Asbestos defendants who file for reorganization under the U.S. Bankruptcy Code and seek to establish a personal injury trust for the payment of claims may transfer their liability insurance recovery rights to the trust even if the insurance policies include provisions barring the transfer of such rights, the U.S. Court of Appeals for the Third Circuit has ruled in a precedential opinion.

A three-judge panel composed of Judges Anthony J. Scirica, D. Brooks Smith and Kent A. Jordan issued the decision Tuesday. The appellate court’s decision affirms a prior opinion by the U.S. District Court for the District of Delaware in In re Federal-Mogul Global.

Federal-Mogul, a Southfield, Mich., automobile parts supplier incorporated in Delaware, filed for bankruptcy in the District of Delaware on Oct. 1, 2001, because of numerous asbestos-related claims filed against it. At the time of the corporation’s bankruptcy filing, 500,000 personal injury claims were pending and it had already spent roughly $350 million to defend and indemnify those claims.

Per U.S. bankruptcy law, all claims against Federal-Mogul were halted so it could establish a reorganization plan and a trust to pay the victims.

Federal-Mogul’s proposed reorganization plan assigned various assets to the victims’ trust, including its recovery rights under its liability insurance. The plan also included provisions that granted insurers the right to assert against the trust any defense to coverage already available under the policies.

In 2007, a Delaware bankruptcy court approved Federal-Mogul’s proposed reorganization plan. Five insurers, which insured Federal-Mogul for personal injury claims, objected to the plan. The insurers charged that the transfer of Federal-Mogul’s recovery rights violated the anti-assignment provisions, which barred the transfer of recovery rights.

The insurers that filed the lawsuit include Allianz Global Corporate & Specialty AG, Certain Underwriters at Lloyd’s of London, Columbia Casualty Co. and First State Insurance Co.

In 2008, the bankruptcy court held that statutes found in U.S. bankruptcy law trump the insurance policies’ anti-assignment provisions. The District of Delaware affirmed the decision in 2009.

The insurers appealed the previous decisions to the Third Circuit, which upheld the previous court opinions.

The appellate court held that the plain language of a U.S. bankruptcy law statute pre-empts any anti-assignment provision found within the individual insurance policies.

Specifically, the court held that Title 11, Section 1123(a)(5)(b) of the U.S. Code permits the transfer of estate property to the trust “notwithstanding any otherwise applicable nonbankruptcy law.”

“The critical words here are ‘notwithstanding any otherwise applicable nonbankruptcy law,’” Scirica wrote in the court’s opinion. “The Supreme Court has held that a ‘notwithstanding’ clause ‘clearly signals the drafter’s intention that the provisions of the “notwithstanding” section override conflicting provisions,’ noting numerous instances when the courts of appeals ‘have interpreted similar “notwithstanding” language … to supersede all other laws, stating that “[a] clearer statement is difficult to imagine.”‘”

The insurers noted that the structure of Section 1123(a) includes a subsection that lists 10 transactions that constitute “adequate means for the plan’s implementation,” including the transfer of the estate’s property. Furthermore, the insurers argued that any transaction listed in the “means” is not subject to the “notwithstanding” clause.

Once again, the court disagreed with the insurers’ claims.

“It is hardly natural to read the ‘notwithstanding’ clause in Section 1123(a) as applying only to some, but not all, of Subsection(a), an approach that contravenes any normal method of statutory interpretation,” Scirica said. “It could hardly be read otherwise; no other express presumption provision is necessary.”

The insurers argued that the phrase “otherwise applicable nonbankruptcy law” found in Section 1123′s language does not encompass private contracts. Furthermore, the insurers contend that other sections of the Bankruptcy Code contain language that explicitly pre-empts private contracts as well as government enactments. For example, 11 U.S.C. Section 363(l) states “notwithstanding any provision in a contract, a lease or applicable law.”

However, the court denied the insurers’ claims, holding that many of the transactions listed under Section 1123(a)(5) implicate contractual rights.

“The plain language of Section 1123(a) evinces clear congressional intent for a pre-emptive scope that includes the transactions listed under Section 1123(a)(5) as ‘adequate means’ for the plan’s information, including the transfer of property authorized by (a)(5)(B),” Scirica’s opinion said. “The plain language also reaches private contracts enforced by state common law, and overcomes the presumption against pre-emption.”

The insurers also claimed that the anti-assignment provisions serve an important purpose because they protect them from covering a risk different from the one they were originally contracted to provide for. Specifically, the insurers claim that by transferring Federal-Mogul’s rights to recover to the trust, their exposure increases because the trust allows claims that would be barred in the tort system.

However, the court disagreed with their assertions. “We doubt whether transfer in this instance materially alters insurers’ risk,” Scirica continued. “The bankruptcy here shifted debtor’s asbestos-related liabilities — based on events which had already occurred and for which the insurers were already potentially responsible — to the post-confirmation trust.”

While the court did rule that Section 1123(a) does trump private contracts, it also held that such pre-emption is not unlimited.

“Any reorganization plan must still comply with all aspects of the Bankruptcy Code and be approved by the bankruptcy court,” Scirica wrote. “In particular, it must satisfy 11 U.S.C. Section 1129(a)(3), which provides that a court shall confirm a reorganization plan only if it ‘has been proposed in good faith and not by any means forbidden by law.’”

The insurers were represented by Danielle M. Spinelli and Craig Goldblatt of Wilmer Cutler Pickering Hale and Dorr; David C. Christian II of Seyfarth Shaw’s Chicago office; and John D. Demmy of Stevens & Lee in Wilmington.

Federal-Mogul was represented by Laura D. Jones and James E. O’Neill III of Pachulski Stang Ziehl & Jones and Kathleen C. Davis of Campbell & Levine, both Wilmington firms.

Attorneys could not immediately be reached for comment.

This article first appeared in Delaware Business Court Insider, a Legal affiliate.

Jeff Mordock can be contacted at 215-557-2485 or Follow him on Twitter @JeffMordockTLI. •