Recent Mass Tort Bankruptcy Cases Help to Define the Outer Limits of Bankruptcy Powers
by David L. Barrack, Fulbright & Jaworski LLP
The Third Circuit Court of Appeals begins its decision in Combustion Engineering Inc., 391 F.3d 190 (3rd Cir. 2004), by noting that the state and federal judiciary have for decades been trying to find a way to cope with the overwhelming volume of asbestos lawsuits and fashion a method to deliver just and efficient resolution of asbestos claims. The court goes on to mention that the Supreme Court denied two efforts to use global settlement class actions to resolve the asbestos avalanche and used both opportunities to call on Congress to enact legislation creating a “national asbestos dispute resolution scheme.” Id. at 200.
Congress has been trying to comply with the Supreme Court’s call for many years. This year there is much fanfare in the media about the bi-partisan introduction of “A Bill to Create a Fair and Efficient System to Resolve Claims of Victims for Bodily Injury Caused by Asbestos Exposure, and for Other Purposes The Fairness in Asbestos Injury Resolution Act.” Depending on which side of the asbestos debate you are on, you are either filled with great hope or despair. The enactment of comprehensive asbestos legislation should greatly reduce the burden on the bankruptcy court system. Whether the asbestos legislation will be enacted by both houses of Congress and signed into law is well beyond the purview of this news update. As of the last report in the media, the asbestos bill was bogged down in committee with some 80 amendments. Senate Judiciary Chairman Arlen Spector (R–Pa.) predicted a yeoman’s effort would get the bill out of committee in one day by voting on all amendments. The committee, however, was prevented from completing the task when an unnamed senator invoked a procedural rule that required the committee to adjourn until its May session.
While Congress does its work, the Bankruptcy Code is being used, some say abused, to hone an expedited formula for defendants to shed their asbestos liabilities, and to allow for resolution and payment of claims to claimants. If perfected, national legislation may not be needed. It may be that companies affected by asbestos liabilities and the asbestos bar are close to fashioning a cookie cutter pre-packaged bankruptcy matrix which addresses the need for quick resolution of mass litigation. In a recent article, one author lamented that “as far more companies facing asbestos liability seek the special protections bankruptcy offers them, the interest in swift resolution at enormous numbers of claims and rapid plan confirmation has resulted in pre-packaged asbestos bankruptcies that flout the provisions of the Bankruptcy Code, often at the expenses of asbestos victims.” See “From Free-Fall to Free-For-All: The Rise of Pre-Packed Asbestos Bankruptcies,” ABI Law Review, Winter 2004, Ronald Barliant, et. al.
In Combustion Engineering, the debtor submitted a pre-packaged bankruptcy plan through which Combustion Engineering and, more importantly, its affiliated corporate sister companies and parents, sought to shed their asbestos liabilities in favor of a two-trust structure. The Third Circuit strongly re-affirmed the limits on the use of the broad equity powers of the bankruptcy court under §105 of the Bankruptcy Code. The Combustion Engineering plan sought to extend a §524(g) channeling injunction to independent non-derivative claims against two non-debtor third parties who did not meet the explicit requirements of §524(g). Recognizing the limitations of §524(g), the lower courts used §105 to issue the channeling injunction.
While the Third Circuit recognized that the Combustion Engineering pre-packaged plan represented a comprehensive effort to find a mechanism for the resolution of liabilities in a very quick and efficient manner, without the need for a multi-year bankruptcy case, the court would not sustain the effort based on a significant expansion of the equity power under §105. The Third Circuit reaffirmed prior law that holds that “Section 105 does not authorize bankruptcy courts to create substantive rights that are otherwise unavailable under applicable law, or constitute a roving commission to do equity” Id. at 236. Moreover, the general grant of equitable power cannot trump the specific. The court would not sustain a use of §105 to grant non-debtor third parties with non-derivative claims an injunction they could not get under §524(g). The Third Circuit also used the its decision to re-affirm the limits of “related to” jurisdiction, and give guidance on the two-trust structure, the use of stub claims to confirm a plan and the going concern requirements of §524(g).
At first blush, Combustion Engineering may appear to be a significant rebuke to the prepackage plan structure. However, upon reflection, the Third Circuit may be drawing a road map to be followed in future cases in an effort to find resolution to mass tort bankruptcy that meets the needs of efficiency and fairness.
A more recent decision from Delaware also impacts on the structure of future plans of reorganization. In a strong defense of the absolute priority rule, the Delaware District Court, in Armstrong World Industries Inc., 320 B.R. 523 (D. Del. 2005), denied confirmation of a chapter 11 plan which provided warrants to old equity while senior unsecured creditors received less than a 100 percent distribution. Under the plan, trade debt would receive a 59.5 percent distribution in respect of their claims. The plan also provided that old equity would receive warrants if the unsecured trade debt voted in favor of the plan. However, if the plan was not approved by the unsecured trade debt, then the warrants would go to the asbestos creditor class, which was a class in priority to trade. The asbestos class had agreed, however, that it would immediately transfer the warrants to old equity. Hence, old equity would get a distribution even if trade was not paid in full and did not approve the plan.
Because trade debt voted against the plan, the plan had to be confirmed by cramdown under Bankruptcy Code §1129(b). District Judge Robreno determined that as matter of law the Armstrong World plan violated the absolute priority rule and accordingly, could not be confirmed. In support of the plan structure, the proponents cited the First Circuit’s decision in In re SPM Manufacturing Corp. 984 F.2d 1305 (1st Cir. 1993) for the proposition that a senior class can give up its distribution to a class many steps below it even though the intervening classes are not paid in full. Judge Robreno rebuffed that argument. Even in the face of a four-year effort by Armstrong World to reorganize and shed its asbestos liabilities, the court reaffirmed that absolute priority rule and denied confirmation. The court found SPM Manufacturing to be inapposite since in that case the creditor giving up its distribution was a secured creditor who received its collateral in respect of its secured claim in a chapter 7 case outside the distribution scheme of the Bankruptcy Code and then pursuant to a sharing agreement, gave part of the collateral to the unsecured creditors. The court held that the distributions in SPM Manufacturing were outside of the Bankruptcy Code’s distribution scheme and thus, not subject to the absolute priority rule. The court held that in a chapter 11 case, distributions to unsecured creditors under a plan all fall within the Bankruptcy Code’s priority scheme and must comport with the absolute priority rule. Unless overturned, Armstrong World puts a break on a creative effort to fashion a consensual plan that returns something to old equity when unsecured trade is not paid in full.
It appears that attorneys are being very creative in their attempts to fashion asbestos dispute resolution, however, the various courts are restricting those overly enthusiastic methods, while leaving room for perfection under the Bankruptcy Code. With guidance from the courts, federal legislation may ultimately prove to be unnecessary.