Restructuring

Background
For companies suffering massive and debilitating exposure to current and future asbestos liabilities, a chapter 11 reorganization offers them the opportunity to resolve these liabilities efficiently and equitably using section 524(g) of the Bankruptcy Code.  If certain statutory requirements are met, section 524(g) permits the bankruptcy court to issue an injunction channeling all current and future asbestos claims against a debtor to a trust established pursuant to a chapter 11 plan.  The trust assumes responsibility for paying the claims, usually in accordance with a predetermined payment schedule and with various assets contributed to the trust, often including the debtors’ interests (including proceeds) in certain insurance policies.  Thus, section 524(g) serves two beneficial purposes:  it provides the debtor a “fresh start” by barring actions against the reorganized debtor and other protected parties, and it protects the interests of asbestos claimants by providing a structure that uses the trust assets to fairly compensate similarly situated claimants.
What happens, though, when the insurance policies the debtor seeks to contribute to the trust contain anti-assignment provisions, standard clauses that bar an insured from transferring policies or insurance rights without an insurer’s consent?  This was the issue addressed by the Third Circuit recently in In re Federal-Mogul Global Inc., when a group of insurers challenged the debtors’ ability to fund a section 524(g) trust through the assignment of certain insurance rights.
The bankruptcy court rejected the insurers’ arguments that the insurance policies’ anti-assignment provisions barred the debtor from contributing the policies to the 524(g) trust, holding that section 1123(a)(5)(B) of the Bankruptcy Code preempts private contracts and permits the assignment of insurance rights to a section 524(g) trust.  This section provides that a chapter 11 reorganization plan shall provide adequate means for its own implementation, including the transfer of estate property to a trust, “notwithstanding otherwise applicable nonbankruptcy law.”  The insurers appealed the decision.  The district court affirmed.  The insurers appealed again.
The Decision
Although the insurers characterized the preemption issue in Federal-Mogul as one of first impression in the Third Circuit, the court noted that it had already addressed the very same question in a previous case:  In re Combustion Engineering, Inc.  There, the court held that a debtor could transfer its insurance rights to a section 524(g) trust notwithstanding the policies’ anti-assignment provisions.  Because, though, the court did not examine the statutory language, structure, and legislative history of section 1123 for a thorough preemption analysis in Combustion Engineering, it took the opportunity to address those factors in Federal-Mogul.
Reviewing the plain language of section 1123(a), the Third Circuit concluded that Congress clearly intended to preempt state law.  The critical words “Notwithstanding any otherwise applicable nonbankruptcy law” unambiguously signaled the drafters’ intent that the provisions of the section were meant to override conflicting state nonbankruptcy law.  Moreover, the insurers were unable to propose a plausible alternative reading of section 1123(a) that disfavored preemption.  A natural and orderly reading of section 1123(a) from general statement to specific instance supported the conclusion that the “notwithstanding” clause applies to all of subsection (a) of section 1123, and not only to certain of the eight numbered subsections under subsection (a) of section 1123.  Further, the Court noted that the language of section 1123(a) demonstrates Congress’s intent that the phrase “nonbankruptcy law” encompasses private contracts – despite no explicit reference to preemption of private contracts – because many of the transactions listed under section 1123(a)(5) implicate contractual rights and because a contract has no legal force apart from the state law (i.e., the applicable nonbankruptcy law) that enforces it.  Thus, the court determined that the plain language of section 1123(a) demonstrates a clear congressional intent that transfers of property authorized by section 1123(a)(5)(B) fall within its preemptive scope.
The Third Circuit also determined that the structure and context of section 1123 did not support a narrow reading of preemption and that a broad reading of preemption would not render other provisions of the Bankruptcy Code superfluous.  The court noted that, if Congress had intended to limit the scope of section 1123’s “notwithstanding” clause, it would have done as it did in many other instances, and it would have expressly limited the scope of section 1123 by making it “subject to” other specific clauses of the Bankruptcy Code.  Instead, Congress chose to limit the “notwithstanding” clause to only “nonbankruptcy law.”  Accordingly, the court found that section 1123(a) by its express terms does not displace other portions of the Bankruptcy Code.
The Third Circuit rejected the insurers’ arguments that prior practice and the legislative history of section 1123(a) supported the view that section 1123(a) does not preempt state law.  The court found that prior practice, however interpreted, deserved little weight, as did the thin and vague legislative history cited by the insurers.  Both were insufficient to overcome the plain and unambiguous meaning of the words Congress used to draft the statute, which the Court already had concluded indicated a clear intent to preempt state law.
Lastly, the court noted that preemption would further the purposes of the Bankruptcy Code.  Federal-Mogul’s use of its existing assets, in this case the insurance policies, to address current and future asbestos claims arising out of past occurrences and to resolve all of its asbestos liabilities was in line with the overarching “fresh start” goal of bankruptcy.  The court further noted that allowing Federal-Mogul to use its valuable insurance policy proceeds to compensate present and future asbestos claimants in exchange for a release from future liability also furthered the policy purposes of section 524(g), which was to help asbestos victims receive maximum value while ensuring the continued viability of a debtors’ business.
Conclusion
Ultimately, Federal-Mogul makes clear that, in the Third Circuit, anti-assignment provisions in a debtor’s insurance policies are preempted by section 1123(a)(5)(B) of the Bankruptcy Code to the extent they prohibit transfer of insurance rights to a section 524(g) trust.  The court’s lengthy and detailed analysis supporting the broad scope of section 1123(a)’s preemption power only discussed a few limitations to that scope.  For example, section 1123(a) does not preempt otherwise applicable nonbankruptcy laws concerned with protecting public health, safety, and welfare.  What remains unclear is where the Third Circuit will draw the line and allow section 1123(a) to preempt applicable nonbankruptcy law in other contexts.