Asbestos Litigation Past, Present and Future
During the mid-1990s, many experts expected that the flood of asbestos litigation would begin to recede by the end of the decade. Now, in the year 2002, when many companies had hoped to enjoy some relief from the onslaught, the end appears farther away than ever. In fact, record numbers of asbestos related personal injury claims have been filed across the country against many old and a significant number of new defendants. It’s now predicted that the total asbestos liabilities in the United States could reach as high as $200 billion dollars, with only $30 to $40 billion dollars of that having been spent to date. Thus, it appears that we still have a long way to go before the nightmare is over.
In 1982, three companies commenced bankruptcy proceedings as a result of asbestos liabilities. Before the end of the 1980s, 13 more would join that group. By the first half of 1990, an additional nine companies filed with eight more to follow by the end of the century. Now, since Jan. 1, 2000, more than 17 companies have commenced Chapter 11 bankruptcy proceedings directly due to their overwhelming asbestos problem. In addition, scores of new defendants who previously had not been subject to asbestos lawsuits are now finding themselves named defendants despite only tangential exposure to the asbestos industry itself.
Bankruptcy cases pending today include but aren’t necessarily limited to G.I. Holdings (GAF), Babcock & Wilcox, W.R. Grace, Pittsburgh Corning, Owens Corning Fiberglass, Federal-Mogul, Armstrong World Industries, US Gypsum, US Mineral Products Company d/b/a Isolatek International, NA Refractories, HW Harbison, Shook & Fletcher Insulation Co., A.P. Green and Kaiser Aluminum. Other companies are expected to file in the near future as well. Historically impacted industries such as insulators, railroads, utilities, chemical companies and shipyards are now being joined by automobile manufacturers, food and beverage manufacturers, textile manufacturers and pulp and paper companies, as well as iron, steel and other metal fabrication industries.
The increase in the number of asbestos claim filings has been attributed to a number of different factors, including, but not limited to, the tort reform movement active in certain states and the proliferation of asbestos specialty firms utilizing state of the art computer and other data processing capabilities. It appears, however, that a substantial number of the claims being filed today involve claimants who, while having been exposed to asbestos at some point, aren’t presently exhibiting any impairment or physical symptoms of such exposure. As an overall percentage of claims being filed, these "non-impaired" claims are becoming a larger and larger portion.
To combat the increasing number of asbestos claims being filed, certain defendants have taken an aggressive stance in the context of a bankruptcy proceeding. For example, in the Babcock & Wilcox case, the debtor is presently attempting to use the bankruptcy process to compel claimants to establish that they were exposed to a product manufactured by Babcock & Wilcox and that such exposure triggered the asbestos disease for which they are pursing a claim. The outcome of this strategy remains unclear. Other asbestos companies are taking a more conciliatory approach in attempting to negotiate a resolution of their asbestos liabilities with the plaintiffs through a plan of reorganization. Finally, there remains a group of debtors who apparently haven’t yet decided whether to utilize a conciliatory or combative posture within their bankruptcy proceedings.
Regardless of the approach each company may take, the ultimate resolution of its asbestos liabilities must likely come from a confirmed Chapter 11 plan of reorganization. In 1994, Congress amended the Bankruptcy Code to include Section 524(g), which is otherwise known as the "Manville Amendment," for the purpose of allowing companies facing massive asbestos exposure to use the bankruptcy courts as a forum to deal with those claims. Under Section 524(g), if at least 75 percent of asbestos claimants vote in favor of a proposed plan of reorganization, the bankruptcy court may issue an injunction prohibiting the assertion of both present and future claims against the company. In addition to a negotiated financial settlement, the debtor must also create a contingency, such as a default by the debtor in making the payments promised in its plan of reorganization, in which event at least 51 percent of its equity would be contributed to a trust fund established for the purpose of resolving asbestos claims.
