Restructuring

This post follows up on a two-part series discussing the potential use of other people’s money to fund claims against a debtor, and when the prospect that a third party, such as an insurer, may be liable on such claims will confer standing on that party to raise issues in the bankruptcy case.  The latest decision on point comes out of the U.S. Court of Appeals for the Ninth Circuit, which now has joined other courts in giving insurers that may be funding a plan standing to participate in mass tort bankruptcies.  In Motor Vehicle Casualty Co. v. Thorpe Insulation (In re Thorpe), the Ninth Circuit found that a plan that likely will increase the economic exposure of an insurer to asbestos claims was not “insurance neutral” and, therefore, affords the insurer the right to be fully and fairly heard before such plan is finalized.
The Debtors
Thorpe Insulation Company and Pacific Insulation Company, the debtors in the underlying bankruptcy proceedings, are California companies that were involved in the distribution, installation, and repair of asbestos-containing products.  Prior to its bankruptcy filing, Thorpe (and Pacific, as successor-in-interest to Thorpe) faced litigation on account of personal injury and wrongful death claims arising from alleged exposure to such products.  At the time of its chapter 11 filing, Thorpe estimated that approximately 2,000 asbestos cases were pending against it, with more suits anticipated to be filed in the future.  Over the years, Thorpe had purchased general liability insurance policies, which it asserted covered claims for injuries caused by asbestos exposure.  Certain types of insured claims were subject to coverage limits.
The Plan and Trust
The debtors’ plan, which was approved by the bankruptcy and district courts, provided for the issuance of injunctions under section 524(g) of the Bankruptcy Code to channel certain asbestos-related liabilities to a trust specifically created to make distributions to present and future holders of asbestos-related personal injury and wrongful death claims.  The trust was funded with cash and securities generated from settlements that Thorpe reached with thirteen of its insurers in exchange for releases of claims and protection under the 524(g) channeling injunctions.  The debtors also assigned their insurance rights to the trust, including policies with non-settling insurers.
The trust’s distribution procedures included a valuation matrix that established the parameters for valuing different types of asbestos-related claims.  Claimants are permitted to bring their claims against the trust or seek the trust’s permission to sue non-settling insurers directly under Thorpe’s insurance policies.  As with most asbestos trusts established under asbestos bankruptcy plans, the trust provided for the establishment of a Trust Advisory Committee, comprised principally of lawyers for asbestos plaintiffs, which has substantial supervisory powers on trust decisions.
Although the plan purported to be “insurance neutral,” the Ninth Circuit pointed out four exceptions in the plan to the insurers’ otherwise preserved defenses:  (i) defenses based on the assertion that the transfer of insurance rights to the trust is unenforceable or otherwise breaches the terms of the any policy, settlement, or other agreement with an asbestos insurer; (ii) defenses that have been released, waived, altered or otherwise resolved in full or in part in any settlement or other agreement with an asbestos insurer; (iii) defenses subject to claim or issue preclusion; or (iv) defenses premised on the commencement of the chapter 11 cases.
The Appeal
Both the bankruptcy court and the district court held that non-settling insurers lacked standing to challenge confirmation of the chapter 11 plan because the plan was insurance neutral.  These insurers appealed from the confirmation order and raised both the standing issue as well as their objections to the chapter 11 plan.  The non-settling insurers’ principal objections to the plan were that the plan impermissibly preempted their state contract law rights, did not comply with section 524(g), was not filed in good faith, and was developed by conflicted counsel.  The Ninth Circuit did not grant a stay of confirmation pending appeal, and while the appeal was under decision, the plan went effective.
Mootness
As a threshold matter, the Ninth Circuit addressed the issue of mootness.  The appellate court stated the appeal was not constitutionally moot if the court could fashion “‘any effective relief in the event that it decides the matter on the merits’” in appellants’ favor.  Because the appellate court could reverse plan confirmation or require modification of the plan, thereby giving relief to appellants, it determined the appeal was not constitutionally moot.  In addition, the appellate court analyzed whether the appeal was equitably moot – that is, whether “‘a comprehensive change of circumstances’ has occurred so ‘as to render it inequitable for [the] court to consider the merits of the appeal.’”  The panel noted that the Ninth Circuit has not articulated a comprehensive test for equitable mootness.  After analyzing the appellate court’s precedent, it endorsed a test similar to that adopted by other circuits, which looks to “whether a stay was sought, whether the plan has been substantially consummated, whether third party rights have intervened, and, if so, whether any relief can be provided practically and equitably.”  The court found the debtors’ plan had not been substantially consummated within the meaning of section 1101(2) of the Bankruptcy Code because not even half of the cash settlement had been transferred to the trust, and only $15 million had been paid out to asbestos claimants.  Among other things, a “transfer of all or substantially all of the property proposed by the plan to be transferred” is one of the conditions to substantial consummation.  Although not mentioned in the Ninth Circuit’s opinion, the debtor’s brief notes that the reason so little money had been transferred to the Trust was because many of the insurers’ settlements provided that they only would pay when the confirmation order and the settlement approval orders become final and unappealable.  (Given the standard for substantial consummation, this essentially puts into place a self-effectuating stay.)  In addition, although it was impossible to toss out the plan entirely, the appellate court found that the bankruptcy court could still fashion viable remedies on remand if the bankruptcy court found appellants’ claims had merit, for example, by changing governance of the trust, amending trust distribution procedures, amending the plan provisions regarding the effect of the trust distribution procedures on direct suits against appellants, or requiring appellees to contribute more to the trust.  Therefore, the appeal was not equitably moot.
