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Combustion Engineering Can a Pre-packaged Bankruptcy Plan Satisfy 524(g)

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First there were class-action settlements that attempted to resolve huge numbers of asbestos claims, until the Supreme Court held that such settlements did not satisfy due-process concerns.3 Next was the wave of asbestos bankruptcy cases, through which companies sought to finally determine their asbestos liabilities by using the injunctive protections afforded by §524(g) of the Bankruptcy Code, 11 U.S.C. §524(g) (2000). Some years after their commencement, many of those "free-fall" bankruptcy cases, such as those filed by W.R. Grace and USG Corp., are still pending, without resolution of the underlying asbestos liability issues. More recently, some companies seek to resolve their asbestos liabilities through pre-packaged bankruptcy cases, by which the debtor files with its bankruptcy petition a disclosure statement and reorganization plan, already voted upon by impaired creditors. Two "pre-packs" filed during 2002 have now concluded,4 with a handful more filed during 2003 still pending.5 The appeals courts have yet to rule on whether the asbestos pre-pack meets the criteria of §524(g). The Third Circuit Court of Appeals should be the first when it determines the appeals in In re Combustion Engineering Inc., likely this summer.6

The Combustion Engineering Pre-packaged Plan

Section 524(g) was enacted in 1994 to codify the manner in which asbestos personal-injury claims were resolved in the Johns-Manville bankruptcy case: establishing a trust to pay present and future asbestos claims, enjoining such claims from being asserted against the debtor and discharging the debtor from such liabilities.7 Combustion Engineering Inc. filed for chapter 11 protection on Feb. 17, 2003, with a proposed pre-packaged reorganization plan and disclosure statement designed to take advantage of these provisions in §524(g). The plan proposed that Combustion and certain entities related to it be permitted to obtain the benefits of §524(g). These related entities included Combustion's corporate parent, Asea Brown Bovari Inc. (US ABB), ABB Ltd. (the ultimate parent of both U.S. ABB and Combustion) and other affiliates, including ABB Lummus Global Inc. and Basic Inc. According to the disclosure statement, Combustion "realized that §524(g) of the Bankruptcy Code, which is designed for companies with large numbers of asbestos-related claims, provides mechanisms for efficiently handling asbestos-related personal-injury claims through a trust and increases the likelihood that the value of an operating business can be preserved."8 The issues that arose in the confirmation proceedings for Combustion's pre-packaged plan included whether §524(g)'s "mechanisms" could apply to that plan, which was negotiated with the express intent of gaining protection for Combustion's non-debtor parents and affiliates.9

In October 2000, Combustion and its corporate parents began negotiations with Joseph Rice, a prominent asbestos claimants' attorney, concerning a pre-packaged bankruptcy plan.10 With an eye toward the ultimate bankruptcy filing, they entered into a "master settlement agreement" that established a pre-petition settlement trust to resolve a portion of Combustion's asbestos liabilities. The trust procedures split the pending asbestos claims into three categories based on the status of the claim as either settled (category 1), resolved but without a documented settlement agreement (category 2) and all other claims (category 3). The trust paid category 1 claimants 95 percent of the agreed value for their claims, paid category 2 claimants 85 percent of the claim value, and paid category 3 claimants 75 percent of the claim value. Thus, each claimant was left with an unsecured "stub" claim that ultimately was impaired under Combustion's soon-to-be-filed bankruptcy plan.11 The pre-petition settlement trust was funded with a $5 million cash deposit from Combustion, a promissory note from Combustion in the principal amount of $100 million, assignment of a loan agreement by which US ABB agreed to pay $402 million upon demand by Combustion, and a guaranty by ABB of the note and the loan agreement.12

