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The U.S. Bankruptcy Court for the District of New Jersey recently revisited the issue of whether filing for bankruptcy as a tactic for resolving disputed, unliquidated liabilities constitutes bad faith warranting dismissal. The 3rd U.S. Circuit Court of Appeals first addressed this issue in Re SGL Carbon Corp., (3d Cir. 1999), dismissing a case filed solely as a means of obtaining leverage to resolve antitrust claims. Since SGL Carbon, some creditors have taken the opportunity to argue that whenever a debtor uses bankruptcy as a means of resolving disputed claims, the bankruptcy is ipso facto a bad-faith filing. The bankruptcy court, in a decision rendered in Re Muralo Co., No. 03-26723 (Bankr. D. N.J. Dec. 4, 2003), recently addressed this issue in a relatively new entrant into the rising tide of asbestos bankruptcy cases. Muralo and an affiliate, both relatively small companies, filed for bankruptcy approximately one year after the bankruptcy filing of another company that previously had provided indemnity to Muralo against asbestos claims. The debtors in Muralo filed for bankruptcy after a year of increasing litigation pressure from numerous asbestos cases that the debtor now had to defend itself. After Muralo filed for bankruptcy, the official committee of asbestos claimants brought a motion to dismiss the case for bad-faith filing. In brief, the asbestos committee argued that Muralo’s filing was merely a litigation tactic to gain an advantage in resolving the company’s asbestos liabilities. The debtor responded that although it was using certain procedural mechanisms available only in bankruptcy to address asbestos liabilities, it had a genuine need for bankruptcy protection to deal with these liabilities. After considering both sides’ arguments, the court concluded that although the debtor was, to a certain extent, using bankruptcy as a “litigation tactic,” the filing was not in bad faith because of the facts and circumstances of the case. It therefore denied the motion to dismiss. FACTUAL BACKGROUND The debtor, Muralo, along with an affiliate, is a small manufacturing concern that produces and distributes paint and related products, including patching and repair products. In 1981, Muralo purchased the Synkoloid product line from the Artra Group Inc. for $1.7 million. The Synkoloid product line consisted, in part, of pipe adhesive and similar compounds. As part of the sale, Artra agreed to indemnify Muralo against pre-1981 products liability claims. This indemnification right was significant because, prior to 1981, some of the Synkoloid products contained asbestos. Muralo contends, however, that, none of the products it produced as part of the Synkoloid line contained asbestos. For 20 years, Artra assumed the defense of Synkoloid asbestos claims against Muralo, generally brought under a successor liability theory. As a result, the debtor had little information about such claims and available defenses. This became an acute problem only when Artra filed for bankruptcy protection on June 3, 2002, and contemporaneously ceased defending the Synkoloid asbestos claims. The Artra filing created serious and immediate problems for Muralo. Initially, Muralo was unable even to obtain information from Artra about asbestos cases that had been filed recently and for which an answer was due shortly. New cases continued to come in, which Muralo needed to address. The debtor attempted to obtain assistance from defense firms that had represented Artra in cases, but many of these firms demanded protection from Muralo against the fees they had previously incurred on behalf of Artra. These circumstances created a chaotic and frenzied atmosphere in which Muralo’s management spent significant amounts of time and substantial funds dealing with asbestos litigation emergencies. During the year after Artra’s bankruptcy filing, Muralo also spent significant time and expense trying to obtain protection from asbestos claims through Artra’s bankruptcy. Muralo, inter alia, sought to utilize the code’s Section 105 equitable powers to extend the stay imposed by Artra’s bankruptcy to claims against Muralo. These efforts were unsuccessful. Muralo also engaged in a lengthy effort to obtain support for its defense from its insurers. The insurers resisted these efforts strenuously. The confluence of these problems created a substantial drain on the finances and management of Muralo. As a result, on May 20, 2003, Muralo filed its own bankruptcy petition. In conjunction with the bankruptcy filing, Muralo initiated an adversary proceeding against all plaintiffs that had brought asbestos claims against it, seeking a declaratory judgment that it was not liable for Synkoloid asbestos claims under any successor liability or similar theory. Shortly thereafter, the court appointed an official committee of asbestos claimants. The asbestos committee promptly filed a motion to dismiss the case as filed in bad faith. It argued that the case was “simply a litigation tactic designed for the sole purpose of obtaining a judgment from this court declaring that the debtors are not liable as successors in interest for asbestos liabilities relating to Synkoloid products.” The debtors responded that although the adversary proceeding was one part of their case, given the circumstances described above, they had a good faith need for bankruptcy protection. Accordingly, the court considered the following questions: “Is dismissal of the petitions of debtors, under the circumstances of this joint case, the intended effect of SGL Carbon? Or, is that precedent being misread, if not abused by the asbestos committee in a tactical ploy of its own?” SGL CARBON SGL Carbon is the leading case in the 3rd Circuit on dismissal for bad-faith filing. That case arose out of a few lawsuits against SGL Carbon concerning antitrust violations in the sale of graphite electrodes. After pleading guilty to antitrust violations, SGL Carbon filed for bankruptcy protection and immediately proposed