Purchasing a §524(g) Injunction –
When Does the Purchase Price Become Property of the Plan Trust?

11 U.S.C. §524(g)(2)(B)(ii)(IV)(bb).

The ability to obtain injunctions in favor of non-debtors, combined with the inability to do so in a cram-down situation, raises a tension unique to asbestos-driven cases. Obviously, if a third party is to benefit from an injunction, it must contribute sufficient assets toward payment of those against whom the injunction will apply. See 11 U.S.C. §524(g)(4)(B)(ii) (requiring a finding that inclusion of a third party in any channeling injunction is "fair and equitable … in light of the benefits provided or to be provided …"). Because cram down against a class of asbestos claimants is prohibited, however, convincing the bankruptcy court that a third party should benefit from the channeling injunction is only the first step. To be effective, the asbestos claimants must likewise be convinced, as a class, that their treatment is "fair and equitable" under the circumstances.

Although §524(g) of the Code is silent on the issue, solicitation of the requisite approval of 75 percent of a class of claimants presumably ought to be governed by the same "good faith" standard controlling solicitations in the context of chapter 11 plan voting and confirmation. See generally 11 U.S.C. §1125(e). Successfully soliciting individual asbestos claimants can often pose a daunting task due to the vast number of claimants, the nature of their claims and the fact that their classes cannot be crammed down.

In one recent case, the solution to the difficulties of pre-petition solicitation and acceptance of a debtor's pre-packaged plan came under heavy criticism from a number of constituencies and raises the fundamental questions of (i) whether the purchase price paid by a non-debtor for a channeling injunction must be contributed solely to the §524(g) trust to be established under the debtor’s plan; and (ii) how that purchase price is to be calculated for confirmation purposes. In Combustion Engineering Inc., case no. 03-10495 (Bankr. D. Del.), the debtor's non-bankrupt parent engaged a prominent asbestos plaintiff's lawyer to assist in structuring the debtor's pre-packaged plan of reorganization and soliciting acceptances from present claimants in order to meet the 75 percent threshold required by 11 U.S.C. §524(g). The soliciting lawyer's fee was computed on a performance-based formula, with a cap of $20.0 million, and was paid entirely by the non-debtor parent. To enhance the prospects of acceptance, the debtor and its parent also funded a trust separate from that to be created under the pre-packaged plan under which present claimants could obtain a distribution outside of the bankruptcy process. The percentage distribution from this non-bankruptcy trust was alleged to be greater than that available under the plan. The trust was funded in part by the debtor in the form of a pre-bankruptcy contribution equal to one-half the value of its assets, and in part by the debtor’s parent in the form of a $30.0 million payment. The trust's administration was made contractually exclusive of the debtor's bankruptcy case, and thus outside of the oversight of the bankruptcy court.

Once the case was filed, those claimants benefitting from the non-bankruptcy trust voted overwhelmingly in favor of the debtor's pre-packaged plan, immediately affording the debtor with the requisite 75 percent acceptances. As might be expected, the debtor’s parent is protected under the channeling injunction contained in the debtor’s plan.

One of the many debates that arose in Combustion Engineering divided the various parties into two camps — those who believe that the bankruptcy court should have looked solely to the formal structure of transactions which occur outside of the bankruptcy process, and those who believe that the bankruptcy court should look behind the structure of any such transactions in order to properly evaluate their impact on the estate. Put another way, if a non-debtor parent or affiliate is in need of a §524(g) channeling injunction, must all amounts paid by that entity in furtherance of obtaining the injunction, whether directly or indirectly, be contributed to the trust established under the debtor’s plan before the plan may be confirmed?

Bankruptcy courts have long recognized that an agreement between non-debtor parties, or the disposition of non-debtor assets, is typically not a proper subject for court scrutiny. As noted by the Court of Appeals for the First Circuit, "[t]he Code does not govern the rights of creditors to transfer or receive nonestate property." In re SPM Mfg. Corp., 984 F.2d 1305, 1313 (1st Cir. 1993). See also In re Allegheny Int’l. Inc., 100 B.R. 241, 243 (Bankr. W.D. Pa. 1988) (wherein the court, although clearly troubled by the implications, nevertheless conceded that while "the Bankruptcy Code does not permit a debtor to pay its pre-petition debts to suppliers … before confirmation of the plan, … it appears to allow third parties to purchase the claims of those suppliers at discounts …"); In re Holland Indus. Inc., 103 B.R. 461, 466 (Bankr. S.D.N.Y. 1989) (noting that "[t]he acts of third parties with respect to property of non-debtors [and] their impact on a debtor's attempt to reorganize does not afford the bankruptcy courts with jurisdiction … merely because of that impact.").

Those arguing in favor of the establishment of the non-bankruptcy trust and the propriety of the success fee paid in Combustion Engineering quite reasonably focused primary attention upon the fact that (i) the debtor would be unable to recover the amounts paid into the trust; and (ii) the debtor had no interest in the success fee or that portion of the trust corpus funded by the debtor’s parent. When drawn to its logical conclusion, this argument suggests that the “fair and equitable” analysis of §524(g)(4)(B) is limited to the confines of the debtor’s plan. As such, the bankruptcy court would lack jurisdiction to even review the propriety of those transactions in which non-debtor assets are concerned. Moreover, if jurisdiction does exist, these types of transactions are benign in the context of plan confirmation, since they simply cannot be unwound to the benefit of the estate.

Opponents of this argument, by contrast, took the position that because the debtor’s parent is receiving a benefit from the bankruptcy process, any use of its property to secure this benefit necessarily confers upon the bankruptcy court the power and the duty to review all aspects of the transaction, even those that do not directly benefit the estate or cannot be unwound. See In re Cajun Elec. Power Co-op., 230 B.R. 715, 733 (Bankr. M.D. La. 1999) (denying confirmation of a debtor's proposed plan because "money being paid to the favored trade creditors … comes indirectly from assets of the estate."). In Cajun, the bankruptcy court disregarded the formal structure of a transaction between a non-debtor plan proponent and various creditors and instead focused on the financial reality of the transaction. Based upon this review, the court concluded that the non-debtor agreements were a "circuitous use of an increase in the purchase price [making it] nothing other than a method of attempting to disguise discrimination against those unsecured creditors whose claims are not being so purchased ... ." Id.

In confirming the debtor's plan, the Combustion Engineering court appears to have sided with the plan proponents by adopting the view that (i) the solicitation fee, even if disgorged, would not flow into the estate, and (ii) the transfers establishing the non-bankruptcy trust, at least for confirmation purposes, are irrelevant since they either cannot be undone or involve non-debtor property. The bankruptcy court’s ruling relies heavily upon citations to the transcript of the confirmation hearing, suggesting that the result obtained in Combustion Engineering may be unique to the specific facts of that case.

Because the language of §524(g) specifically permits a channeling injunction to extend to non-debtor parents, affiliates and subsidiaries, the use of non-debtor assets in order to facilitate the approval of any proposed plan will continue to be an issue in asbestos-driven bankruptcy cases. The extent to which the bankruptcy court can or will scrutinize the use of these non-estate assets, however, remains an open question which will likely be resolved only on a case-by-case basis. The lessons of Combustion Engineering may provide some guidance on the parameters for avoiding considerable litigation in the pre-packaged context. Perhaps one such lesson is that no solicitation procedure in the mass torts arena can likely be both effective and efficient, and still remain free from criticism.