the contingent nature of the liabilities faced by the debtor. See In re SGL Carbon Corp., 200 F.3d 154 (3d Cir. 1999).

Furthermore, if a co-defendant's claim is not disallowed under section 502(e)(1)(B) because there is no co-liability, but the claim remains contingent, the bankruptcy court will have to determine whether or not to conduct an estimation hearing pursuant to section 502(c). The claimant in turn will need to consider how the evidence it presents at the estimation hearing with respect to the valuation of its claim affects its position in the underlying litigation, including the potential for collateral estoppel or admissions with respect to liability issues based on the findings or outcome of the estimation hearing. See 4 Collier on Bankruptcy ' 502.04[3] (Alan N. Resnick & Henry J. Sommer eds, 16th ed.). These considerations may also provide additional impetus towards settlement and fixing of a claim amount for purposes of avoiding disallowance under section 502(e)(1)(B) or the costs and risks associated with an estimation hearing.

The plaintiffs in the underlying litigation, although not directly impacted by section 502(e)(1)(B), will also be well served to evaluate their settlement position in light of the consequences of 502(e)(1)(B). It may be in the interest of plaintiffs to achieve a global settlement of the underlying litigation in conjunction with resolution of the bankruptcy claims for a variety of reasons relating to 502(e)(1)(B).

First, there are risks to plaintiffs from piecemeal settlement of bankruptcy claims. These include the risk that the settling debtor will be found liable for a significant percentage of the damages in the underlying litigation so as to reduce plaintiffs' potential recovery, or the risk that that plaintiffs will be found to have released the parent or successor entities from liability through settlement with the insolvent subsidiary, as occurred in the Alper litigation. See Flake v. Schrader-Bridgeport Int'l, Inc., No. 3:07-0925, 2011 U.S. Dist. LEXIS 30372, at *26 (M.D. Tenn. Mar. 23, 2011).

Second, plaintiffs risk disallowance of their claims by the bankruptcy court and the potential assertion of a defense of collateral estoppel or res judicata in the underlying litigation. Moreover, the solvent co-defendants in the underlying litigation may be more disposed to reach a settlement sooner rather than later in order to quantify their claims for contribution or indemnification or otherwise fix their liability so to permit a partial recovery or allocation of responsibility through the bankruptcy process that would otherwise be barred by section 502(e)(1)(B).

Robert Sidorsky is a shareholder in the New York office of Butzel Long, P.C. His bankruptcy work focuses on litigation arising out of complex financial and accounting transactions as well as cross-border insolvency issues. He can be contacted at [email protected].

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In a series of recent decisions, the bankruptcy court for the Southern District of New York has broadly interpreted section 502(e)(1)(B) of the Bankruptcy Code in disallowing substantial claims arising in the context of: 1) liability for environmental remediation; or 2) complex environmental tort litigation that often ensues in cases of longstanding environmental pollution or contamination. Thus, section 502(e)(1)(B) has proven an effective, although arguably controversial, mechanism in limiting the liability of debtors for claims for contribution or indemnity by co-liable parties both under the statutory mechanism of the Comprehensive Environmental Response, Compensation, and Liability Act, 42 U.S.C. ” 9601 et seq. (CERCLA), and under state common law governing claims for contribution and indemnification.

Accordingly, the application and potential consequences of section 502(e)(1)(B) need to be evaluated by each of the parties to significant multi-party environmental litigation in which one of the defendants or potential defendants has filed for bankruptcy or a bankruptcy filing is a strategic consideration in limiting liability for exposure to the costs of remediation and/or litigation.

Operation of Section 502(e)(1)(B)

Section 502(e)(1)(B) requires disallowance of a claim by a creditor if each of the following three elements is met: 1) the claim is for reimbursement or contribution; 2) the claim is “contingent” at the time of its allowance or disallowance; and 3) the creditor asserting the claim is “liable with the debtor” on the claim of a third party. The policy underlying section 502(e)(1)(B) is principally to prevent “double-dipping” or redundant recoveries by holders of the same underlying claim against the estate. See In re Hemingway Transport, Inc., 993 F.2d 915, 923 (1st Cir. 1993); see also In re GCO, LLC, 324 B.R. 459, 465 (Bankr. S.D.N.Y. 2005). Section 502(e)(1)(B) thus represents an exception to the general principle of recognition of contingent claims in bankruptcy and can be a trap for the unwary.