a plan of reorganization providing for the satisfaction of civil antitrust claims with time-delimited credits for future purchases of electrodes. Moreover, at the time it filed, SGL Carbon was, by its own account, a healthy company that was not suffering any impairment as a result of the litigation. In addition, SGL Carbon had established a $240 million reserve for any judgment, and shared its risk with its international conglomerate affiliates. Based on these facts, the 3rd Circuit directed that SGL Carbon’s case be dismissed. COMPARISON TO SGL CARBON The court in Muralo focused its analysis of the motion to dismiss on a comparison of the facts of SGL Carbon to the instant case. It focused on four primary areas of comparison: � The effect of the underlying litigation on business operations. � The relative magnitude of the exposure from the underlying litigation. � The nature of litigation tactics embodied in the bankruptcy filing. � The timing and need for protection from the automatic stay. The court first noted that, in contrast to SGL Carbon, the impact of the asbestos litigation on Muralo was severe. “Management’s sleepless nights, fear of high dollar value default judgments and turnover orders, and constant litigation-based chaos characterized debtors’ business environment in the year preceding the May 2003 recourse to Chapter 11.” In contrast, the court noted, SGL Carbon had been operating in an apparently ordinary manner prior to its bankruptcy filing, notwithstanding the pending antitrust cases. Thus, the court concluded that the serious impact of the asbestos litigation on Muralo, in contrast to SGL Carbon, was a significant indicator of good faith. Likewise, the court was moved by the relative magnitude of the debtors’ exposure to asbestos claims. The court noted that, as a result of the asbestos claims, the debtors — small, family-owned companies — were not “financially healthy.” Because of the flood of litigation they faced, the debtors were incapable of operating normally, on either a financial or management level. By contrast, in SGL Carbon, the litigation had little impact on the ability of management to run the company. Moreover, SGL Carbon had no difficulty in establishing a $240 million reserve to protect itself from the financial effects of any judgment. The bankruptcy court also distinguished the nature of the “litigation tactics” used in SGL Carbon and Muralo. In SGL Carbon, the debtor’s primary motivation for filing for bankruptcy and proposing the plan it proffered was to gain leverage in an ongoing bargaining process. In Muralo, the court noted, the debtor was not seeking leverage. Rather, it was attempting to accelerate the resolution of a key, threshold issue in its asbestos liabilities. This effort moreover came after a year of manic efforts to fend off asbestos claims; attempts to obtain relief as part of Artra’s bankruptcy case; and litigation against insurers to obtain their protection. There was also little prospect for cash being available to pay claims in full. This was in stark contrast with SGL Carbon, which filed bankruptcy shortly after the antitrust litigation began, and had no difficulty establishing a reserve to provide cash to pay a judgment. Finally, the court focused on the timing of Muralo’s bankruptcy filing, and its need for the protection of the automatic stay. The court noted that Muralo spent a full year after Artra’s bankruptcy trying to find other means to protect itself. The automatic stay was critical to stop the huge outflow of money and management energy that took place during that year. The court concluded that, unlike SGL Carbon, this was an appropriate use of the automatic stay. OTHER ISSUES The asbestos committee also contended that the adversary proceeding Muralo brought was indicative of bad faith. The bankruptcy court rejected this argument. The court noted that, regardless of the result of the adversary proceeding, the debtor could propose a viable plan of reorganization. In addition, although the court did not pass on the merits of the adversary proceeding itself, it noted that the question of whether the adversary proceeding was a proper means for Muralo to resolve its asbestos liabilities was part of the decision whether to let the adversary proceeding proceed, not whether the bankruptcy case as a whole should be dismissed. The court concluded by comparing Muralo’s bankruptcy filing to other cases in which courts have considered motions to dismiss for bad-faith filing. It again returned to a fact-specific comparison of each case, as it had done with SGL Carbon. The court noted that, in SGL Carbon, the 3rd Circuit stated, “The requisite fact intensive inquiry [into good-faith filing] requires determining where [the debtor's] petition falls along the spectrum ranging from the clearly acceptable to the patently abusive.” Indeed, it stated that “In some sense, essentially all bankruptcy filings are ‘litigation tactics’ as countermeasures to debt collection efforts.” In reviewing the facts of Muralo’s case, the bankruptcy court concluded that, although the bankruptcy may be a “litigation tactic,” it fell within the acceptable range of the spectrum. CONCLUSION In SGL Carbon, the court recognized that each debtor’s motion for filing a bankruptcy case falls along a “spectrum ranging from the clearly acceptable to the patently abusive.” Only in a case at the latter end, such as SGL Carbon, should the case be dismissed. The lesson of Muralo is that just because a bankruptcy filing can be characterized as a “litigation tactic” in resolving disputed, unliquidated claims, does not mean that the case is “patently abusive” or in bad faith. If a case can be characterized as a “litigation tactic,” the debtor still can show that it was in such dire straits, or was on the way to falling into such dire straits, that bankruptcy is an appropriate option. If you are interested in submitting an article to law.com, please click here for our submission guidelines.

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