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Over the past several years, the accelerated pace of asbestos-related personal-injury claims has driven more and more otherwise profitable businesses into bankruptcy. Many of these companies are major domestic and international corporations, including various Halliburton Co. subsidiaries, Federal-Mogul Corp., Armstrong World Industries Inc., Owens Corning, G-I Holdings Inc. (formerly GAF Corp.) and W.R. Grace & Co. Other corporate giants are regularly the subjects of speculation about potential asbestos-driven bankruptcy filings. According to a 2002 study published by the RAND Institute for Civil Justice, total costs for all asbestos claims could reach as high as $265 billion. The same study noted that, through the end of 2000, roughly 600,000 claims had been filed against some 6,000 defendants. Despite recent calls by President George W. Bush for Congress to enact asbestos-related legislation, businesses have come to believe that there is no more efficient and sure way to limit or eliminate such claims than through a strategic bankruptcy filing. In Re: Combustion Engineering Inc., a Dec. 2, 2004, decision by the 3rd U.S. Circuit Court of Appeals, significantly changes the landscape of asbestos-driven bankruptcies. It provides bankruptcy practitioners with their first circuit-level critique of how a debtor may properly resolve asbestos-related personal-injury claims under �524(g) of the U.S. Bankruptcy Code. The decision isn’t a clear victory for any one side, but it does place some limits on potential debtors’ ability to confirm asbestos-driven Chapter 11 plans. To understand the import of the 3rd Circuit opinion, lawyers first need to know how ever-increasing numbers of asbestos Chapter 11 cases generally operate. Companies that seek bankruptcy protection to shed asbestos liability, at least to date, generally negotiate — well in advance of any bankruptcy filing — a settlement with counsel who represent at least 75 percent of known asbestos claimants, as well as a proposed future claimants’ representative. Only after they agree to the settlement does the debtor file its “pre-packaged” Chapter 11 plan of reorganization. The settlement typically creates a post-confirmation trust to pay current and future asbestos-related claims. The insurance policies of the debtor often fund the trust in large part. According to the landmark 3rd Circuit decision, the case unfolded as follows: Combustion Engineering (CE), the debtor company, manufactured steam boilers containing asbestos insulation from the 1930s through the 1960s. Its asbestos-litigation problems began in the 1960s. In 2002, it had received more than 79,000 asbestos-related claims. By the time the company filed for bankruptcy in 2003, roughly 160,000 cases were pending. To address the burgeoning asbestos claims, the company negotiated a settlement with the plaintiffs. It called for the filing of a Chapter 11 bankruptcy, which was to include a �524(g) injunction protecting CE from future asbestos claims. The settlement upon which CE based the plan called for the creation of two separate trusts to satisfy claims. To garner the requisite approval of the current asbestos claimants, CE contributed half of its assets to a pre-petition trust to pay such claimants as much as 95 percent of their claims before the bankruptcy filing. Funding for the post-confirmation trust under the proposed plan of reorganization, in turn, would come from a combination of CE’s rights to proceeds under insurance policies and settlement agreements, cash and future cash flow from CE, as well as cash and stock from its parent and nondebtor affiliates. Negotiation of the settlement took place between the company, its counsel and counsel for a significant number of asbestos plaintiffs. According to the opinion, CE’s insurers were not a party to the master settlement agreement, despite the fact that insurance proceeds principally would fund the post-confirmation trust. Eighty-seven days before filing for bankruptcy, CE transferred in excess of $400 million to the pre-petition settlement trust to pay various claims pending against the company. The amounts of payment varied in accordance with how long the claim had been pending against CE. The plan won approval of the requisite number of creditors for confirmation, and the bankruptcy court recommended confirmation to the district court over the objection of several insurers. The district court confirmed the plan, with some modifications, overruling the objection of the debtor’s insurers. In a lengthy opinion, the 3rd Circuit vacated and remanded the case. INSURER STANDING Although Combustion Engineering addresses a number of issues that arise in asbestos bankruptcy cases, two paramount issues include 1. standing of certain parties to participate in the appellate process, and 2. the propriety of using a two-trust system whereby the debtor (or entities it creates) pay current claimants a