It doesn’t appear necessary in the context of Section 524(g) that the trust own a 51 percent interest in the company immediately after the reorganization, but rather, the stock may be pledged to secure a long term financial obligation by the debtor to the trust. As such, it’s possible for existing equity through a negotiated settlement to continue to own all or a portion of the reorganized company. This result was achieved in 2001 in the EJ Bartells Chapter 11 case, as it had been in the early 1990s in the asbestos Chapter 11 cases of Amatex Corporation, Pacor, Inc. and DI Distributors, Inc.
In any bankruptcy proceeding, including those involving massive asbestos liabilities, there are certain common elements which exist and are necessary in order to allow the reorganization process to move forward. Specifically, at the commencement of bankruptcy, the company becomes what’s known as a debtor-in-possession. Under the Bankruptcy Code, the existing management of the company is authorized to continue to manage the company as a debtor-in-possession. Shortly after the filing of the bankruptcy proceeding, one or more creditors’ committees are likely to be formed. A trade creditors’ committee, typically consisting of the seven largest unsecured creditors, will be formed by the Office of the United States Trustee for purposes of representing the interests of general unsecured creditors. Also, a committee of asbestos claimants will likely be formed. This committee may consist of either individual claimants or attorneys representing such claimants.
Both the unsecured creditors’ committee and the asbestos claimants’ committee have the right to retain their own independent counsel to represent their interests during the course of the bankruptcy proceeding. The fees for such counsel are paid by the debtor-in-possession. In addition, it’s typical for accountants and actuaries to be retained in these cases. The jobs of one or both of these professionals is to present estimates of the values of the existing assets which belong to the debtor-in-possession as well as to present an estimate of the present and future liabilities facing the company. It’s not unusual for the debtor-in-possession and the asbestos health claimants committee to hire separate actuaries and accountants.
Another important component of an asbestos reorganization case is the "guardian ad litem" or "legal representative" for unknown, future asbestos claimants. Future asbestos claimants generally consist of persons who have been exposed to asbestos containing materials and may or may not have suffered some harm as a result, but aren’t yet aware of the existence of such exposure or potential for a claim. Under the United States Constitution, due process requires that these persons’ interests be represented in order for the liabilities that may exist to be compromised within the context of a bankruptcy proceeding. The cost of the guardian ad litem as well as the guardian ad litem’s counsel, and other professionals are also paid by the debtor-in-possession. Thus, it quickly becomes obvious that the cost of an asbestos reorganization proceeding can be substantial.
Status Report on Pending Cases
None of the current large asbestos Chapter 11 companies has asked the court to confirm a plan of reorganization. However, there have been significant developments in those cases, including the appointment of legal representatives for unknown, future asbestos claimants in most of the cases. Other developments, which relate to Babcock & Wilcox, Garlock, Inc. and Fuller-Austin Insulation Company, are described as follows.
Babcock & Wilcox Decision
On Feb. 8, 2002, the U.S. Bankruptcy Court for the Eastern District of Louisiana surprised some asbestos plaintiffs’ attorneys by holding that Babcock & Wilcox ("B&W") wasn’t insolvent shortly before bankruptcy when it transferred valuable assets to its parent corporation, even though B & W was faced with huge present and future asbestos claims. At the time of the transfer, B&W had reasonably estimated its present and future asbestos liabilities to be less than the enterprise value or going concern value of B&W. The fact that B&W’s asbestos estimates turned out to be low, in hindsight, was held to be irrelevant. Because the estimates were reasonable when made, B&W was "solvent," and the transfers couldn’t be revoked.
