Re: Future Claims and Mass Torts in Bankruptcy

National Bankruptcy Review Commission

One Columbus Circle N.E., Suite 5-130 ¶ Washington, D.C. 20544 ¶ 202-273-1813 ¶ Fax: 202-273-1048 ¶ e-mail

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To: National Bankruptcy Review Commission
Interested Persons

From: Elizabeth Warren, Reporter, NBRC
Melissa Jacoby, Staff Attorney, NBRC

Date: March 24, 1997

Re: Future Claims and Mass Torts in Bankruptcy

Many businesses have looked to the bankruptcy system for a systematic and equitable structure to deal with mass torts. Recognizing and treating current and identifiable future tort claims in bankruptcy can prevent a debtor from collapsing as a consequence of a catastrophic event, mass injury linked to a product, or a similar calamity. In these cases, collapse would adversely affect the labor force and other businesses that depend on the company, and also would deprive all claimants of the benefit of the company’s going concern value and future earning power. In liquidation cases, being able to bring future claimants into the process permits more equitable apportionment of assets among all those who have been affected by a company's actions. Giving courts better tools to deal with cases involving significant tort liability offers the prospect of greater certainty, both as to outcomes and recoveries for tort claimants and general creditors.

In its extended deliberations on this topic, the National Bankruptcy Review Commission has profited from thoughtful discussions and helpful comments from a number of people. In particular, Barry Adler, Frederick Baron, Donald Bernstein, Hon. David Coar, Jeffrey Davis, David Epstein, Malcolm Gaynor, Leonard Goldberger, Robert Greenfield, Barbara Houser, Ralph Mabey, Hon. Robert Mark, Michael Reed, Hon. Jack Schmetterer, Alan Tenenbaum, George Triester, Jeffrey Warren, Stephen Case and Lawrence King have been generous in contributing their time to this proposal.

The Commission has decided to make a comprehensive recommendation to Congress to deal with mass torts and future claims in bankruptcy. A working draft of that proposal is attached. The Commission invites your comments, which can be sent by regular mail or by e-mail to the addresses listed above. The Commission plans to consider this topic further at the morning session of its April 18 meeting.

This is a draft proposal. The Commission has not voted on any of the specific items listed here, and both the scope and the details of the proposal could change significantly in future iterations. This draft is the product of lengthy discussions, and one for which the Commission actively solicits feedback at this juncture in its deliberations.

The Working Group calls your attention to the definition of future claims. The provision has been redrafted to make it less repetitive and the provision from the asbestos amendments has been added to limit eligibility for future claims treatment to "big problems." The group would be grateful for comments on the approach used here and whether a different approach would be superior.

The Working Group also draws your attention to the question of the standard of care applicable to activities of the claims representative. There was a lengthy discussion on this point at the January meeting. The goal is to provide adequate assurance that the representative will not merely be a lackey of the plan proponents who want the claims washed away. At the same time, it is important that standards not be so stringent that no one could serve or that the representative would lack the requisite flexibility to craft creative solutions. The Working Group also solicits comments about the appropriate mechanism for a court to determine that a proposed class meets the eligibility requirements. Any thoughts on the standard and the triggering mechanism would be particularly welcome.

Finally, the Working Group notes that this proposal contains no specific provision for a mechanism to assure adequate funding is made available. The Working Group invites comments on whether it should be left to the parties, including the future claims representative, to negotiate about the adequacy of funding, or whether the statute should contain a standard against which the court makes an independent judgment regarding funding.

The Working Group is grateful for the many thoughtful contributions people have made to this proposal.

Summary of Key Features of

a Future Claims Proposal

A definition of "future claim" would be added to the definition of "claim." A number of constraints are embedded in the concept of "future claim," including the requirement that such claim be based on the debtor’s pre-bankruptcy acts or omissions that may give rise to liability although the actual injured parties have not been discovered by the time of filing. The claims would have to be reasonably capable of estimation. A debtor would have to be subject to demands for payments for the injuries and likely to be subject to future demands for payment on similar grounds.

Whenever a debtor intended to deal with future claims, there would have to be a future claims representative for the class and adequate notice would have to be provided to the class.

If all applicable constraints were satisfied, the prospective recovery for a holder of a future claim would be limited to the amount estimated for allowance of that claim, most likely to be distributed through a trust or an insurance fund. Channeling injunctions would be specifically authorized.