Combustion's pre-packaged plan was advanced with the support of the claimants' representative and the "future claimants' representative," who was appointed as required by §524(g) to represent the interests of those persons who did not have an existing asbestos personal injury claim but who would have such a claim in the future. The only impaired creditors under the plan were those holding asbestos personal-injury claims, certain intercompany claims and equity interests. All other unsecured claims were unaffected by the bankruptcy filing.13 The plan sought, among other things, to establish a trust as expressly provided by §524(g) to satisfy the "stub" claims left over from the pre-petition settlement trust and all future asbestos claims, thereby insulating Combustion and its affiliates from asbestos claims going forward. The §524(g) trust was funded by the remaining half of Combustion's value, its right to insurance proceeds (the face amount of which exceeded $320 million), and a $20 million secured note convertible by the §524(g) trust into 80 percent of the reorganized Combustion Engineering. ABB, U.S. ABB, Lummus and Basic also made various financial contributions and concessions toward funding the §524(g) trust.14

The Plan's Compliance with §524(g)

Various insurers of Combustion and certain asbestos personal injury claimants objected to confirmation of the plan. The insurers claimed that their rights were impaired under the plan because, among other things, the plan predetermined the manner in which asbestos claims would be reviewed and ultimately paid from the §524(g) trust.15 The objecting parties argued that the plan did not satisfy the requirements for confirmation under §1129 of the Bankruptcy Code, and contended that the plan did not meet the strict requirements of §524(g). First, they protested that §524(g) could not be extended to enjoin asbestos claims against Combustion's non-debtor affiliates, including ABB, U.S. ABB, Lummus and Basic. But §524(g) provides that its injunction may bar legal action against certain third parties, including a third party that allegedly is liable for asbestos-related claims because of its ownership of a financial interest in the debtor, its past or present affiliation with the debtor, or as a predecessor of the debtor.16 An injunction under §524(g) also may be extended to insurers of the debtors or a related party.17

The bankruptcy court and, subsequently, the district court, held that releases and the §524(g) channeling injunction provided by the Plan could be extended to ABB, U.S. ABB and to affiliates that did not contribute to the trust, but solely to the extent that their respective asbestos liabilities were derivative of Combustion's asbestos liabilities. As the bankruptcy court noted: "Their own direct, non-CE related liability, if any, is not within §524(g) and is not protected by the injunction."18 Although those courts held that §524(g) could not provide protection to Lummus and Basic for their independent asbestos liabilities, they held that an injunction could be issued pursuant to 11 U.S.C. §105(a) to provide that protection.19

A second ground for objection was the funding of the §524(g) trust. Pursuant to §524(g), a trust established to satisfy asbestos claims must not only assume the debtor's asbestos-related liabilities, but also must own the majority of the voting shares of the debtor, its parent or a subsidiary and "be funded in whole or in part by the securities of one or more of debtors involved in such plan and by the obligation of such debtor or debtors to make future payments, including dividends."20 The bankruptcy court held that this provision was satisfied because the trust was being funded with 80 percent of Combustion's equity, and rejected the contention that ABB's stock was required to fund the §524(g) trust.21 Certain parties objecting to confirmation argued, however, that because Combustion ceased operations pre-petition, its stock is "worthless and provides no future economic benefit to creditors from future operations," as they contended is required by §524(g).22 The bankruptcy court and district court both rejected the argument, the latter holding that "reorganized Combustion will have a real estate business in which it will own and lease properties."23 In its brief to the Third Circuit, Combustion and U.S. ABB acknowledged that Combustion's business is now limited to owning and leasing a single real estate parcel, but argued that the financial contributions of U.S. ABB to the plan rendered that fact irrelevant, especially because the statute does not expressly require that the reorganized debtor have "substantial" operations.24

The contrast between the pre-petition settlement trust and the §524(g) trust gave rise to yet another issue. Under the §524(g) trust distribution procedures, the amount a claimant is paid is determined based on that claimant's asbestos-related disease.25 However, under the pre-petition settlement trusts, claimants are not paid based on their disease, but on the status of their claim at the time they seek payment from that trust.26 Pursuant to §524(g)(2)(B)(ii)(V), the court must find that the §524(g) trust is "in a financial position to pay present claims and future demands that involve similar claims in substantially the same manner" (emphasis supplied). The bankruptcy court, while making the finding required under this provision to confirm the plan, did not discuss this requirement in any detail.27