The various issues that arise in the application of section 502(e)(1)(B) were analyzed in a pair of decisions by bankruptcy judge Robert E. Gerber in the Southern District of New York. In In re Lyondell Chemical Co. (Lyondell), 442 B.R. 236 (Bankr. S.D.N.Y. 2011) and In re Chemtura Corp. (Chemtura), 443 B.R. 601 (Bankr. S.D.N.Y. 2011), the court disallowed claims for contribution for environmental remediation costs under CERCLA. Judge Gerber in turn relied in part on the earlier decision of Bankruptcy Judge Burton R. Lifland in In re Alper Holdings USA, Inc. (Alper), No. 07-12148, 2008 Bankr. LEXIS 2634 (Bankr. S.D.N.Y. Sept. 10, 2008), in which Judge Lifland applied section 502(e)(1)(B) to disallow claims by creditors for indemnification for future defense costs and potential liability in defending against personal injury and property damage claims allegedly caused by environmental contamination, as asserted by multiple plaintiffs in the underlying litigation. These three decisions served to clarify the scope of section 502(e)(1)(B), particularly because, as noted by courts and commentators, the terms used in 502(e)(1)(B), including “contribution,” “reimbursement,” “contingent,” or “liable with the debtor,” are not defined in the Code, nor does the Code set forth standards for their application. See Lyondell, 442 B.R. at 243-44.

Lyondell and Chemtura both dealt with claims by “potentially responsible parties” (PRPs) that are liable for remediating pollution under CERCLA. PRPs that fund remediation actions can seek contribution from other PRPs “during or following any civil action” instituted under CERCLA. In addition, CERCLA permits “private parties” to seek contribution after they settle their liability with the Environmental Protection Agency (EPA).

The Contingency Requirement

Judge Gerber in his decisions first addressed the “contingency” element of section 502(e)(1)(B). In this regard, certain of the creditors argued that their claims were not contingent in the sense that their liability for remediation costs had already accrued, although the amount of the costs was not yet fixed. Judge Gerber found that that the Second Circuit decisions in In re Chateaugay Corp., 944 F.2d 997 (2d Cir. 1991) and Olin Corp. v. Riverwood Int'l Corp. (In re Manville Forest Products Corp.), 209 F.3d 125 (2d Cir. 2000), although not directly holding that claims are contingent until costs for remediation work are actually expended or paid, supported that proposition. The court observed that the Second Circuit “described those claims as contingent because the scope, amount, and form of the environmental liability was undetermined.” Chemtura, 443 B.R. at 617.

Furthermore, Judge Gerber relied on the holding of Judge Lifland in Alper, in which Judge Lifland found that future defense costs and indemnification of any liability resulting from the underlying environmental tort litigation were “contingent” claims since “the amounts and ultimate liability are presently unknown.” Chemtura, 443 B.R. at 617 and Lyondell, 442 B.R. at 248 (citing Alper, 2008 Bankr. LEXIS 2634, 2008 WL 4186333, *6-7).

In particular, the creditors in Chemtura and Lyondell, in arguing that their claims were not contingent, relied on Judge Christopher S. Sontchi's decision in RNI Wind Down Corp., 369 B.R. 174 (Bankr. D. Del. 2007), in which he drew a distinction between contingent and unliquidated costs in ruling that the debtor was liable for payment of future defense costs to a corporate director who was a defendant in the underlying security fraud litigation giving rise to the claim. Both Judge Gerber and Judge Lifland, however, read RNI Wind Down narrowly, as applying to a fixed right to “advancement” of defense costs as opposed to “reimbursement.” See Alper, 2008 Bankr. LEXIS 2634, at *21; Chemtura, 443 B.R. at 619.

Accordingly, Judge Gerber applied a bright-line rule, holding that “until and unless amounts are actually paid, the claims for reimbursement or contribution with respect to those amounts remain contingent for 502(e)(1)(B) purposes.” Lyondell, 442 B.R. at 248 (emphasis in original). Thus, in Lyondell and Chemtura, the claimants could only recover for their respective costs of remediation that were both incurred and actually paid.

Judge Gerber further justified his holding with respect to the contingency prong of 502(e)(1)(B) by pointing out the practical uncertainty as to whether the PRP “might or might not wind up making the payment for which it then would be seeking reimbursement or contribution.” Lyondell, 442 B.R. at 249-50; Chemtura, 443 B.R. at 618-19.

In the case of an indemnification claim with respect to ongoing environmental litigation, it could be argued that exposure to future defense costs is a virtual certainty, although the unpredictability of litigation, including whether a case will be dismissed at the pleading stage or after a motion for summary judgment, as well as potential appeals, can make cost estimation difficult. Under Judge Gerber's analysis in the CERCLA context, however, “the fact that the amount of future costs is known or fixed does not render the claim non-contingent where the costs have not yet been incurred and paid by the claimant.” Chemtura, 443 B.R. at 620.