substantial majority of their claims pre-petition. The 3rd Circuit addressed, as a threshold matter, whether the appellant/insurers had standing to challenge confirmation of the plan on appeal. In Combustion Engineering, as in other cases involving �524(g) trusts, no one contests the fact that the debtor company sought insurance proceeds to satisfy a significant portion, if not substantially all, of the claims to be paid by the �524(g) trust. Accordingly, insurers have taken a keen interest in these cases. As to insurer standing, the 3rd Circuit first distinguished trial-level standing in bankruptcy court from appellate standing. The 3rd Circuit recognized “the broad right of participation in the early stages of a bankruptcy proceeding,” but distinguished it from appellate standing, which is “determined by the specific claims presented.” Based on the specifics of the CE case, the 3rd Circuit determined that the insurers had appellate standing to challenge plan provisions if the provision diminished the appellants’ property or impaired their rights. But, also based on the facts of the case, the 3rd Circuit found that the insurers only had limited standing to challenge the district court’s modification of a plan provision purportedly ensuring that the insurers’ pre-petition contractual rights remained unaltered. Further, the 3rd Circuit concluded that primary and excess carriers that issued policies to the nondebtor affiliates affected by the plan had limited standing to challenge aspects of the confirmation order that purport to violate anti-assignment provisions contained in such policies. PLAN STRUCTURE FLAWED The 3rd Circuit then remanded the case for further development of the facts regarding whether the structure of the plan — which involved a pre-petition trust and post-petition �524(g) trust and called for pre-petition payments to claimants in partial settlement of their claims — violated the Bankruptcy Code. The court noted that the requirement that reorganization plans provide similar treatment to similarly situated claims furthers the Bankruptcy Code’s policy of “equality of distribution among creditors,” and that various code sections are designed to ensure this policy. The court concluded that CE’s payments to the pre-petition trust satisfied at least four of the five elements of �547(b) regarding avoidable preferential transfers, and when viewed as a whole, the plan “may lack the requisite equality among creditors” based on potential disparity in recovery. Because the 3rd Circuit found that the two-trust structure may violate the code’s requirement of equality among creditors, another part of the remand to the district court was further development of those facts. The 3rd Circuit also took issue with the plan’s injunction of claims against two nondebtor affiliates of CE. The district court relied on Bankruptcy Code �105(a), which allows a court to issue any order “necessary or appropriate to carry out the provisions of” the code as a basis to enjoin asbestos-related personal-injury claims against such nondebtor parties. The 3rd Circuit held that �524(g) injunctions are available only to parties alleged to be directly or indirectly liable for claims against the debtor. The nondebtor affiliates of CE to which the judge granted an injunction under the plan fell outside this category, since the claims against such parties were “wholly separate from any liability involving Combustion Engineering.” Thus, the 3rd Circuit vacated the channeling injunctions under the plan in favor of the two nondebtor affiliates of CE. In Combustion Engineering, the 3rd Circuit tackled a number of major issues confronting parties involved in asbestos-related Chapter 11 bankruptcy cases, including the disparity in treatment of similarly situated claims, injunctions in favor of nondebtors, and standing to participate in the case and on appeal, to name a few. By striking down the use of a pre-petition trust used to preferentially pay current claimants a substantial portion of their claims and the use of Bankruptcy Code �105(a) to enjoin claims against nondebtors, the 3rd Circuit gutted a part of the settlement resulting from creative and innovative lawyering. As to standing, the court confirmed that, once on appeal, a party may only challenge provisions contained in Chapter 11 plans if such provisions diminish the appellants’ property or alter their rights as they existed prior to the petition date. Ultimately, the opinion presents a thorough and substantive rewriting of the rulebook used in this burgeoning group of cases. David P. McClain is a shareholder in McClain, Leppert & Maney, a Houston-based commercial bankruptcy and litigation firm that has represented insurers in connection with asbestos-driven bankruptcy cases. The firm also represents the Official Employment-Related Issues Committee in the Enron Corp. Chapter 11 case. McClain’s e-mail address is [email protected].

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