And you thought that counting the vote in the 2000 presidential election in Florida was a mess. Consider what the bankruptcy court in In re Quigley Company Inc., 346 B.R. 647 (Bankr. S.D.N.Y. 2006), faced when resolving a dispute over the proper method of estimating over 200,000 unliquidated asbestos-related personal injury claims for purposes of voting on a chapter 11 reorganization plan. Participatory democracy—in bankruptcy as well as in real life—is messy business.

The dispute in Quigley arose in the context of voting on a reorganization plan proposed in this asbestos-related bankruptcy case. The bankruptcy court had to consider two estimation issues. First, whether the traditional estimation methodology of valuing unliquidated claims at $1 each for voting purposes was appropriate, or alternatively, whether such claims should be weighted based on the severity of the impairment suffered by individual claimants. Second, whether a discount should be applied to the value of votes of certain asbestos-related claimants who had accepted a pre-petition settlement. Although addressing facts and circumstances that are particular to asbestos-related bankruptcy cases, this decision has wider implications for other types of bankruptcy cases that involve pools of unliquidated claims that necessarily will be affected by the reorganization process.

Background

Prior to bankruptcy, Quigley Co. Inc. (Quigley), a subsidiary of Pfizer Inc. (Pfizer), was engaged in manufacturing refractory products that contained asbestos. 346 B.R. at 649. When substantially all of Quigley's assets were sold, Quigley and Pfizer retained all liability arising from the asbestos-containing products. Quigley was eventually subject to hundreds of thousands of asbestos-related personal injury claims, many of which were also asserted against Pfizer. Id.

In contemplation of bankruptcy, Pfizer negotiated a settlement with more than 80 percent of the asbestos claimants. Pfizer agreed to pay approximately $430 million—to be divided among the settling asbestos claimants based on negotiated disease categories and exposures—in exchange for which Pfizer would receive a release. Quigley, however, did not receive a release pursuant to the settlement. Id. at 649-50.

The parties also negotiated a reorganization plan for payment of present and future asbestos claims that provided for the creation of a post-confirmation trust to be funded with approximately $645 million to be contributed by Pfizer and Quigley. Id. The settling asbestos claimants agreed that if the assets of the trust were insufficient to pay 100 percent of the value assigned to present and estimated future claims, the settling asbestos claimants would reduce their claims against the trust by 90 percent. The bankruptcy court found that the trust would not be able to pay 100 percent of such present and estimated future claims and, accordingly, the 90 percent dilution of the settling asbestos claimants would apply. Id.

The disclosure statement included a schedule of claim values based on the level of asbestos-related disease or impairment that would be paid by the trust. Id. at 651. To expedite administration of the bankruptcy case, however, holders of unliquidated asbestos claims were not required to file proofs of claim. Id. (Filing of proofs of claim would not have made the bankruptcy court's task any easier, as tort-based claims are usually filed as unliquidated and must still be estimated for voting purposes. See Bankruptcy Rule 3018.)

Quigley filed a voting procedures motion requesting the bankruptcy court to estimate unliquidated asbestos claims at $1 each for voting purposes. Id. at 652. The motion was opposed by a group of asbestos claimants who did not settle with Pfizer. They argued that the votes should be weighted according to the severity of their impairments, and that in determining the requisite acceptances under §1126(c), the votes of the settling asbestos claimants must be diluted by 90 percent to reflect the reduction of their claims against the trust. Id.

The bankruptcy court approved the voting procedures requested by Quigley on a modified basis. It ordered that each asbestos claimant designate on its ballot the applicable disease category and indicate whether its claim was included in the Pfizer settlement. Id. Significantly, the bankruptcy court reserved decision on the appropriate manner of tabulating the votes and all objections to the estimation methodology were preserved. Id. The asbestos claimants voted overwhelmingly to accept the plan. Id.

Appropriate Estimation Methodology

In considering the two alternative estimation methodologies, the Quigley court was guided by the principle, as enunciated in Pension Benefit Guar. Corp. v. Enron Corp. (In re Enron Corp.), 2004 WL 2434928, at *5 (S.D.N.Y. Nov. 1, 2004), that "any estimation should ensure that the voting power is commensurate with the creditor's economic interest in the case." Id. at 654. The first estimation methodology values all unliquidated claims at $1 for voting purposes. The second weighs the votes by assigning values based on the severity of each claimant's impairment.