Judge Gerber also noted that his ruling was supported not just by bankruptcy policy, but also advanced CERCLA's policy goal of encouraging expeditious cleanup, “because claimants are encouraged to remediate promptly by the threat of disallowance of claims that have not been fixed.” Lyondell, 442 B.R. at 251; Chemtura, 443 B.R. at 619.

The Co-Liability Requirement

The second element of section 502(e)(1)(B) analyzed by the court in Lyondell and Chemtura in the CERCLA context, and in connection with common-law claims for indemnification in Alper , is the requirement of “co-liability.” In Lyondell , Judge Gerber applied 502(e)(1)(B) to exclude not only statutory contribution claims under section 113(f) of CERCLA, but also claims arising under section 107(a), which the Supreme Court held in U.S. v. Atlantic Research , 551 U.S. 128 (2007) permits private parties to recover from another PRP without establishing liability to a third party.

Nevertheless, for purposes of section 502(e)(1)(B), Judge Gerber focused on whether the actual bankruptcy claim was predicated on some form of shared or co-liability for remediation costs. The court observed that the statutory language is broad and there is no requirement under section 502(e)(1)(B) “that the debtor and the party asserting the claim be liable on the claim of the third party in the same action, under a common statute, or on the same legal theory.” Lyondell, 442 B.R. at 244 n.10.

Thus, Judge Gerber reasoned that although a claim under section 107(a) need not be based on co-liability to a third party, Atlantic Research did not hold that a claim under section 107(a) cannot be based on co-liability. Lyondell, 442 B.R. at 252. In this instance, where the claimant and the debtors had both been designated as PRPs by the EPA, and had a shared statutory obligation, the court found that the bankruptcy claims were in substance claims predicated on co-liability since they relied on the theory that if the debtors paid less than their share of clean up costs, the claimants would have to pay more, so as to bar recovery under section 502(e)(1)(B). Lyondell, 442 B.R. at 253.

The court also rejected those cases adopting the use of a trust into which claims could be paid to be expended on remediation of the waste sites on the ground that this would not avoid the possibility of redundant payments under section 502(e)(1)(B). See Chemtura, 443 B.R. at 622-23; Lyondell, 442 B.R. at 254-55.

In Alper, Judge Lifland also construed the co-liability requirement broadly in the context of potential liability among co-defendants in environmental tort litigation. The court in Alper addressed co-liability under state statutory and common law principles, in this case the law of Tennessee, which governed the underlying tort claims. The court reaffirmed that the co-liability requirement is determined by reference to the complaint in the underlying third-party action and whether “'the causes of action in the underlying lawsuit assert claims upon which, if proven, the debtor could be liable absent the automatic stay.'” Alper, 2008 Bankr. LEXIS 2634, at *22 (quoting In re GCO, LLC, 324 B.R. at 465). Thus, notwithstanding that the bankruptcy court had expunged the bankruptcy claims of the plaintiffs in the underlying tort litigation, Judge Lifland rejected the argument that the claimant could not be co-liable with Alper because the allegations as to co-liability remained pending in the underlying actions.

Furthermore, Judge Lifland found that the claimant's argument that the co-liability requirement could not be satisfied because Tennessee had statutorily abolished the common-law doctrine of joint and several liability was also without merit. In this regard, the court focused on the theory of liability pled in the underlying actions, which asserted liability against the claimant based on successor liability in contrast to subsequent, independent negligent conduct. Accordingly, under the rationale of Alper, claims based on various theories of successor, vicarious or alter ego liability fall within the ambit of section 502(e)(1)(B) because such claims could encompass co-liability of the debtor with its corporate successor or parent entities. Alper, 2008 Bankr. LEXIS 2634, at *24-25.

Judge Gerber in Lyondell addressed a similar argument that CERCLA does not always require joint and several liability for superfund sites, and therefore section 502(e)(1)(B) should not apply, but found this argument flawed since if liability was apportioned separately among the potential claimants, there would be no claim against the debtor in the first place. Lyondell, 442 B.R. at 255. While the court's reasoning applies to contribution claims, it would not necessarily preclude a bankruptcy claim based on a contractual indemnification clause that shifted liability arising out of the operation of the site. In this regard, indemnification clauses may be broadly worded to extend beyond damages that are proximately caused by the indemnifying party or may provide for indemnification of even negligent conduct, absent gross negligence or fraud.