The district court, however, rejected the argument that under the plan, "the present and future claimants will be treated differently...[because] the claims handling procedures are not the same for the settlement trust and [the §524(g)] personal-injury trust."28 The objecting parties argued that the pre-petition trust was negotiated and adopted as but one piece of the entire pre-packaged plan; indeed, the district court recognized this fact in its ruling:

[I]t is a given when the stub claim was created [under the pre-petition settlement trust] that Combustion Engineering's bankruptcy was imminent. Indeed, the Master Settlement Agreement expressly contemplated the bankruptcy.29
However, the district court rejected the argument that the requirement of substantially similar treatment under §524(g) was not met because those claimants who settled pre-petition would receive a percentage payment more than three times greater than that of claimants who were paid under the §524(g) trust, would be paid sooner and would be paid with some $400 million unavailable to the §524(g) trust.30 The district court explained:
It may be true that pre-petition claimants against the settlement trust will receive more. The court is satisfied, however, that these persons were not similarly situated to persons who were not able to participate in the settlement trust. Even within the settlement trust, claimants are not similarly situated and their recovery will vary depending on the status of their claims.31

Thus, the district court impliedly recognized that asbestos claimants are not treated equally under the respective trusts. Resolution of this issue will depend on whether the Third Circuit determines that the pre-petition settlement agreement is a part of one simultaneously negotiated pre-packaged plan, or whether the plan stands on its own with the §524(g) trust at its core.

Conclusion: Third Circuit to Decide

According to the district court, the objecting parties' theme was that the plan represented "a corrupt attempt by solvent companies to obtain the benefits of a channeling injunction under the Bankruptcy Code by bribing the plaintiffs' bar. The supposed bribe is immediate payment to present claimants, from whom counsel will recoup their fees, at the expense of future claimants, who may be far sicker but who represent a far less certain source of revenue for counsel."32 The court dismissed these arguments, but did strike a cautionary note:

That does not mean that this is a perfect plan. Nor does it mean that the court is enamored with the process by which it evolved. The courts and the public deserve a process that is not so easily impugned with charges of conflicts of interest and tainted votes, whether those charges are ultimately proved or not.33

The Third Circuit Court of Appeals will now have the opportunity to determine whether this pre-packaged plan, with all its warts, satisfies the rather strict requirements of §524(g). The issues on appeal extend beyond those arising under §524(g), including most prominently the insurers' standing to object to confirmation of the plan. In light of what seems to be a growing trend toward pre-packaged asbestos bankruptcies, the Third Circuit's resolution of the appeals will provide guidance in the future to those who attempt to structure the pre-petition resolution of asbestos personal injury claims.


Footnotes

1 Danielle Alfonzo Walsman, an associate at Stroock, assisted in the research for this article. Return to article

2 Stroock is counsel to the Official Committee of Unsecured Creditors in In re USG, No. 01-2094 (JKF) (Bankr. D. Del.), and In re W.R. Grace, No. 01-01139 (JKF) (Bankr. D. Del.). Return to article

3 See Ortiz v. Fibreboard Corp., 527 U.S. 815 (1999); Amchem v. Windsor, 521 U.S. 591 (1997). Return to article

4 In re Shook & Fletcher Insulation Co., No. 02-02771-BGC-11 (Bankr. N.D. Ala. 2002); In re J.T. Thorpe Co., No. 02-41487-H5-11 (Bankr. S.D. Tex. 2002). Return to article

5 In re Combustion Engineering Inc., No. 03-10495 (Bankr. D. Del. 2003); In re Mid-Valley Inc., No. 03-35592 (JKF) (Bankr. W.D. Pa. 2003) (involving Halliburton Co.); In re Congoleum Corp., 03-51524 (KCF) (Bankr. D. N.J. 2003). Return to article

6 Oral argument of the appeals was, at press time, scheduled for June 3, 2004. Previously, by order of the Third Circuit dated Jan. 7, 2004, oral argument on the appeals from the lower courts' confirmation orders in Combustion Engineering was postponed pending the Third Circuit's resolution of various petitions for mandamus seeking the disqualification of the district court judge, Alfred M. Wolin, from five asbestos bankruptcy cases other than Combustion Engineering. See In re Kensington Int'l. Ltd. & Springfield Assoc., 353 F.3d 211 (3d Cir. 2003). Return to article