A chapter 7 liquidation might include provisions for holders of future claims, if the situation satisfied the same constraints as those imposed on chapter 11 plan proponents.

A good faith purchaser under 11 U.S.C. §§ 363 or 1123 would take free and clear of future claims based on successor liability for pre-sale acts of the debtor if the notice, hearing and estimation requirements for dealing with holders of future claims had been met at the time of the sale. The bankruptcy court would be authorized to enjoin suits against a successor brought by holders of future claims whose claims had been discharged.

Dealing with future claims would be permitted but not mandatory. Even if there were potential liabilities that satisfied the definition of future claim, a chapter 11 plan proponent might propose a plan that did not deal with those future claims, and they would ride through the bankruptcy and would remain postpetition obligations of the debtor. Provision for future claimants would not be necessary in all chapter 7 liquidations. Most cases would liquidate without future claims provisions. In some cases, however, where it was likely that a substantial class of future claimants would exist, a trustee might have to provide for those claimants as well as for the present claimants.

National Bankruptcy Review Commission

One Columbus Circle NE, Suite 5-130 ¶ Washington, D.C. 20544 ¶ 202-273-1813 ¶ Fax: 202-273-1048 ¶;

Outline of Future Claims Proposal

March 12, 1997

At the December 1996 meeting of the National Bankruptcy Review Commission, the Commissioners decided to work toward developing a specific recommendation for dealing with future claims in bankruptcy. The Mass Torts and Future Claims Working Group settled on some basic principles in their approach. The definition of "claim" would have to be clarified to create a uniform understanding of what claims would be sufficiently cognizable to be acknowledged, treated, and discharged in bankruptcy. The future claims provision would be designed to deal with estimable claims that threatened the economic survival of the business, not to provide generic discharges of currently unknown and speculative future liabilities. The Bankruptcy Code would have to provide for meaningful representation of holders of future claims in the bankruptcy case generally and in the plan negotiation process. Any proposal would have to strike a balance between the need for adequate compensation to victims and permitting an otherwise viable business to continue operations. The Working Group concluded that, of the currently available choices for dealing with mass torts, the bankruptcy process offers clear advantages.

This outline briefly addresses each of these features.

I. Defining Future Claims

Using the current definition of "claim," which includes "unliquidated," "contingent," and "unmatured" liabilities, [ FN: See 11 U.S.C. §101(5).] some courts have allowed debtors dealing with mass tort or products liability to provide for and discharge future claims. Not all courts, however, recognize a claim if a cause of action has not accrued under non-bankruptcy law. [ FN: See , e.g. , In re Frenville , 744 F.2d 332 (3d Cir. 1984).] This creates inequity among creditors and does not comport with the Bankruptcy Code’s broad conception of "claim." Even the courts that have permitted debtors to deal with and discharge future claims have worked without statutory line-drawing guidance and thus have allowed debtors vastly different degrees of latitude in bringing future claims into the process. In some cases courts have held that remote and unanticipated claims based on the debtors’ prepetition conduct can be discharged even if there isno identification, representation, or treatment in the plan, [ FN: See , e.g. , Texaco Inc. v. Sanders , 182 B.R. 937 (Bankr. S.D.N.Y. 1995).] while in other instances a debtor has not been able to reorganize its businesses because it was not able to convince a court that the court had the power to channel legitimate holders of future claims away from the business. [ FN: See Kathryn R. Heidt, "Products Liability, Mass Torts and Environmental Obligations in Bankruptcy: Suggestions for Reform, " 3 Am. Bankr. Inst. L. Rev. 117, 126 (1995).]

The Working Group definition is designed to permit a reorganization to deal with liabilities that threaten not only the future of the company but that also threaten future compensation for those injured by the company. It is also designed to permit parties with unmatured claims to be represented in a liquidation. In both cases, the objective of inclusion is to provide some compensation for parties who might otherwise end up with nothing. The constraints and limitations in the definition of "future claim" would provide the gatekeeping function designed to prevent debtors from taking a broad and generic discharge in bankruptcy, including a discharge of currently unknown and speculative future liabilities based on past events. The standards also would eliminate the possibility that a bankruptcy reorganization would become an automatic liability "bath;" a plan could deal with future claims only if failure to deal with those claims would make it unfeasible to reorganize the business. Due to the restrictions in the definition of future claims, most cases, including liquidations, would not be burdened with considerations about future claims.