The bankruptcy court noted that judicial support for the $1 weighted-vote paradigm comes from two early mass tort bankruptcy cases, Manville¹ and A.H. Robins.² Id. In upholding that estimation procedure against challenges that a $1 valuation was arbitrary and disenfranchised certain claimants, each of those circuit courts rejected the arguments in the face of overwhelming creditor acceptances that rendered the alternative procedures irrelevant because they would not have changed the outcome of the vote. Id., citing A.H. Robins, 880 F.2d at 698 (rejecting the challenge to the voting procedure "because, in view of the outcome of the vote, the challenged procedure was at most harmless error").

The bankruptcy court also considered the alternative methodology of estimating votes according to the claim values scheduled in the plan. It acknowledged that "this approach fulfills the expectations of the claimants since their votes are presumably cast, in part, based on the amount the creditors expect to receive from the Trust." Id. (The bankruptcy court also had to decide between competing arguments for using historical claim settlement values as opposed to the plan-based values; and ended up using the plan-based values.)

As in Manville and A.H. Robins, the differences in estimation methodologies were rendered irrelevant by the overwhelming acceptance (85 percent) of the plan by the asbestos claimants. Because the acceptance requirements of §1126(c) were satisfied using either method, the bankruptcy court utilized the $1 per vote estimation method requested in Quigley's voting procedures motion, holding that to do so would be harmless error at most. Id. at 656.

Dilution of Settled Claims

The bankruptcy court's inquiry did not end with its decision on the appropriate estimation methodology. It still had to consider whether to dilute the votes of the settling asbestos creditors and, if so, whether there would be sufficient acceptances to satisfy the "two-thirds in amount" requirement under §1126(c). It concluded that the 90 percent dilution was appropriate because it ensured that voting power was commensurate with the settling asbestos claimants' economic interests and the economic realities of the case. Id. at 657-58.

After discounting the weight of the settling asbestos claimants' votes, the bankruptcy court calculated that the acceptances were insufficient to satisfy the "two-thirds in amount" test under §1126(c). Id. at 658. As it turned out, this result was obtained regardless of the estimation methodology used. Id. at 659. (Under the $1-per-vote estimation method, the minimum dollar amount was missed by a mere 1 percent.) Accordingly, the plan could not be confirmed on a consensual basis. The bankruptcy court, however, left for another day a decision on the issue of whether the plan could be crammed down over the objections of those holders of asbestos claims that voted to reject the plan. Id.

Some Lessons

Quigley illuminates the difficulties of fairly enfranchising unliquidated claims, not only in terms of the mechanics of voting, but also in the pre-bankruptcy planning process. To the extent practitioners have the luxury of time in preparing a chapter 11 case, careful thought must be given to how the voting for a class of unliquidated claims will be conducted. This need is underscored in pre-packaged bankruptcy cases, where achieving the benefits sought may be entirely dependent on the bankruptcy court as endorsing the integrity of the pre-petition voting process.

In the face of demands to employ competing estimation methodologies, bankruptcy courts must struggle with adopting voting procedures that ensure fundamental fairness and due process in a manner that appropriately respects the rights to relative voting power based on the likely size of the claim. The threshold issue is how to value a class of unliquidated claims to accurately reflect inherently different amounts in a manner that will not unfairly disenfranchise claimants with potentially larger claims. This tension is typically reflected in asbestos-related bankruptcy cases where a large group of claimants with relatively slight impairment (e.g., non-malignant pleural thickening) compete for voting power against a much smaller group of claimants with much more substantial impairment (e.g., mesothelioma, which is ultimately fatal). This issue should be of equal concern to bankruptcy courts, plan proponents and claimants who may potentially object to voting procedures.

In that respect, judicial economy is not well-served by approving voting procedures that may prove to be inherently and fundamentally unfair. While weighting each unliquidated claim at $1 for voting purposes may be seductively simple and convenient, it may ultimately prove to be a bad bet. If the plan is approved by an overwhelming majority of the class of unliquidated claims, then, of course, any structural unfairness would be mooted and objections dismissed on the basis of harmless error; however, this is unknowable until after the voting has been conducted. If, on the other hand, the bankruptcy court guesses wrong, a successful challenge to the estimation methodology may result in the need to repeat the entire voting process, or force a confirmation by cramdown. Taking this gamble would be an expensive indulgence, and may prove disastrous for a debtor-in-possession that is running short on time to reorganize as the new 18-month hard cap on exclusivity looms ever closer.

