The California Court of Appeal has reversed a ruling holding that liability insurers of an asbestos company had immediate obligations to perform in full once a trust was established through section 524(g) of the bankruptcy code that concurrently extinguished the liability of the policyholder vis a vis the asbestos claimant creditors. Fuller-Austin v. Highlands Ins. (Cal. App. Jan. 19, 2006). The “acceleration” of insurers’ obligations that these 524(g) trusts might create has caused apoplexy in the insurance industry, and the California court’s reversal of the insurance ruling that the creation of the trust meant the insurers had immediate obligations to perform for the total (non-bankruptcy) value of the future claim stream no doubt produced a collective sigh of relief from the insurance industry (and their reinsurers).
There are two bankruptcy elements in these modern asbestos-driven bankruptcies that, when combined with prior rulings of courts dealing with bankruptcy effects on insurance, yielded an extraordinary result: immediate obligations of insurers to pay the future asbestos obligations of the policyholder-debtor immediately and in full. Before turning to the Fuller-Austin decision itself, it is important to understand what debtors like Fuller-Austin were trying to achieve.
The first step in an asbestos-driven bankruptcy is to take the asbestos claims stream and estimate its value. The debtor then needs to satisfy that creditor claim in the bankruptcy, which it does by setting up a trust and funding it with cash (from itself and sometimes its corporate parent), stock, and preexisting insurance rights. The debtor receives a channeling injunction that bars the assertion of any asbestos-related claim against itself (and sometimes against non-debtors, see Susan Power Johnston and Katherine Porter, Extension of Section 524(g) of the Bankruptcy Code to Nondebtor Parents, Affiliates, and Transaction Parties, 59 Business Lawyer 511-12 (2004)), and the injunction furthermore funnels all claims to the trust. In other words, the debtor is able to emerge from bankruptcy shorn of its asbestos liabilities without fear of any future claims.
The trust in turn is charged with resolving the asbestos claims and sets up an administrative compensation process, usually with relaxed standards of proof, to “adjudicate” the tort claims. The claimant may have the right further to bring an action in court, though with no ability to seek punitive damages for example.
This is the model that was used in the Manville bankruptcy and was confirmed, expanded, and modified by Congress in 1994 when the bankruptcy code was amended with the addition of section 524(g), 11 U.S.C. § 524(g), a provision specially designed to deal with asbestos-driven bankruptcies. While certain procedural and substantive changes were implemented in 524(g), from the debtor’s perspective one key was that 524(g) made clear that future claims, claims by persons exposed to asbestos but who at the time of the bankruptcy filing had no legal claim, would have their claims channeled to the trust as well. Dealing with “futures” has been the Achilles heel of several non-bankruptcy deals in the class-action context, Ortiz v. Fibreboard Corp., 527 U.S. 815 (1999); Amchem v. Windsor, 521 U.S. 591 (1997), so the express conferral of power on bankruptcy courts to limit the right to sue of future claimants was quite significant.
How did all this impact insurance companies? In most jurisdictions, the court have adopted a model of asbestos insurance recoveries where insurers from the 1940s through the mid-1980s together are liable to pay the policyholder’s defense costs and costs of settlements and judgments. There remained key questions in the insurance cases concerning the order of payment by insurers, which principally was an issue for the excess insurance carriers. The question is whether, if one were an excess insurer in 1970 that wrote coverage excess of $50 million, an amount that would represent about one-quarter of one year’s asbestos expense for a major defendant, that insurer is required to perform once the insured/asbestos-defendant pays $50 million or whether that insurer is effectively excess to the sum total of all primary and excess coverage, both before and after its policy period, that attaches lower than $50 million. E.g., United States Gypsum Co. v. Admiral Insurance Co., 643 N.E.2d 1226 (1991) (holding that an umbrella carrier was excess to policies before and after its policy year). If one assumes a constant level of $50 million annual coverage, the 1970 excess carrier might than be excess to hundreds of millions of dollars in “underlying” coverage. The key point is that the objective of excess carriers was to defer as long as possible the time at which they were required to perform; given the size of excess policy limits, the likelihood that asbestos liability will suck dry an entire insurance program, and the value of holding onto money as long as possible so as to “earn out” the value of claims, excess insurers have been banking on deferring their obligations to pay.