Babcock & Wilcox Company filed Chapter 11 in Louisiana in February, 2000. Nineteen months earlier, in July, 1998, B&W had transferred to its parent corporation assets consisting of all the shares of stock of three operating subsidiaries and two large notes receivable. Those assets had a book value of approximately $622 million. The transfers reduced B&W’s book value by approximately 80 percent. The plaintiffs asserted that the transfers violated a Louisiana fraudulent transfer statute that creates a "revocatory action" (similar to the "avoidance actions" with which all bankruptcy lawyers are familiar) which permits creditors to revoke a transfer by a debtor "that causes or increases the obligor’s [debtor’s] insolvency." The Louisiana Civil Code provides that a debtor is insolvent "when the total of his liabilities exceeds the total of his fairly-appraised assets." The court noted that the definition of insolvency under the Bankruptcy Code is virtually identical.
In 1993, B&W’s vice president of finance began, for the first time, to estimate potential future asbestos loss contingencies in the financial statements, despite legal advice that this wasn’t necessary. The asbestos reserve booked by B&W as of July 1, 1998 was $866 million. Its independent auditors stated the financial statements were prepared according to generally accepted accounting principles (GAAP).
At trial, the experts hired by the asbestos creditors’ committee and the legal representative for future asbestos claimants testified that the B&W estimate was too low. However, B&W’s expert testified that B&W’s estimate was reasonable based on the information available at the time the estimate was prepared.
The court determined that B&W’s going-concern value, available insurance and other assets as of July 1, 1998 were worth $1.850 billion. The court also determined that B&W’s asbestos reserve, in hindsight, was too low. However, at the time it was prepared, it was reasonable. Because it was a reasonable estimate when prepared on July 1, 1998, B&W was solvent on that date, and the transfers couldn’t be set aside.
In reaching its conclusion, the court decided (i) that the unasserted contingent future claims of individual asbestos claimants do constitute liabilities for the purpose of determining solvency under the fraudulent transfer statute, (ii) that the estimation of future claims must be objectively, not just subjectively reasonable, and (iii) that the court is not bound by GAAP in making a solvency determination. However, the court recognized that any estimate of asbestos liabilities is problematical, and different assumptions may be made that result in huge ranges of possible results. The court said:
"Predicting the future is always uncertain, and hindsight is perfect. Under the present circumstances in which the court is attempting to determine the amount of future asbestos liabilities for determining B&W’s solvency as of July 1, 1998, the court cannot use hindsight and can only determine whether the predictions by B&W were reasonable under the circumstances existing at the time they were made. Applying that standard, the court concludes that B&W’s estimates were reasonable and thus the plaintiffs have failed to carry their burden of proving that B&W was insolvent."
The B&W decision has been appealed. If it withstands appeal, it may provide some protection for companies which have transferred assets despite pending present and future asbestos claims against them.
The Garlock Tactic
In October, 2001, Garlock, Inc., a defendant in numerous asbestos lawsuits in Texas, succeeded in removing the lawsuits from the Texas state trial courts into federal court on the basis that one of the other defendants in those suits, Federal-Mogul, had filed Chapter 11 in Delaware. Garlock moved to transfer the suits against it to the Delaware federal courts on the basis that Garlock had contribution claims against Federal-Mogul which were related to the Delaware bankruptcy. However, the success was short-lived, because the asbestos plaintiffs’ attorneys responded by dismissing their suits against Federal-Mogul, so that Garlock no longer had contribution claims against the bankrupt company, and, therefore, the federal courts no longer had jurisdiction. After the dismissals, the federal courts in Texas remanded the suits back to the same Texas state trial courts where they had been pending. So far the Fifth Circuit Court of Appeals has upheld the asbestos plaintiffs’ position in the matter. Therefore, the Garlock strategy doesn’t seem to be a viable way for a non-bankrupt asbestos defendant to take away the home court advantage from the asbestos plaintiffs.
