Pre-petition product liability claims can be among the biggest challenges facing chapter 11 debtors. Not knowing how many people may have been injured by products sold before the petition is filed and the aggregate amount of the claims made after the petition greatly complicates the efforts to resolve a case. A bankruptcy product liability insurance policy could be a solution to this uncertainty.

A case in point: A toy manufacturer that filed for chapter 11 sold two products before the filing that had the potential for long-term liabilities. Its snow sleds for children and above-ground swimming pools could each have a useful life of more than 30 years. Accordingly, the debtor needed a method to maintain reserves for product liability claims that could appear for three decades. There were at least three types of creditors: those who had sued before the petition was filed for claims that were not yet resolved; those who might file a claim post-petition for a pre-petition injury, and most uncertain were those who might be injured post-petition.

While a review of the debtor's claims history for the sleds and above-ground pools prior to the filing would be helpful, claims projections for 30 years following the filing are speculative at best. Thus, it is extremely difficult to accurately determine the number of product-liability litigants and the dollar amounts necessary to reserve for these claims.

Creating an Insurance Mechanism to Fund Claims

In this situation, the chapter 11 plan created a product liability trust to fund the cost of claims and litigation. The foremost objective in establishing the trust was to ensure that all current and future product liability creditors received a prompt and equitable recovery. In the court-approved product liability trust agreement, a clause allowed the trustee to purchase insurance for these product liability claims.

An important aspect of the insurance plan in this case was the observation of loss payments during a transition period to help clarify future loss payment patterns. During the transition period, the debtor continued to be responsible for smaller claims (in the form of a deductible), and the insurer would pay for large losses. In this example, the product liability trustee set the transition period for three years and decided to earmark up to $50,000 for each product liability claim. Once a liability claim exceeded this self-insurance amount, the insurance policy became operative.

If a debtor or a trustee is concerned about the ultimate aggregate value of claims within the self-insurance level, an alternative risk transfer plan can be considered. This option allows the debtor or the trustee to fund unexpected immediate cash needs for losses with insurance and reimburse the insurer for the time value of money over the transition period. During that period, the debtor or trustee can also accrue the expected interest gained from the asset pool.

Establishing such a transition period allows the debtor or the trustee to evaluate actual liability issues after the debtor files its petition and to better project the ultimate value of such claims. Once the probability of continued liability claims is patterned, the debtor or the trustee can explore the continuation of self insurance or a complete insurance solution after the transition period.

Benefits to Both Debtors and Creditors

A debtor with heavy product liability claims that files for chapter 11 will find it difficult to pay back "sum-certain" creditors, such as suppliers. Once a chapter 11 petition has been filed, these creditors will cooperate with a debtor only if they can be reasonably assured of a recovery that is reasonable in time and amount. The ability to distribute funds equitably and quickly to sum-certain creditors is impeded by the unknown volatility of actual product liability claims. Without the protection of high-limits liability insurance, creditors can be left in limbo for years. There is also the risk that product liability claims will eliminate any meaningful recovery. This defeats the essence of the Bankruptcy Code: resolving creditors' issues promptly and permitting the debtor a fresh start.

Traditional pre-petition liability policies can help, but only in a limited way. A debtor's product liability policy purchased before the petition is filed may provide some protection. But problems, such as insufficient limits, unrenewed or canceled coverage due to non-payment of premium or failure to report claims, can jeopardize or nullify coverage.

One remedy may be for the debtor or trustee to purchase bankruptcy product liability insurance, a new type of insurance policy purchased after the petition is filed to cover injuries caused by products sold pre-petition. A bankruptcy product liability policy can bring more certainty to the cost and time of disposing of claims by injured creditors. Based on actuarially sound forecasting methods and a cap on the compensation an injured creditor may receive, a bankruptcy product liability policy can benefit all parties with a fair, expeditious dissemination of funds.

For companies striving for a turnaround, a bankruptcy product liability policy can expedite the claims resolution process. Such a policy provides coverage for injured claimants, but it is less costly than traditional policies. The policy frees funds to pay back sum-certain creditors and to pay for the debtor's operating costs, both critical to enhancing a debtor's chances for recovery. Conversely, without such a policy, creditors may be reimbursed less because the level of claims reserves will need to be conservatively high to respond to a severe claim, class action or numerous moderate claims that may emerge. A bankruptcy product liability policy thus reduces concern over the uncertainty of product liability claims. In essence, such a policy shifts a burden of risk from the debtor and all of its creditors to the insurance company.

With a bankruptcy product liability policy, the debtor can proceed with confidence in ensuring prompt and reasonable returns to the creditors without fretting over possible liability claims that could cripple its recovery effort. In effect, such a policy segregates the claims of product liability creditors, enabling the debtor to be in a better position to allocate funds to other creditors.

When considering the value of paying the bankruptcy product liability insurance policy premiums, the important question is: What is the pain threshold for assuming and paying product liability claims? If there is a real possibility of assets being greatly reduced or eliminated as a result of product liability claims, then the bankruptcy product liability insurance policy is an option worth exploring.

Final Considerations

Finally, when considering a bankruptcy product liability policy, one should make sure that:

• The protection is global; that is, it does not have geographic restrictions that could leave the policyholder vulnerable to an uninsured loss merely as a result of where the loss occurred.
• It does not contain a cancellation clause that allows the insurer to cancel coverage mid-term. Only a few insurance companies will provide such a "no-cancellation" commitment.
• It offers sufficiently high limits over an appropriately long period.
• The insurer has strong claim paying and financial ratings from A.M. Best, Standard & Poor's and Moody's to support the high limit and long-term commitment.

Such a bankruptcy product liability insurance policy protects where other pre-petition coverage is insufficient or non-existent. It can lower the hurdles to the successful disposition of a bankruptcy case.

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Footnotes

¹ John Cavanaugh is a vice president in the global liability practice of Chubb & Son, Warren, N.J. He can be reached at (908) 903-3171. Return to article

² Earl Stamm, a member of the Pennsylvania Bar, is located in Wyncote, Pa., a suburb of Philadelphia. For 27 years, his practice has concentrated on the representation of insurance companies and other parties in interest in commercial reorganization cases. He can be reached at (215) 887-2612. Return to article