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In his State of the Union address on Feb. 2, President Bush placed the asbestos litigation crisis on the national agenda, stating that “Justice is distorted and our economy is held back by irresponsible class actions and frivolous asbestos claims.” The president called upon Congress to pass legislation to address this issue. The president’s call came two weeks after Senator Arlen Specter, R-Pa., announced that he is finalizing legislation, to be co-sponsored by Senator Mike De Wine, R-Ohio, which would create a $140 billion trust fund to compensate victims of asbestos-related diseases. The bill proposes to remove asbestos claims from the tort system, providing instead for claimants to be compensated through a trust fund capitalized by contributions from approximately 8,000 asbestos defendants and insurers. With the goal of providing fair and efficient compensation for claimants and providing businesses with certainty regarding their asbestos liability, the bill provides for the fund administrators to evaluate claims based on specific medical criteria. Last session, the Senate failed to pass a similar bill. The Rand Institute for Civil Justice (which has been examining the asbestos claims system since the early 1980s) notes that, to date, more than 730,000 individuals have filed asbestos claims involving more than 6,000 separate defendants. The last decade has seen a sharp increase in the number of cases filed, a majority of which have been filed by individuals who are not currently impaired by asbestos-related disease. The last 15 or so years have seen otherwise healthy companies seek Chapter 11 bankruptcy protection in an effort to control mass tort liability arising from the exposure to asbestos of their employees, customers and others. Commentators agree that while Chapter 11 provides a mechanism for addressing such liability, and a process by which interests can be addressed, the interests involved in asbestos liability are complex and not readily resolved. A number of vexing issues have been raised among the many asbestos-related bankruptcy cases filed. Recently, in In re Combustion Engineering Inc., 391 F.3d 190 (3d Cir. 2004), the 3d U.S. Circuit Court of Appeals addressed whether, and in what circumstances, a channeling injunction to manage companies’ asbestos liability may extend to nondebtors. Generally, with injuries arising out of exposure to asbestos, neither the victim nor the extent of the victim’s injury is immediately ascertainable: An extended period of exposure is often followed by a long latency period before the injury manifests. Years-even decades-pass between the initial exposure and the time at which a victim’s injury becomes apparent. Companies that used asbestos in their products or manufacturing processes in the 1920s began seeing asbestos-related personal injury lawsuits brought against them in the 1960s. Asbestos-related claims expanded dramatically in the 1980s and 1990s. In the context of an asbestos-related bankruptcy case, this latency period results in what is called the “future claimants’ dilemma”-the risk that present claims may so overwhelm a company that it is forced to liquidate, effectively precluding the possibility of any recovery for future claims as they manifest. In 1994, Congress added � 524(g) to the Bankruptcy Code in response to this very specific problem: how best to enable both companies and claimants to handle liabilities and injuries arising from asbestos-containing products. Section 524(g) codified the resolution reached in MacArthur Co. v. Johns-Manville Corp., 837 F.2d 89, 92-93 (2d Cir. 1988). Broadly, � 524(g) provides for the creation of a trust, which is funded by the stock, future earnings and, frequently, contributions from insurance carriers of the reorganizing debtor. All asbestos-related claims against the debtor or third parties arising out of their relationship with the debtor are channeled into the trust. In connection with the confirmation of the debtor’s plan of reorganization, the bankruptcy court enters an injunction prohibiting any asbestos-related claim from being asserted against the debtor (or covered third parties) and requiring that all such claims be asserted instead against (and paid out of) the trust. Section 524(g) protects the reorganizing debtor by shielding it from asbestos liability, but this section is also intended to protect future asbestos claimants whose claims would be ill-served if the company were forced to liquidate: A trust established under � 524(g) is intended to provide an adequately funded corpus from which future claims may be satisfied. For companies facing mounting and potentially overwhelming asbestos liability, � 524(g) is important not only as a mechanism to permit the company to remain viable and to manage asbestos claims, but also for the protection it provides to several groups of nondebtors, shielding them from asbestos-related liability that may arise due to a relationship the nondebtor had with the debtor. However, courts have disagreed as to whether a channeling injunction may be extended to these nondebtors. ‘Combustion Engineering’ For several decades, Combustion Engineering Inc. manufactured steam boilers containing asbestos insulation. As the court observed, “[t]he company was first named as a defendant in an asbestos-related lawsuit in the 1960s, and its asbestos liability increased steadily over the next thirty years.” 391 F.3d at 203. Combustion Engineering sought relief under Chapter 11 the Bankruptcy Code, filing its petition on Feb. 13, 2003, with a proposed prepackaged reorganization plan that was designed to take advantage of the protections offered by � 524(g). As the court noted, “Combustion Engineering defended asbestos-related litigation for nearly four decades until mounting personal injury liabilities eventually brought the company to the brink of insolvency.” Id. at 201. As part of the plan, Combustion Engineering and its parent company, Asea Brown Boveri Inc. (US ABB), sought to shield two nondebtor affiliates of US ABB-ABB Lummus Global Inc. and Basic Inc.