Mass Torts Committee

Volume 6, Number 1 / February 2008

In This Issue

• ABI's 19th Annual Spring Meeting: Committee Educational Session
• Insurance Assignment and Preemption Stipulation Allows Federal-Mogul to Emerge from Bankruptcy

• Committee Officers
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Insurance Assignment and Preemption Stipulation Allows Federal-Mogul to Emerge from Bankruptcy

Written by: Edwin J. Harron and Travis N. Turner

Young Conaway Stargatt & Taylor, LLP; New York

In the case of In re Federal-Mogul, the plan proponents[1] and certain of Federal-Mogul’s insurers reached an innovative agreement that resulted in an uncontested plan confirmation ruling, allowing the debtors to consummate their reorganization plan promptly and free of appeals. Toward the end of 2007, Federal-Mogul faced strong market pressure to conclude its bankruptcy case. This pressure resulted primarily from the fact that its exit lender’s commitment to provide a $3.5 billion financing facility was set to expire on Dec. 31, 2007. Absent consummation of its plan by that deadline, Federal-Mogul was faced with having to renegotiate its credit facility in a tight credit market and risked further delaying its emergence from bankruptcy.

To allow the company to move forward with the consummation of its plan, Federal-Mogul, its asbestos constituencies and those of its insurers who stood in opposition to plan confirmation agreed to carve out from the confirmation process the issue of whether the Bankruptcy Code preempts state law and authorizes the assignment of insurance proceeds to a §524(g) trust notwithstanding the terms of any anti-assignment provisions in the insurance policies at issue. The asbestos insurance rights assignment issue was central to Federal-Mogul’s plan. Under §524(g), a debtor seeking to obtain the protections of a channeling injunction is required to establish and fund a trust to pay the pending and future asbestos claims for which the company is liable. The plan provided for the funding of Federal-Mogul’s trust by transferring to it the right to collect proceeds from the insurance coverage Federal-Mogul has available to pay asbestos claims in addition to funding the trust with a substantial equity stake in the reorganized company. Federal-Mogul consummated its plan on Dec. 27, 2007, and even though several insurers may yet pursue limited appeals related to the assignment and preemption issue, those appeals will not undermine the “finality” of the confirmation order or otherwise impact Federal-Mogul’s emergence from bankruptcy.

Federal-Mogul filed for bankruptcy on Oct. 1, 2001. The proceedings lasted over six years and encompassed parallel insolvency proceedings in the United Kingdom. Federal-Mogul’s 164-page plan addresses several distinct sources of asbestos liability that impacted various segments of the Federal-Mogul enterprise. At one point, there were more than 40 objections to plan confirmation. Over the course of the case, the bankruptcy court grappled with many sophisticated and complex issues, including the extent to which a §524(g) channeling injunction could be extended to parties whose asbestos liabilities were intertwined with Federal-Mogul’s as a result of past acquisitions. By the conclusion of its confirmation hearing, Federal-Mogul had resolved substantially all plan objections except for the insurance assignment and preemption objections and objections related to Cooper Industries’ ability to channel claims to Federal-Mogul’s §524(g) trust.[2]

The plan was carefully constructed to render it “insurance neutral” in accordance with prevailing Third Circuit case law.[3] Many of the insurance neutrality provisions of the plan arose from prior negotiations between the debtors, certain asbestos insurers, the asbestos claimants’ committee and the future claimants’ representative, and were the subject of a stipulation approved by the bankruptcy court on Sept. 19, 2006 (the “First Insurance Stipulation”).[4] Under the First Insurance Stipulation, the stipulating insurers agreed to narrow the scope of their plan objections to “whether, under the Bankruptcy Code as a matter of law, the Assignment is valid and enforceable against the Insurers notwithstanding anti-assignment provisions in or incorporated in the Policies and applicable state law.”[5] The First Insurance Stipulation also provides that if the bankruptcy court determined that the Code authorizes the “assignment of the Asbestos Insurance Policies, their proceeds and/or other Asbestos Insurance Assets to the Trust, notwithstanding the terms of the Asbestos Insurance Policies or applicable nonbankruptcy law, the Asbestos Insurance Companies will be barred from asserting any defense that such assignment is prohibited by the Asbestos Insurance Policies or applicable nonbankruptcy law.”[6] This left the insurance assignment and preemption issue as the only contested issue between the debtors and many of its insurers.

Consistent with the First Insurance Stipulation, which left the preemption and assignment dispute to be resolved by the bankruptcy court, several insurers objected to the confirmation of the plan on the grounds that “the assignment of the policy rights to the Trust is prohibited by the applicable insurance policies and state law and that nothing in the Bankruptcy Code or other federal law preempts applicable state law or otherwise authorizes the Court to impair their state law rights and defenses” (the Preemption Issue”).[7] The plan proponents argued in response that the “assignment of rights in certain insurance policies to the Trust is valid and enforceable under Sections 524(g), 541(c)(1) and/or 1123(a)(5)(B) of the Bankruptcy Code,” which sections “preempt any anti-assignment provisions and state law defenses that may be provided under the insurance policies and applicable state law.”[8]

In mid-2007, the bankruptcy court held an extensive plan confirmation hearing on eight separate trial days spanning three and half months. Near the conclusion of the hearing, Judge Fitzgerald stated that she anticipated confirming the plan and overruling the objections concerning the Preemption Issue.[9] 

Notwithstanding Judge Fitzgerald’s expressed predisposition towards the Preemption Issue, the plan proponents still faced the likelihood that the plan would not become effective by the approaching Dec. 31, 2007, exit financing deadline. Both the plan and the exit financing facility required a final, nonappealable confirmation order before either would become effective.  Although applicable case law strongly suggests that the plan proponents would prevail in any appeal of the confirmation order arising from the Preemption Issue, even under the most expedited of schedules the course of any appeals would undoubtedly have prevented the consummation of the plan by year’s end. To avoid any appeals of the confirmation order, the plan proponents and the insurers agreed to carve out the Preemption Issue from the confirmation order and to address it in a separate order (the “Preemption Order”).

This novel agreement separated the Preemption Issue from plan confirmation, but left the stipulating parties with the same arguments on appeal that they would have had if the bankruptcy court had resolved the Preemption Issue as part of the confirmation ruling. Specifically, the insurers agreed not to argue in any appeal of the Preemption Order that by separating the Preemption Issue from the confirmation order the plan proponents had conceded that Federal-Mogul’s assignment of insurance rights to the Trust was an unnecessary provision in the plan or that the bankruptcy court lacked jurisdictional or statutory authority to grant the Preemption Order. The plan proponents likewise agreed not to argue that any appeal of the Preemption Order would be moot as a result of the substantial consummation of the Plan.

As a result of the stipulation on the Preemption Issue, the bankruptcy court was able to confirm the Plan on an “uncontested” basis on Nov. 8, 2007. The plan confirmation was affirmed by the district court on Nov. 16, 2007. Federal-Mogul emerged from bankruptcy, and its plan became effective on Dec. 27, 2007. The bankruptcy court has not yet ruled on the Preemption Issue.