The working hypothesis for dealing systematically with future claims logically begins with the notion that a future claim can be a cognizable claim in bankruptcy, under the following circumstances:

A definition of "future claim" should be added as a subset of the definition of "claim" in 11 U.S.C. § 101(5). "Future claim" should be defined as:

a right to payment or equitable relief that has not accrued under non-bankruptcy law that is created by one or more acts or omissions of the debtor if:

1) the act(s) or omission(s) occurred before or at the time of the order for relief;

2) the act(s) or omission(s) may be sufficient to establish liability when injuries ultimately are manifested;

3) at the time of the petition, the debtor has been subject to demands for payment for injuries arising from such acts or omissions and is likely to be subject to substantial future demands for payment on similar grounds;

4) the holders of such rights to payments are known or, if unknown, can be identified or described with reasonable certainty; and

5) the amount of such liability is reasonably capable of estimation or no harm results from failure to estimate.

The definition of "claim" in section 101(5) should be amended to add a definition of "holder of a future claim," which would be an entity that holds a future claim.

Defining "future claims" in the statute would resolve the current debate over the kinds of future liabilities that can be resolved as claims in bankruptcy. This definition would circumscribe the conditions under which a plan proponent could deem a potential liability to be a future claim in a way that is consistent with the preexisting definition of claim and the spirit of the Bankruptcy Code generally. The definition is intended to limit the claims that would be eligible for treatment to those significant tort liabilities that meet specified standards. It would be clear that a plan proponent could deal with identifiable holders of future claims in a plan and discharge those claims, if the plan met the requisite standards that are delineated here and in the following pages.

In this draft, the definition of "future claims" is a subset of the definition of claims. In so doing, the provision would avoid the possibility of creating a lacuna between "claim" and "future claim." This approach also would avoid the problems that were created by the Asbestos Amendments, which were part of the Bankruptcy Reform Act of 1994. [ FN: 11 U.S.C. §524(g), (h).] Because those amendments deal with injuries that may become manifest in the future without defining which of those may give rise to a claim, they create great uncertainty when the courts try to interpret them in the context of other provisions in the Bankruptcy Code. [ FN: If Congress adopted the types of recommendations that are contained in this proposal, the Asbestos Amendments may be superfluous.]

II. Protecting the Interests of Holders of Future Claims

If a plan proponent intended to channel collection of inchoate claims away from the debtor business, the interests of the holders of such claims should be represented in the plan negotiation process and the plan should provide reasonably sufficient resources to fund the payment of future claims. Procedural due process requires that a claim holder, or representative thereof, receive notice and the opportunity to be heard insofar as practicable. [ FN: See Mullane v. Central Hanover Bank and Trust Co. , 339 U.S. 313 (1950). An inchoate claim, such as a future claim, may not be entitled to Constitutional protection under the Fifth Amendment because it is not a property interest. See, e.g. , Ralph R. Mabey & Jamie Andra Gavrin, "Constitutional Limitations on the Discharge of Future Claims in Bankruptcy, " 44 S.C.L. Rev. 745 (1993); Silver v. Silver , 280 U.S. 117, 122 (1929). The Working Group concluded as a matter of public policy that it wished to consider bankruptcy treatment for future claimants only in circumstances in which appropriate notice efforts had been made and the claimants were adequately represented by a future claims representative.] The Bankruptcy Code should delineate the steps that a plan proponent would be required to take to satisfy concerns of due process and fairness. The requirements that could be built into the Code should not be interpreted to preclude other logistical methods that might be necessary to satisfy due process, such as publication notice.

Future Claims Representatives

The bankruptcy court shall order the appointment of a representative for each class of holders of future claims. This representative shall have the power to file claims on behalf of the class of future claims and to cast votes on behalf of the holders of future claims.

The court has the discretion to determine whether the representative(s) will have the powers, rights, obligations, and duties of a committee under section 1102.

A future claims representative shall be subject to suit only in the court where the representative performed his or her services. Such representative shall have no personal liability for any act or omission taken in good faith on behalf of the holder of the future claim. This exculpation does not extend to criminal acts or the improper receipt of any personal benefit by a future claims representative.

A holder of a future claim may elect during the pendency of a bankruptcy to represent his or her own interests and may opt out of being represented by the future claims representative.

