Section 524(g) of the Bankruptcy Code is a unique and powerful tool that provides the means for a debtor plagued with massive asbestos liabilities to reorganize by channeling such claims into a trust. While asbestos bankruptcies are becoming less frequent, precedent construing Section 524(g) remains important because the use of channeling injunctions outside the context of asbestos liability is often influenced by Section 524(g) precedent, as in In re Continental Airlines, 203 F.3d 203 (3d Cir. 2000). For that reason, a recent U.S. Court of Appeals for the Third Circuit opinion, In re W.R. Grace & Co., Nos. 12-1521/12-2904, 2013 U.S. App. LEXIS 18346 (3d. Cir. Sept. 4, 2013), is noteworthy for its confirmation that, in the face of some creative arguments to the contrary, a channeling injunction under Section 524(g) can indeed bind “all asbestos-related claims” against a debtor, including indirect claims from a governmental body for indemnification and contribution arising from an alleged failure to warn.

The Third Circuit’s opinion arose from W.R. Grace & Co.’s ongoing attempts through Chapter 11 to resolve its present and future asbestos liabilities. To accomplish that goal, the debtor and its creditors committees proposed a joint plan of reorganization that, pursuant to Section 524(g), sought to impose a channeling injunction to funnel all of its asbestos liabilities to trusts created to assume and satisfy them.

The state of Montana and Queen Elizabeth II in Right of Canada (collectively, the indirect claimants) sought indemnification and contribution from Grace arising from litigation filed against them based upon their alleged failure to warn citizens about the dangers of asbestos. Under the Grace plan, these claims would have been discharged and resolved by the trusts.

As a result, the indirect claimants objected to plan confirmation citing three fundamental flaws: First, the indirect claimants argued that “Section 524(g) permits a channeling injunction to extend only to personal injury, wrongful death, and property damage actions, not to … claims for indemnification and contribution … [that] arise from [indirect claimants'] alleged failures to warn their citizens.” Second, the plan improperly discriminated against indirect claims because (1) such creditors were required to prove that they actually tendered a payment to an individual with a direct asbestos injury and (2) trust payments were to be on a “first-in, first-out” basis, which potentially could deplete the trust corpus before all of the indirect claims were known or could be proven. Third, the plan was unfair with respect to future claimants because the payout amounts and underlying procedures were uncertain and the trusts were to be advised by a committee that included lawyers for those with direct personal injury claims. The district court affirmed the bankruptcy court’s denial of the objections and confirmation of the plan, finding that indirect claims (i.e., indemnity claims) were “properly enjoined and channeled into the trust” and that the record was “devoid of any evidence indicating disparate treatment.”

The Third Circuit began its analysis by examining the permissible scope of a channeling injunction under Section 524(g). The text of Section 524(g) allows a court to “enjoin entities from taking legal action for the purpose of directly or indirectly … recovering … with respect to any claim or demand that … is to be paid in whole or in part by a trust described in § 524(g)(2)(B)(i).” Interpreting this language, the Third Circuit found that a “Section 524(g) channeling injunction can … include any right to or demand for payment that arises from the debtor’s underlying asbestos liabilities … whether it was raised during the bankruptcy proceeding or is contingent on a future event.” After reviewing the legislative history, the Third Circuit concluded that Congress was especially concerned with the “long latency period of many asbestos-related diseases” and the resulting “‘lingering uncertainty’ [that] can ‘undermine the fresh start objectives of bankruptcy.’” Consequently, the Third Circuit determined that indirect claims were within the scope of Section 524(g) because it “evinces an intent to include all potential asbestos-related liability of a debtor, regardless of when such liability arose.” Most importantly, the Third Circuit dismissed any substantive difference between claims for indemnity and contribution based on a failure to warn and claims for direct personal injury and property damage because all such claims are inherently based on the same events — exposure to Grace’s asbestos products or the production thereof.

Next, the Third Circuit considered the indirect claimants’ allegations of discrimination. The Third Circuit noted that Section 524(g) requires, analogous to other plan confirmation requirements under Chapter 11, that similar claims be paid “‘in substantially the same manner.’” While the precise standards for such equality are not statutorily defined, the Third Circuit found that “all claimants in a class must have ‘the same opportunity’ for recovery.” Reviewing the treatment of indirect claims under the plan, the Third Circuit found that “the only indirect claims that will not be paid … are those for which Grace has no underlying liability.” The Third Circuit found no evidence of improper discrimination, declaring that “there is no ‘legal authority that requires a debtor to reimburse third parties for wrongs for which the debtor is not responsible.’” Moreover, the “first-in, first-out” claim-processing scheme similarly passed muster because “it would be wholly unreasonable to require asbestos victims … to … wait … until all indirect claims accrue.” The Third Circuit acknowledged that the trust may have insufficient funds for all future claimants, but dismissed this concern because the plan “endeavors to make that scenario as unlikely as possible.”

Lastly, the Third Circuit turned to a discussion of whether the channeling of future claims meets Section 524(g)’s “fair and equitable” requirement. “The provision requires a reviewing court to consider whether, given the funds available in a trust, it is ‘fair and equitable’ to channel future demands to that trust.” The court found that the indirect claimants’ concerns over a lack of certainty with respect to the amounts and procedures for future distributions were irrelevant to the fairness of the channeling injunction and, further, were baseless under any conception of relevance. The Third Circuit found that calculating the monetary amount and number of future claims is simply “impossible.” It also dismissed the indirect claimants’ concerns regarding the trust committee, reasoning that such committees exercise limited control over distributions and because there was no evidence of improper conduct.

The Grace opinion reflects a broad, debtor-friendly application of channeling injunctions. Although Section 524(g) is limited by its terms to asbestos liabilities, this interpretation may create additional room for argument that similarly broad channeling injunctions under 11 U.S.C. Section 105 might be appropriate and reasonable for companies facing massive tort liabilities unrelated to asbestos.

Francis J. Lawall, a partner in the Philadelphia office of Pepper Hamilton, concentrates his practice in national bankruptcy and reorganization matters. He routinely lectures to various creditor groups concerning general bankruptcy issues, including preferences, reclamation, the role of creditors committees and related issues. Erik L. Coccia is an associate in the firm’s Philadelphia office and concentrates his practice in national bankruptcy and reorganization matters.