Standing
Having determined that it could hear the appeal, the Ninth Circuit panel went on to address the bankruptcy standing of appellants.  As we have reported here and here, to have standing in bankruptcy proceedings, a party must meet the constitutional requirements for litigants in federal cases, as well as the standing requirements of section 1109(b) of the Bankruptcy Code.  In finding that appellants had party in interest standing under section 1109(b) to object to confirmation of the plan, the appellate court’s analysis focused on the bankruptcy court’s and district court’s conclusion that because the plan was insurance neutral, appellants had no standing.
The Ninth Circuit’s analysis of “insurance neutrality” was similar to the Third Circuit’s in In re Global Industries Technologies, Inc., which was decided last spring.  Like the Third Circuit, the Ninth Circuit held that, because the plan could have a substantial economic effect on the insurers, it was not “insurance neutral.”  In so holding, the Ninth Circuit determined that the plan’s potential to increase the liabilities of the objecting insurers had a “real world” monetary impact that was sufficient to allege an injury in fact on the part of the insurers.  The plan did so in several ways.  First, it was possible the plan will have a preclusive effect on asbestos suits brought against appellants by claimants because the plan bound appellants to the trust’s resolution of their claimed liability without affording them an opportunity to participate in establishing the valuation matrix.  Second, appellants must indemnify trust payments pursuant to settlements with claimants, without necessarily having an opportunity to challenge settlement amounts as unreasonable.  Third, the plan permitted asbestos claimants to file direct suits against appellants.  If the trust ran out of money, the channeling injunction would force claimants to seek damages from non-settling insurers, increasing the likelihood of claims against appellants.  Fourth, the plan may affect appellants’ ability to recover costs under their reinsurance with settling insurers.  Because of these changes to appellants’ insurance policies and relationships, the appellate court concluded that the debtors’ plan had the potential to substantially affect appellants economically and, therefore, was not “insurance neutral.”
For the same reasons – the plan’s effect on appellants’ contractual rights, financial interests, and the possibility of affecting their litigation rights in court, all of which potentially will increase appellants’ liabilities – the Ninth Circuit also determined that appellants met both Article III standing requirements and federal court prudential standing requirements.
As a result, the Ninth Circuit reversed the decisions of the bankruptcy and district courts.  Recognizing that no “tidy solution” existed to the case, the Ninth Circuit remanded the confirmation issues back to the bankruptcy court so that appellants could have a full and fair opportunity to present evidence and be heard on those issues before the bankruptcy court.
The Take-Away
As a result of decisions such as GIT and Thorpe, it appears that the bar for debtors to demonstrate “insurance neutrality” is rising in mass tort cases.  Simply stating a plan is “insurance neutral” and that it preserves insurance defenses may not suffice.  Notwithstanding the preservation of insurance defenses, a likely increase in insurers’ exposure under a plan may afford the insurer party in interest standing to challenge the plan.
As with the Third Circuit, the Ninth Circuit in Thorpe seemed to be influenced to some degree (although to a lesser extent than the Third Circuit) by objecting insurers’ contentions that asbestos claimants’ counsel has somehow hijacked the reorganization process (in Thorpe, through structuring of the trust and the valuation matrix).  The Third Circuit in GIT honed in more explicitly on this concern about the integrity of the bankruptcy proceeding and specifically instructed the bankruptcy court to conduct a more searching review of the insurers’ allegations of collusion between the debtors and claimants’ counsel.  In Thorpe, the Ninth Circuit did not remand with any specific instructions for investigating appellants’ allegations of collusion, but did suggest as a potential remedy on remand new governance for the trust, if the bankruptcy court is ultimately persuaded that the trust is in the hands of biased parties.  It remains to be seen whether insurers will raise this concern more strategically in asbestos cases in the future.