In considering the co-liability element of section 502(e)(1)(B) with respect to common-law claims for contribution or indemnity, bankruptcy courts will therefore need to evaluate the nature of the claims in the underlying litigation and whether those claims are based on successor or joint and several liability. Moreover, even when the applicable state law follows the traditional common law rule of joint and several liability for tort claims, such as under New York law, the court could be faced with the issue of whether the alleged tortious conduct in the underlying litigation constituted independent or supervening negligence so as to exclude joint and several liability. These issues in turn raise the question of whether the court in appropriate cases should conduct an inquiry into the factual basis for generalized allegations of liability contained in the underlying complaint giving rise to a claim for indemnification against the debtor.

Strategic Considerations Under Section 502(e)(1)(B)

The broad application of section 502(e)(1)(B) in these decisions raises a number of strategic considerations for both insolvent (or potentially insolvent) defendants and solvent co-defendants in complex environmental litigation, particularly where liability is based on a chain of ownership or operation of the site at issue over many years. In theory, the same policy considerations that would encourage PRPs to promptly establish their liability for remediation costs so as to avoid disallowance of their claims should also incentivize joint defendants facing expensive and protracted litigation to settle sooner so as to fix the amount of their claims. In practice, however, this may prove difficult to achieve depending on the demands of the plaintiffs, the time required for potentially dispositive motion practice, and complex issues as to causation and allocation of damages. Nevertheless, in situations where one or more of the primary defendants or indemnifying parties has filed for bankruptcy, depending on the percentage of recovery that can be expected, the parties will have an incentive to achieve a settlement so as to fix their respective claims in the bankruptcy.

In this multi-party environmental litigation scenario, a defendant who is facing substantial exposure to litigation claims will have a strong incentive to file for bankruptcy protection sooner than it might otherwise to protect itself not only against claims by plaintiffs under the automatic stay, but also to avoid claims for contribution and indemnification by co-defendants. The creditors holding such claims will also need to consider whether they can effectively challenge the bankruptcy filing as “premature” given the contingent nature of the liabilities faced by the debtor. See In re SGL Carbon Corp., 200 F.3d 154 (3d Cir. 1999).

Furthermore, if a co-defendant's claim is not disallowed under section 502(e)(1)(B) because there is no co-liability, but the claim remains contingent, the bankruptcy court will have to determine whether or not to conduct an estimation hearing pursuant to section 502(c). The claimant in turn will need to consider how the evidence it presents at the estimation hearing with respect to the valuation of its claim affects its position in the underlying litigation, including the potential for collateral estoppel or admissions with respect to liability issues based on the findings or outcome of the estimation hearing. See 4 Collier on Bankruptcy ' 502.04[3] (Alan N. Resnick & Henry J. Sommer eds, 16th ed.). These considerations may also provide additional impetus towards settlement and fixing of a claim amount for purposes of avoiding disallowance under section 502(e)(1)(B) or the costs and risks associated with an estimation hearing.

The plaintiffs in the underlying litigation, although not directly impacted by section 502(e)(1)(B), will also be well served to evaluate their settlement position in light of the consequences of 502(e)(1)(B). It may be in the interest of plaintiffs to achieve a global settlement of the underlying litigation in conjunction with resolution of the bankruptcy claims for a variety of reasons relating to 502(e)(1)(B).

First, there are risks to plaintiffs from piecemeal settlement of bankruptcy claims. These include the risk that the settling debtor will be found liable for a significant percentage of the damages in the underlying litigation so as to reduce plaintiffs' potential recovery, or the risk that that plaintiffs will be found to have released the parent or successor entities from liability through settlement with the insolvent subsidiary, as occurred in the Alper litigation. See Flake v. Schrader-Bridgeport Int'l, Inc., No. 3:07-0925, 2011 U.S. Dist. LEXIS 30372, at *26 (M.D. Tenn. Mar. 23, 2011).

Second, plaintiffs risk disallowance of their claims by the bankruptcy court and the potential assertion of a defense of collateral estoppel or res judicata in the underlying litigation. Moreover, the solvent co-defendants in the underlying litigation may be more disposed to reach a settlement sooner rather than later in order to quantify their claims for contribution or indemnification or otherwise fix their liability so to permit a partial recovery or allocation of responsibility through the bankruptcy process that would otherwise be barred by section 502(e)(1)(B).

Robert Sidorsky is a shareholder in the New York office of Butzel Long, P.C. His bankruptcy work focuses on litigation arising out of complex financial and accounting transactions as well as cross-border insolvency issues. He can be contacted at [email protected].

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