7 H.R. No. 103-835, 103rd Cong. (1994); see U.S. Code. Cong. and Adm. News, p. 3348-50. Return to article

8 Disclosure Statement, Article 3.1(b) at page 20. Return to article

9 Combustion's asbestos problems traced historically to asbestos used as insulation in boilers it manufactured, as well to various acquisitions by Combustion of companies that themselves had asbestos liabilities. Asbestos claims began to have a material effect on Combustion's financial performance in the mid-1990s. Combustion then exhausted its primary layer of insurance, its excess carriers disputed liability to it, and the number of claims filed against Combustion multiplied. Significantly, U.S. ABB and other "non-debtor affiliates" of Combustion were also saddled with an exorbitant number of asbestos claims. See Disclosure Statement, Article 2.4(a) at 13-14. Return to article

10 Mr. Rice was designated "claimants representative" and was ultimately paid a $20 million "success fee" by ABB and U.S. ABB. The bankruptcy court held that Mr. Rice had a conflict of interest in also representing claimants who were suing ABB and its affiliates. In re Combustion Engineering Inc., 295 B.R. 459, 476-79 (Bankr. D. Del. 2003). The district court reversed but did not reach the merits, holding that the bankruptcy lacked subject matter jurisdiction over that issue. Rice v. Combustion Engineering Inc., No. 03-755, Sep. 15, 2003 (Wolin, J.). Return to article

11 Disclosure Statement, Article 3.7 at 22-24. Return to article

12 In re Combustion Engineering Inc., 295 B.R. at 467-68. Return to article

13 Id. at 474. Return to article

14 Id. at 475-76. Return to article

15 Id. at 474-75. Return to article

16 See 11 U.S.C. §524(g)(4)(A)(ii)(I). Return to article

17 See 11 U.S.C. §524(g)(4)(A)(ii)(III). Return to article

18 295 B.R. at 481. Section 524(g)(2)(A) provides that the district court shall have exclusive jurisdiction over any proceeding concerning the §524(g) injunction. Accordingly, the bankruptcy court (Fitzgerald, B.J.) issued findings of fact and conclusions of law as to non-core issues, which were subsequently adopted by the district court (Wolin, D.J.), and the bankruptcy court issued final rulings on core matters that were in substantial part affirmed by the district court. See In re Combustion Engineering Inc., No. 03-10495, Confirmation Hearing and Bench Opinion, July 31, 2003 (Wolin, J.). Return to article

19 Id. at 482-83. Return to article

20 11 U.S.C. §524(g)(2)(B)(i)(II). Various objecting parties also argued that this section required the payment of dividends to the trust, but the district court held that all this clause requires is that dividends be paid to the trust if any are declared. Bench Opinion at 159. Return to article

21 The bankruptcy court relied on the plain language of the statute that the trust shall be funded with the majority of the stock of the debtor, the parent corporation "or" a subsidiary. Id. at 489. Return to article

22 See Brief of Travelers Appellants (in the U.S. Court of Appeals for the Third Circuit), Sept. 15, 2003, at 29. Return to article

23 Bench Opinion at 158-59. Return to article

24 See Brief of Appellees Combustion Engineering Inc. and Asea Brown Boveri Inc. (in the U.S. Court of Appeals for the Third Circuit), Sept. 25, 2003, at 85-86. Return to article

25 Disclosure Statement, Article 8 at 40-51. Return to article

26 Disclosure Statement, Article 3.7(a) at 23-24. Return to article

27 295 B.R. at 490. Return to article

28 Bench Opinion at 158. Return to article

29 Bench Opinion at 152. Return to article

30 See Brief of Appellants First State Insurance Co. and Hartford Accident and Indemnity Co. (in the U.S. Court of Appeals for the Third Circuit), Sep. 15, 2003 at 49-52. Return to article

31 Bench Opinion at 158. Return to article

32 Bench Opinion at 166. Return to article

33 Bench Opinion at 167. Return to article


Journal Date: 
Tuesday, June 1, 2004

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