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Companies have long wrestled with the task of estimating future products liabilities in connection with making financial disclosures, issuing dividends and implementing restructuring. Until recently, courts have had little occasion to address future liability estimation, except in the bankruptcy context. Last year, the courts in In re Babcock & Wilcox Co., 274 B.R. 230 (Bankr. E.D. La. 2002) ( B&W), and In re W.R. Grace & Co., 281 B.R. 852 (Bankr. D. Del. 2002), issued the first two opinions directly addressing the standards for estimating future asbestos liabilities as of an historical point in time. The B&W and Grace opinions reveal a judicial first look at a complex and increasingly important area of law for lawyers doing products liability, bankruptcy and transactional work. A central question facing the B&W and Grace courts was the extent to which future asbestos claims count as liabilities affecting the solvency of the defendant companies involved in those cases, and whether those liabilities should be quantified with the benefit of hindsight. It is well settled that a company cannot transfer assets for less than fair consideration if it is insolvent or if the transaction would make it so, without risking “constructive” fraudulent-transfer liability. B&W and Grace had undertaken complex restructuring transactions reducing each company’s net worth, to the benefit of affiliated companies and/or shareholders. Based on asbestos claims received as of the date of the transactions, both companies were solvent and therefore ostensibly free from possible constructive fraudulent-transfer liability. Asbestos creditors nonetheless moved to void the transactions as fraudulent, contending that unasserted future asbestos claims had rendered B&W and Grace insolvent at the time the transactions occurred. DEFINING FUTURE CLAIMANTS In deciding the extent to which future asbestos claims can cause present insolvency, the B&W and Grace courts could have adopted the liability estimation standards that apply in the bankruptcy or accounting contexts. Under � 524(g) of the Bankruptcy Code, future asbestos liabilities are not discharged, but rather are channeled to a trust funded by a reorganizing asbestos defendant for the purpose of compensating present and future asbestos claimants. Typically, the debtor and other parties in the bankruptcy advance competing estimates of the total liability to be funded. A distinctive feature of estimation under � 524(g) is the presumption, based on epidemiological findings, that new liabilities will arise for 50 years or more following the cessation of industrial exposure to asbestos. Sec. 524(g) requires that all probable future liabilities be considered, including those arising from injuries or perhaps even exposures that have not yet occurred. Congress recognized that such liabilities did not meet the code’s broad definition of a “claim,” and so defined them as “future demands, [the] actual amounts, numbers, and timing of [which] … cannot be determined.” 11 U.S.C. 524(g)(2)(B)(ii). However, the B&W and Grace courts did not adopt the code’s expansive concept of “future demands.” While the Grace court did not expressly address whether or how the claims estimation standards under � 524(g) would differ from those applied to fraudulent transfers, the B&W court stressed that estimates of B&W‘s liabilities under � 524(g) would be judged by a very different standard from that applicable in the fraudulent-transfer context. Although each court was applying a different state’s statutory definition of insolvency, both courts decided to limit their solvency analysis to potential future claimants with an actual, legally cognizable injury at the time of the challenged transfer. The implication is that potential future claimants who are not injured as of a given transfer are not required to be factored into a fraudulent-conveyance solvency analysis. This division of future claimants into those with injuries and those without raises the question of when asbestos-related injury occurs. In Grace, only three years had passed between the challenged transfer and Grace’s bankruptcy petition, which stayed further claims. The Grace court was willing to presume, subject to later proof, that individuals suing Grace during these three years likely had already suffered an injury by the time of the transfer. The Grace court reasoned that liability arises as soon as tortious injury occurs, regardless of when the injury becomes diagnosible, is diagnosed or is sued upon. Therefore, proof that potential claimants with unknown injuries existed at the time of Grace’s transfer would be admissible to establish Grace’s insolvency. However, the defendants in Grace did not limit their liability estimate to claimants with injuries. Instead, they conceded that all future claims reasonably foreseeable as of the date of Grace’s transfer were relevant to quantifying Grace’s asbestos liability and thus its solvency. Consequently, the Grace court did not have to decide whether an asbestos-related injury anticipated to arise more than three years in the future could be said currently to “exist.” In theory, the undiagnosed subclinical injuries of future claimants could be inferred from medical testimony. However, current medical understanding of asbestos-related disease does not support a bright-line test as to when injury occurs, as demonstrated by the litigation over this issue under Maryland’s statutory cap on tort damages. See, e.g., John Crane Inc. v. Scribner, 800 A.2d 727, 733-42 (Md. 2001). Therefore, the Grace opinion may limit consideration of future claims in the fraudulent-transfer context to only those claims asserted within a few years following the challenged transfer. The defendants in B&W argued that potential future claims were entirely irrelevant to B&W’s solvency at the time of its restructuring transaction because, regardless of whether such claimants were injured or not, B&W had never been held liable in any asbestos case. The B&W court disagreed, noting that B&W had escaped liability in court by paying hundreds of millions of dollars to settle asbestos claims, and had recognized future claims in its internal liability estimates. Relying on Louisiana case law holding that a cognizable claim arises the moment a single asbestos fiber begins to cause cellular damage, the court appeared to hold that all future claims by individuals exposed to B&W’s asbestos-containing products had to be considered in determining the company’s solvency. The court did not reach the issue of whether, in quantifying the liabilities arising from these subclinical injuries, the amounts that B&W had typically paid to unimpaired nonmalignancy claimants should apply, as opposed to the higher amounts that would have been paid to those claimants who manifested a diagnosible injury in the future. CHOICE-OF-LAW ISSUE A critical question in the B&W and Grace cases was which law to apply to determine whether future claims presented cognizable injuries-the law applicable to the fraudulent-transfer claim, or the various laws of each of the jurisdictions in which