In February, 2002, the California Superior Court held that the Chapter 11 Plan of Reorganization ("Plan") which had been confirmed by the U.S. Bankruptcy Court in Delaware in 1998 triggered the obligation of Fuller-Austin’s excess insurance carriers to pay the full amount of their policies into the Fuller-Austin Settlement Trust (the "Asbestos Trust") which had been set up pursuant to the Plan. The Court overruled numerous objections of the excess carriers when it held that Fuller-Austin’s confirmed bankruptcy Plan is a binding federal court judgment and adjudication that establishes Fuller-Austin’s liability and its legal obligations to pay damages to all pending and future asbestos claimants. An insurance company is liable for, and its obligation to pay is triggered by, that portion of a liability that exceeds its attachment point, irrespective of whether the policy holder or the underlying insurance company has paid the underlying limits or nothing at all.
Where available insurance in a lower layer of coverage isn’t sufficient to cover the loss in its entirety, an excess insurance company is responsible for that portion of the loss that exceeds its stated attachment point-regardless of whether the underlying insurance company has paid or can pay an underlying judgment or settlement. If one of the primary insurance carriers is insolvent, the excess carrier still must pay if the total loss exceeds the stated attachment point. Similarly, the fact that Fuller-Austin will only be able to pay a percentage of its total asbestos liabilities does not decrease the obligations of the excess carriers. The excess carriers cannot hide behind the bankruptcy of their insured. In summary, the Fuller-Austin decision affirms the principle that a Chapter 11 plan of reorganization triggers the obligation of asbestos insurers to pay the limits of their coverage into bankruptcy court to help fund the asbestos trust. The outcome of the Fuller Austin decision is almost certainly going to be appealed.
Given the cost and complexity of a bankruptcy proceeding involving massive asbestos liabilities, substantial advance planning and preparation are essential. Long before available insurance coverage is exhausted, particularly when the debtor is a smaller company, the process must begin. It’s important to understand the scope and availability of insurance coverage, including any disputes that may exist with insurance carriers. Thus, an important component of the planning team will be experienced insurance coverage counsel. In addition, a realistic assessment of the future liabilities must be undertaken with defense counsel to attempt to gain a reasonable understanding of the likely flow of new cases into the future and the cost of resolving those cases. Equally important is the preparation of the underlying business operations to ensure that they can withstand the rigors of a bankruptcy proceeding. Key members of the management team must be brought into the process so that they know what to expect when the time comes for filing the bankruptcy proceeding and they can share their individual insight into the likely operational issues that will arise.
Although it’s not always possible, any company facing substantial asbestos liabilities should consider the potential for filing a "pre-packaged" bankruptcy proceeding. Under this type of proceeding, an informal committee of asbestos claimants is established prior to the commencement of a bankruptcy proceeding for purposes of negotiating a resolution. In addition, a guardian ad litem is selected to represent the interests of future asbestos claimants. Depending upon the nature and relationship with the company’s insurers, they may also be brought into the process. The advantage of a pre-packaged bankruptcy proceeding is that it reduces the time and expense of a traditional bankruptcy proceeding by allowing many of the normal processes which occur during a bankruptcy proceeding to occur prior thereto. If a deal can be struck with the asbestos claimants, then a plan of reorganization and disclosure statement are distributed to the asbestos creditors prior to the filing of the bankruptcy proceeding and the votes are obtained. Once the votes are obtained, the bankruptcy process is then commenced with the plan of reorganization and disclosure statement being filed on the case’s first day.
While major companies like Babcock and Wilcox and Pittsburgh Corning may have the financial wherewithal to engage in a protracted bankruptcy fight with asbestos claimants in an effort to reorganize, smaller companies face a much different challenge. These companies must identify their available insurance coverage as early as possible, and make a realistic determination of how long that insurance will last in light of the current litigation environment. If it appears that the insurance isn’t going to outlast the existing litigation claims, then advance planning is critical. Entering into a bankruptcy proceeding with little or no insurance coverage is never recommended and makes the reorganization of that company substantially more difficult, if not impossible. Thus, it’s critical to obtain the assistance of bankruptcy counsel who have experience with asbestos Chapter 11 cases early in the process to help ensure the best possible outcome. Failure to address these issues early on could substantially prejudice a company’s ability to reorganize.