One obvious reminder provided by Quigley is that the doctrine of harmless error may give the bankruptcy court a "free pass" in avoiding what might be an otherwise difficult decision between competing estimation methodologies. Despite the fact that an objection to a proposed estimation methodology might be intellectually sound, it is easily mooted by the raw power of an overwhelming majority vote accepting a plan. To the extent that using an alternative estimation valuation methodology could not possibly change the numerical outcome of the vote, even the most meritorious objection results in a big "so what." Nevertheless, creditors (and the bankruptcy process itself) are well-served by getting it right the first time.

Quigley also presents an encouraging example of how judicial thinking seems to have moved beyond the "one size fits all" paradigm of estimating all unliquidated claims at $1 each for voting purposes. The Quigley court demonstrated a greater sensitivity to fundamental fairness by recognizing that failure to acknowledge ultimate differences in the relative size of unliquidated claims has the inherent effect of disenfranchising certain claims by dilution of their voting power when it declined to reflexively adopt a universal $1-per-claim valuation.

The willingness of courts to look beyond the $1 weighted vote paradigm presents further challenges and opportunities for plan proponents, both before and after the bankruptcy case is filed. Plan proponents (and their allies in the bankruptcy case) must carefully think through the mechanics of the voting procedures, knowing that the vote of a class of unliquidated claims may well affect the outcome of the reorganization case. This is particularly important where, like in Quigley (and as in many pre-packaged bankruptcy cases), a pre-petition settlement with holders of unliquidated claims serves as the economic centerpiece of the reorganization case.

It is all but impossible to deal with a class of unliquidated claims outside of a bankruptcy case, especially in many instances where it will become necessary to bind dissenting minorities in such class and involuntarily effect third-party releases in order to successfully reorganize. This is often the case with asbestos, environmental, product liability and other mass tort claims, as well as for claims arising from securities or other types of class action suits. Settlements of class action-type claims are frequently folded into reorganization plans and funded with proceeds of companion settlements of disputed insurance coverage claims. Indeed, the ability to liquidate such claims and bind any possible dissenters is often a compelling reason to bring the bankruptcy case in the first instance.

What these cases have in common is the structural need to deal with a critical mass of similarly classified, unliquidated claims. Although classes of unliquidated claims are often represented by a handful of lawyers who "make the deal," splinter groups of dissident claimants make the process somewhat like herding cats. As a result, it may be na•ve and dangerous, for planning purpose, to take acceptances by all claimants for granted. The challenge is magnified when underlying factual differences in the amounts of the respective unliquidated claims create fractures in what might—to the outside world—seem like a monolithic block of creditors. This reality will force plan proponents, as well as claimant representatives, to adopt strategies that integrate the economics of settlements with the mechanics of voting procedures. The best economic deal might easily fall flat if it is dependent on plan confirmation that cannot be achieved because of structural impediments resulting from flawed voting procedures.

In the past, class settlements were often made in the aggregate, deferring the difficult decision of how to allocate the proceeds among the various claimants whose individual claims differed due to facts and circumstances such as, for example, severity of injury, different disease categories, or amount of economic loss from decline in value of a security. As in Quigley, it is unclear whether the claimants' representatives who made the 90 percent settlement-reduction deal considered the possible dilutive effect on the voting power of those claimants who were to participate in the settlement. Perhaps it was undertaken as a calculated risk; perhaps they took comfort in the fact that two circuit courts had previously blessed the $1 weighted vote paradigm and assumed that the bankruptcy court would do so too. Knowing that bankruptcy courts may be receptive to fact-based weighting of votes may force more settlements to reflect a matrix-based approach to classifying and valuing claims. Indeed, the simple days of undifferentiated, unallocated bulk settlements in anticipation of a follow-on bankruptcy case may be long gone.

In the pre-packaged bankruptcy context especially, getting it right the first time can have a salutary effect on the efficacy of the effort once the bankruptcy case is filed. Structural disenfranchisement may support objections based on good faith in the pre-petition vote solicitation process, thus forcing a resolicitation and undoing any benefit of going through the pre-pack in the first instance. Even if a remedial resolicitation is not required, such structural infirmities may become an impediment to consensual confirmation and may even open up the case to the challenge of a competing plan.

Conclusion

In the settlement negotiation process, there is an inherent tension between doing what is necessary to make the deal, and doing what is necessary to confirm the plan. Achieving this delicate balance is part of the art of effectively dealing with blocks of unliquidated claims in bankruptcy.

 

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Footnotes

1 Kane v. Johns-Manville Corp. (In re Johns-Manville Corp.), 843 F.2d 636 (2d Cir. 1988).

2 Menard-Sanford v. Mabey (In re A.H. Robins Co.), 880 F.2d 694 (4th Cir.), cert. denied, 493 U.S. 959 (1989).