the underlying asbestos claims are likely to be asserted. Unless the law of the fraudulent-transfer claim were to apply, a court would face the nearly impossible task of assessing future claims against the laws of their anticipated “local” jurisdictions to determine which, if presented, would be cognizable. The Grace court noted the infeasibility of looking to the law governing each potential future personal injury claim, and applied the law applicable to the fraudulent-transfer claim based on 3rd U.S. Circuit Court of Appeals bankruptcy choice-of-law rules. The B&W court judged the status of future claims using the law applicable to the fraudulent-transfer claim, without discussing the choice-of-law issue. Under the applicable Louisiana and New Jersey tort law, the B&Wand Grace courts found that potential future asbestos claims, even absent significant physical injury, presented liabilities relevant to the solvency analysis. Presumably a different result would obtain in a fraudulent-transfer case governed by state law that did not recognize asbestos claims based on exposure or subclinical injury alone. ACCOUNTING STANDARDS REJECTED In addition to the overarching question of which future claims to count, the B&W and Grace courts also addressed the important questions of who should do the counting, and when. Both B&W and Grace had analyzed their own liabilities at the time of their restructuring transactions, and had concluded that they were solvent based on all then-available information. In B&W, the defendants argued that its good-faith belief in the company’s solvency, grounded in generally accepted accounting principles, should control on the question of whether it was solvent under the Louisiana revocatory statute. This argument has some appeal. Many companies periodically estimate contingent liabilities using Financial Accounting Standards Bulletin No. 5 (FASB-5). FASB-5 requires disclosure of contingent liabilities that are “probable,” “reasonably estima[ble],” and “material.” The Securities and Exchange Commission further requires that the “measurement of the liability should be based on currently available facts, existing technology, and presently enacted laws and regulations, and should take into consideration the likely effects of inflation and other societal and economic factors.” SEC Staff Accounting Bulletin 92, 1993 WL 194317. This approach to estimating liabilities is consistent with estimation standards under most fraudulent-transfer statutes. However, these accounting and disclosure rules do not set firm standards, as can be seen from the varying disclosures made by companies with asbestos liabilities. Some companies attempt broadly inclusive estimates comparable to those made under � 524(g). Others estimate only liability for pending claims, or a subset of pending claims. Many companies make no estimates at all, concluding that their future asbestos liabilities are not “probable,” “reasonably estima[ble]” or “ material.” It is therefore not surprising that the B&W and Grace courts refused to defer to internal, historical liability estimates conducted under FASB-5. That refusal reflects the reality that accounting principles are applied within an essentially self-regulatory regime that is not intended as a substitute for anti-fraud statutes or for the robust disclosure triggered by the adversary process. Even though the B&W court was unwilling to defer to B&W’s FASB-5 liability estimate as a matter of principle, it did so in practice, finding the estimate “not so unreasonable” in comparison to the estimates of the plaintiffs’ experts to permit a finding of insolvency. Crucial to the court’s decision was its refusal to judge B&W’s liabilities in hindsight. The court stressed repeatedly that only information available at the time of the challenged transfer would be considered in assessing solvency. In rejecting hindsight, the court limited the impact of its ruling that every potential future claimant against B&W was by definition injured and therefore relevant to solvency. By considering only those future claims that could have been predicted based on information available to B&W at the time of its restructuring, the B&W court came close to adopting the “reasonably foreseeable” standard rejected by the Grace court. In contrast, the Grace court held that all information concerning Grace’s liabilities existing at the time of the company’s restructuring-even if unknown or unknowable at that time-could be used to establish Grace’s insolvency. While recognizing the potential unfairness of judging liabilities in hindsight, the Grace court charged Grace with knowledge of concededly unknowable facts, apparently based on the perceived unfairness to creditors of not doing so. IMPACT OF THE TWO DECISIONS Several lessons emerge from the B&W and Grace opinions. It is now reasonably clear, for example, that there are at least three different standards for estimating products liabilities, applicable in the accounting, financial-transfer and bankruptcy contexts. Because these standards focus on distinct factors, a company with significant asbestos liabilities should, before engaging in restructuring, consider reviewing its liabilities under multiple standards with restructuring specifically in mind. Choice of law may emerge as an important factor in determining whether a particular transfer is held to be fraudulent. If courts follow B&W and Grace and apply the law applicable to the fraudulent-conveyance claim to determine which underlying future claims count as liabilities, then outcomes will depend on the tort law of the relevant jurisdiction. This result might undermine the significant uniformity found among state and federal fraudulent-transfer statutes, but the alternative of applying the laws of 50 or more jurisdictions to yet-unasserted claims appears impractical. Finally, the B&W court’s suggestion that FASB-5 estimates may be used as an admission of liabilities in the fraudulent-conveyance context creates a disincentive to estimate future claims under FASB-5, particularly for defendants new to the asbestos litigation that lack a track record on which reasonably accurate future claims projections might be made. Even well-established defendants have found that the rapid growth of unimpaired claims — unlimited by any medical or epidemiological model or event — has made meaningful estimates of future liabilities under FASB-5 virtually impossible. Companies may increasingly find that their future asbestos liabilities cannot reasonably be estimated under FASB-5 in light of the complex medical and choice-of-law issues raised by the B&W and Grace decisions, even as the need to assess those liabilities more carefully in the restructuring context grows. Mark P. Goodman is a partner, and Steve Vaccaro is an associate, in the litigation department at New York’s Debevoise & Plimpton (www.debevoise.com). They represent a broad range of clients, including clients in asbestos litigation and other mass tort actions. If you are interested in submitting an article to law.com, please click here for our submission guidelines.

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