-from asbestos liability. The trust was to be funded by contributions from, among others, Combustion Engineering, US ABB, Lummus and Basic. Although the bankruptcy court noted that Basic and Lummus shared certain insurance coverage with Combustion Engineering, the court found that the asbestos liabilities of Basic and Lummus were not otherwise derivative of or related to Combustion Engineering’s liability. As a consequence, the bankruptcy court found that a � 524(g) injunction could cover only those liabilities that Basic and Lummus shared with Combustion Engineering (i.e., those resulting from their prior affiliation or other relationship with Combustion Engineering or ownership of Combustion Engineering’s assets), but not those that were direct claims against Basic and Lummus only (i.e., their independent liabilities). However, the bankruptcy court held that, although it could not include Basic and Lummus within a channeling injunction under � 524(g), it could, under � 105 of the Bankruptcy Code, issue an equitable channeling injunction with respect to the affiliates’ independent liabilities. The bankruptcy court recommended approval of the plan, and the district court confirmed the plan. In reviewing whether a court may extend a channeling injunction to include nondebtors’ independent liabilities, which are not derivative of a debtor’s liabilities, the 3d Circuit rejected the lower courts’ positions. Reasoning that � 524(g) sets express requirements for a nondebtor to avail itself of the benefits of a channeling injunction, the court of appeals held that a bankruptcy court may not use its general equitable powers under � 105(a) to expand a channeling injunction beyond those requirements. Section 524(g) provides that the benefits of a channeling injunction may extend to a transferee or successor to the debtor’s assets with respect to any claim made on account of that transfer or succession; lenders to the debtor or trust, with respect to a claim based upon any such loan; and any third party whose liability arises out of its association with the debtor because of a number of circumstances. These include the third party’s ownership of a financial interest in the debtor (or an affiliate or a predecessor of the debtor); the third party’s involvement in the management of the debtor (or a predecessor of the debtor), or service as an officer, director or employee of the debtor or a related party; the third party’s provision of insurance to the debtor or a related party; or the third party’s involvement in a transaction changing the corporate structure-or in a loan or other financial transaction affecting the financial condition-of the debtor or a related party. The 3d Circuit agreed with the lower courts’ determination that Basic and Lummus did not fall within any of the express provisions of � 524(g). Basic and Lummus’ asbestos liability, as the court noted, was not derivative of Combustion Engineering’s liability. Indeed, the court found that the relationship among Basic, Lummus and Combustion Engineering was too indirect to support bankruptcy court jurisdiction. While these two companies were affiliates of a common parent company, the court observed that this relationship alone was insufficient to bring asbestos claims against Basic and Lummus within the ambit of a channeling injunction entered in connection with Combustion Engineering’s Plan. The court stated that “[a]ny corporate relationship between Combustion Engineering, Basic and Lummus derives from the ABB holding company structure and a common parent that is not seeking bankruptcy protection. The record demonstrates that Combustion Engineering, Basic and Lummus are independent corporate entities, with separate and distinct management and operations. Combustion Engineering does not currently own or control nondebtors Basic and Lummus. A corporate affiliation between lateral, peer companies in a holding company structure, without more, cannot provide a sufficient basis for exercising federal subject matter jurisdiction. Such an affiliation could be relevant to the jurisdictional inquiry if supported by factual findings demonstrating that a suit against Basic or Lummus would deplete the estate or affect its administration.” Id. at 227-28. A finding of no commonality In addition, the court found that no commonality existed between the claims against Basic, Lummus and Combustion Engineering. Indeed, “the asbestos-related personal injury claims asserted against Combustion Engineering, Basic and Lummus [arose] from different products, involved different asbestos-containing materials, and were sold to different markets.” Finally, the court rejected the view that sufficient commonality existed because the companies employed “common production sites.” Id at 231. The court also rejected the proposition that � 105(a) could provide an independent basis for issuing a channeling injunction. The court stated that “[h]ere, the Bankruptcy Court relied upon � 105(a) to achieve a result inconsistent with � 524(g)(4)(A) . . . .Because � 524(g) expressly contemplates the inclusion of third parties’ liability within the scope of a channeling injunction-and sets out the specific requirements that must be met in order to permit inclusion-the general powers of � 105(a) cannot be used to achieve a result not contemplated by the more specific provisions of � 524(g).” Id. at 236-37. Although a bankruptcy court’s equitable powers under � 105(a) are extensive, they are not unlimited. Courts have consistently held that � 105(a) may be invoked only to achieve the purposes of another section of the Bankruptcy Code. When, as here, that section establishes a specific procedure or requirement, a bankruptcy court may not use � 105(a) as a basis for deviating from or contravening that more specific provision. In sum, � 524(g) channeling injunctions remain powerful and important tools for managing asbestos claims, but the 3d Circuit has emphasized the bright line that the Bankruptcy Code draws regarding the requirement that only claims that are derivative of the debtor’s own liability may be the subject of these injunctions. Rudolph J. Di Massa Jr. is a partner at Philadelphia’s Duane Morris, and the chairman of the firm’s reorganization and finance practice group. He concentrates his practice in the areas of commercial litigation and creditors’ rights. Kevin P. Ray is an associate at the firm who practices in the area of reorganization and finance law.

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