Those who participated in the Working Group’s discussions agreed that the success and validity of the system would depend on whether holders of future claims had an advocate, and they strongly endorsed the use of future claims representatives in all cases to represent the interests of classes of holders who were not identified specifically during the bankruptcy proceedings.

This proposal recognizes that more than one representative might be necessary to represent multiple groups of holders of future claims with competing interests. It might be inappropriate to sweep all holders of future claims into a class with a single representative if the nature of their injuries were quite dissimilar. Narrowly defining the constituency of a future claims representative is consistent with the intent of related provisions that require adequate treatment as a prerequisite to discharge.

An exculpation clause would provide reasonable protection against suit for a representative who has fulfilled the duty to represent the future claimants. Otherwise, the threat of personal liability might unduly discourage qualified individuals from acting in this capacity. At the same time, the standard of care applicable to a future claims representative must have sufficient substance to offer meaningful guidance. Mindful of these goals, the Working Group has not yet settled on an applicable standard of care. For example, in developing the standard of care applicable to such a representative, there was concern that a state law fiduciary standard would be too high, since a fiduciary often knows more about the needs of his or her beneficiaries than might be possible for someone representing the holders of inchoate, future claims. On the other hand, such representatives should be held to a duty that will ensure fair treatment of future claimants, taking into account the circumstances of the case.

Determination of the Claim

The Bankruptcy Code presently authorizes the estimation of contingent or unliquidated claims in section 502(c). Although section 502(c) provides that this estimation is for the purpose of "allowance," the case law is divided on whether estimation provides a determination of the amount needed for such claims or whether it provides only a ballpark figure for voting and places no limit on distribution. [ FN: Cf. In re Poole Funeral Chapel Inc. , 63 B.R. 527 (Bankr. N.D. Ala. 1986) with In re MCorp. Financial Inc. , 137 B.R. 219 (Bankr. S. D. Tex. 1992). See also In re Eagle-Picher Industries Inc. , 189 B.R. 681, 683 (Bankr. S.D. Ohio 1995) ( "it is ‘contingent or unliquidated ’ claims, the value of which we are estimating. This is to be distinguished from estimating the value which claimants might take in satisfaction of their claims through some bankruptcy mechanism such as a trust ").] The latter interpretation can place a debtor in a precarious position, as the amount of funds set aside for payment of future claims necessarily is based on the estimation process. This is a problem with all claims, but it is exacerbated in the circumstances of a future claim. The Working Group recommends a change for future claims because it is essential to the structure of dealing with such claims, but it realizes that leaving the Code ambiguous regarding the treatment of present claims may be problematic. The Working Group plans to consider this problem further.

Section 502(b) should be amended to provide that the court may determine contingent, unliquidated, or future claims prior to confirmation of a plan for purposes of distribution as well as allowance and voting and to permit determination for a class of claimants as well as for individuals within the class. In addition, 28 U.S.C. § 157(b)(2)(B) should specify that the determination of the amount of future claims would be included in core jurisdiction.

Clarifying that estimation establishes the amount available for distribution injects certainty into the process for debtors and creditors alike. Whether a potential future claim can be reasonably estimated is an essential element of the proposed definition of future claim. Courts should be empowered, although not required, to make binding determinations, as the details of a plan often are fact-specific.

The estimation procedures are written to give the court as much flexibility as possible in determining claims, including the use of estimation from other fora. Future claims should, of course, be estimated based on their present value.

The Working Group has heard about both successes and failures in estimation procedures, the latter of which can lead to grossly inadequate trust assets. Examples of failed estimation often have involved multiple and sometimes unanticipated types of future claims. More recent cases seem to have had more accurate claims estimation processes. The proposed definition of future claim would require that the claims be "reasonably capable of determination." Unidentified, unanticipated, speculative claims would ride through the bankruptcy process under this proposed structure. However, estimation procedures clearly are not foolproof, and the Working Group may continue to assess this issue.

Formal determination of claims may not be required in all cases. The future claims representative may conclude, for example, that if a trust is funded with all the stock of the debtor, then formal estimation would waste both time and resources.

