Court Allows Nonconsensual Releases of Third-Party Claims to Be Included In Settlement Agreement

As Part of the Settlement, the Debtor Sought to Purchase Its Insurance Policies Back from the Insurers

According to the opinion, before the debtor ceased operations back in the 1980s, it contracted with shipbuilders to outfit the interiors of ships. For decades after terminating this business, the debtor continued its corporate existence to address personal injury, asbestos-related claims. As of June 2024, 2,700 such claims remained unresolved. As is usually the case, the debtor carried insurance policies that it maintained provided coverage for the claims. While the coverage periods had ended in 1984, the insurers continued partially to reimburse the debtor for its defense costs and liability payments made to asbestos claimants to resolve the claims.
In July 2024, the debtor filed a motion that requested Bankruptcy Court approval of a settlement agreement with some but not all of its insurers. As is typically the case in asbestos bankruptcy cases, pursuant to the agreement, the insurers would pay the debtor a set sum and the debtor would establish a trust to distribute the funds to holders of asbestos claims. Once the insurers made the payment, they would be released and discharged from all claims related to the policies and the asbestos claimants would be enjoined from asserting claims against the insurers. As part of the settlement, the policies would be deemed “sold” back to the debtor pursuant to Section 363 of the Bankruptcy Code, free and clear of claims, and then terminated by the debtors, the practical effect being it was as if the policies had never been issued.
The motion to approve the settlement agreement was opposed by the Office of the U.S. Trustee, certain individuals, and Huntington Ingalls Industries, Inc. (HII). According to the opinion, HII may have held future potential contribution claims against the Debtor under state law related to the asbestos claims. After an evidentiary hearing, the court overruled the objections and approved the settlement agreement. HII appealed the ruling and filed a separate motion for a stay pending the appeal. The opinion sets forth the court’s decision denying the requested stay.

The Supreme Court’s Ruling In Purdue Does Not Apply to Bankruptcy Sales and Settlement Agreements

The court began its analysis by noting in order to obtain a stay of a bankruptcy court order pending appeal, the party seeking the stay must establish that, among other things, it will likely succeed on the merits of the appeal. HII argued that the Supreme Court’s prohibition of nonconsensual third-party releases in Purdue under a plan of reorganization should also apply to bankruptcy sales under Section 363 of the Bankruptcy Code, and because whether a court could enjoin claims against a seller in a bankruptcy sale was an issue of first impression in the U.S. Court of the Appeals for the Fourth Circuit, the court’s ruling should be stayed until it could be reviewed on appeal.
The opinion notes that “injunctions and releases have long accompanied ‘free and clear’ sales in bankruptcy.” Moreover, liability insurance contracts are property of the bankruptcy estate owned by the debtor, and debtors often enter into “buyback” sale agreements with their insurers as part of settlements to obtain funds to pay claimants that are approved both pursuant to Sections 363(b) and (f) as sales “free and clear” of other interests and settlement agreements under Federal Rule of Bankruptcy Procedure 9019.
In this case, the court held the debtor satisfied the requirements for approval of its settlement agreement with the insurers pursuant to Section 363 and Rule 9019. The agreement facilitated an orderly distribution of the sale proceeds to asbestos-related claims while avoiding extensive litigation costs of coverage disputes with the insurers. The court approved the sale of the policies free and clear of asbestos claims because the asbestos claimants could be compelled to accept a money satisfaction for their interests, as provided by Section 363(f)(5) of the Bankruptcy Code. The debtor met the “uniform and liberal” requirements of Bankruptcy Rule 9019 because the settlement was above “the lowest point in the range of reasonableness” when considering the probability of the debtor’s success in any ensuing litigation, any collection difficulties, and the complexity, time, and expense of the litigation.
The court rejected the argument that Purdue prohibited nonconsensual releases in the context of bankruptcy Section 363 sales or settlement agreements. The opinion cites cases that distinguished “bar orders that are a necessary part of a settlement agreement” from the “nonconsensual third-party releases disallowed in Purdue,” and cited another Bankruptcy Court that recently ruled Purdue did not prohibit a release of claims in a settlement agreement with insurers under Section 363 or Rule 9019. The court noted the Purdue court itself expressly limited application of its ruling to bankruptcy plans and did not mention bankruptcy sales under Section 363. Further, in a typical bankruptcy sale, the claims against the debtor transferred to the proceeds of the sale. The Opinion noted the settlement agreement between the Debtor and its insurers contained that provision.
The court also reasoned that, absent the bankruptcy sale and settlement some, but not all, of the asbestos claimants could pursue claims directly against the policies under state law. Allowing only some creditors to recover against the policies directly contravened a fundamental principle that bankruptcy should eliminate a “race to the courthouse.” The debtor was seeking to monetize its policies and put all the asbestos claimants on equal footing with respect to the coverage, while simultaneously maximizing recoveries for all claimants by avoiding costly litigation with the insurers. The court found this was why the settlement agreement was in the best interest of all of the debtor’s creditors. Without the injunction prohibiting third parties from pursuing claims against the insurers, the insurers would have little incentive to fund the settlement and enter into the buy-back. Ultimately, the court ruled that HII had not established it was likely to succeed on the merits of its appeal.