Channeling Injunctions

Many courts have used channeling injunctions to bring insurance proceeds to the estate to distribute to the beneficiaries, but they have had no express statutory authority to do so. The 1994 Asbestos Amendments specifically provided for channeling injunctions, but only in that narrow class of cases. [ FN: 11 U.S.C. §524(g)(1)(A).] Channeling injunctions have been recognized as serving an appropriate, useful, and beneficial role in the equitable treatment of tort claimants. For purposes of dealing with mass torts and future claims, the Code should provide that the court is empowered to use this valuable tool.

Section 524 should be amended to authorize courts to issue channeling injunctions.

This addition to the Code would establish that in appropriate cases, courts could issue channeling injunctions that would protect the reorganized debtor from claims that have been recognized and treated in the plan through the use of a claims representative, and would direct those rights to payment to a reasonably funded pool of resources. Of course, it would be inappropriate to channel future claims away from the reorganized company unless the plan of reorganization made reasonable provisions for the payment of these claims. [ FN: To streamline proceedings and provide flexibility, it might be appropriate to recommend that the Rules Committee amend Fed. R. Bankr. P. 7001 as well to provide that channeling injunctions are available without requiring an adversary proceeding, since Rule 7001(7) currently provides that adversary proceedings include those to obtain injunctions or other equitable relief.] Courts would have jurisdiction to enforce channeling injunctions.

Channeling injunctions are frequently used in connection with funding a trust to deal with future claimants. While this provision is designed to permit such approaches, nothing here requires that trusts would be the sole method of compensating future claimants. Other approaches, such as insurance policies in favor of future claimants, may be superior in some cases. Moreover, parties may find lower-cost, creative alternatives to deal with future claims. This proposal is designed to provide the tools for such initiatives.

III. Discharge

If the plan proponent had taken all required steps, the discharge of reasonably identifiable future claims would benefit most creditors. Again, the group of future liabilitieseligible to be discharged would be limited by the restrictions in the definition of future claims and by other related provisions.

Section 1141 should be amended to clarify that confirmation binds holders of future claims that have been filed under the plan, and that any further liability against the debtor is discharged.

Again, it bears repeating that the claims subject to discharge are those that meet the applicable standards. Only if a claim is filed (or deemed filed) and "dealt with under the plan" would the claim be subject to discharge. Any latent claims of victims that result from the debtor’s prepetition actions that do not fit this category, and have not been treated in the plan, will ride through the bankruptcy to the reorganized debtor or to a successor entity. [ FN: In all likelihood, these recommendations would prevent the result reached in Texaco Inc. v. Sanders , 182 B.R. 937 (Bankr. S.D.N.Y. 1995), in which the court held that private environmental damage claims had been discharged by Texaco ’s bankruptcy even though claimants were not represented in the bankruptcy and no provisions were made for their types of claims.]

Nothing in this section discharges a debtor from a newly incurred, postpetition liability. In the same way that any debtor post-filing has a current obligation to meet its postpetition obligations and to abide by all laws and regulations, the debtor dealing with future claims would have the same obligation. If, for example, a manufacturer had a duty to warn consumers when it learned of certain kinds of defects and the duty to warn arose or continued postpetition, then the debtor would be required to meet those postpetition obligations. The future claims provision is designed to deal only with liability for prepetition acts or omissions of the debtor, not to create immunity from currently arising liabilities.

IV. Successor Liability

The treatment of future claims should not depend on the form of reorganization or liquidation chosen by the parties. Instead, parties should have the flexibility to use all the tools of reorganization and liquidation, including sales free and clear, and future claims should have the same protection in all cases.

Sections 363 and 1123 should be amended to clarify that a trustee may dispose of property free and clear of future claims that might arise as through successor liability if the same requirements for dealing with future claims in a plan of reorganization had been met. An automatic injunction would enjoin holders from suing a successor/good faith purchaser, which the bankruptcy court would be authorized to enforce.

This recommendation offers protection to both debtors and creditors. This would not fully insulate a buyer; a tort victim who did not have a claim in the bankruptcy case would notbe left without redress. At the same time, holders of future claims that are reasonably identifiable should not be able to receive preferential treatment over other holders by going after assets on a successor liability theory when the terms of the sale of the assets expressly provide for a sale free and clear of past liability. The channeling injunction would ensure that the successor is protected from certain suits after the insulation from this liability has been built into the successor’s purchase price.

Freeing the productive assets of the business from the uncertainty of future products liability will encourage buyers to offer a better price, which will provide more assets to fund a greater return for potential holders of future claims.