In this context, the developments in the bankruptcy cases took on added importance to excess insurers. Under a key decision more than a decade ago in the Seventh Circuit, UNR Indus., Inc. v. Continental Cas. Co., 942 F.2d 1101 (7th Cir. 1991), two crucial issues were resolved: (1) the debtor/insured’s establishment of the trust in exchange for the release of the asbestos claims against it (which were channeled and funneled to the trust) constituted a “judgment” as to which the insurers had a mature obligation to indemnify (even though payment to any individual claimant might not occur for decades); and (2) while a claimant might receive only a percentage payment from the insured/debtor/trust due to its limited funds, the value of the claim for insurance-indemnification purposes was the face value (not the end-of-the-day paid value) of the claimant’s damages. As to the second point, even though an individual settlement is paid in “bankruptcy dollars” in calculating the duty to indemnify the value of the claim extinguished is determinative (not the value paid to extinguish the claim, an amount that takes into account the insured’s insolvency).
The consequence of the UNR decision for excess insurers was frightful: they could be required to immediately perform calculated against the full value of the debtor’s claim portfolio, even though the trust itself might not pay out the individual claims for years to come.
The situation became more acute for excess insurers after 524(g) was passed by Congress in 1994. Section 524(g) requires 75 percent approval by creditors, typically the asbestos claimants (and commercial bondholders). Utilizing the pre-packaging structure under the bankruptcy code, through which debtors may negotiate the plan of reorganization prefiling, debtors began to file section 524(g) “pre-pack” bankruptcies wherein the debtor/insured/defendant would strike an agreement with the asbestos plaintiffs (in reality, their contingency-fee-paid lawyers) to establish a value of the portfolio of asbestos claims and payment values. This informal estimation process (with the asbestos-plaintiffs’ lawyer taking a percentage recovery) yielded huge nominal values, since they include asbestos claims that will be asserted for the next thirty years.
Thus, insured/debtors/defendants would negotiate a pre-pack bankruptcy plan where often the key asset that would be used to fund the massive asbestos liabilities driving the bankruptcy was insurance rights. E.g., In re Johns-Manville Corp., 40 B.R. 219, 229 (S.D.N.Y. 1984) (insurance among “the most important assets of the estate”). Moreover, the creditors’ committee (the asbestos-plaintiffs’ lawyers) would be in charge of the trust – which insurers likened to the fox guarding the hen house. (This also resulted in strange reversals of roles where some policyholder lawyers, who for years worked for asbestos defendants, suddenly became the lawyers for the trusts/creditors, working for the asbestos claimants who were suing the asbestos-defendants who had formerly been their clients – a situation that produced intriguing professional ethics and bankruptcy issues.)
Fearing that they were being set up in these pre-pack 524(g) deals (and insurers were not alone in being critical of these pre-pack, 524(g) arrangement), insurers sought to protect their interests by intervening in the bankruptcy proceedings, leading to fights over the insurers’ standing to object to a plan (given that insurers were debtors to the estate not creditors). In Re Combustion Engineering, (3d Cir. Dec. 2, 2004); In Re A.P.I. Inc., 331 B.R. 828, 842 (Bankr. D. Minn. 2005); Barron & Budd, P.C. v. Unsecured Asbestos Claimants (321 B.R. 147, 157-52 (D.N.J. 2005); Metropolitan Life Ins. Co. v. Alside Supply Center (In Re Clemmer), 78 B.R. 160 (Bankr. E.D. Tenn. 1995). Insurers (and others) fought against each other where one insurer settled the coverage with the debtor/insured. In Re Dow Corning, 192 B.R. 415, 421 (Bankr. E.D. Mich. 1996); MacArthur Co. v. Johns-Manville Corp., 837 F.2d 89 (2d Cir. 1988); see also In Re FortyEight Insulations Inc., 133 B.R. 973 (Bankr. N.D. Ill. 1991), aff’d, 1149 B.R. 860 (N.D. Ill. 1992). Insurers sometimes would seek to litigate coverage questions against their insured in bankruptcy (though those courts often were thought to be favorable fora for the debtor/policyholder), presenting questions of core/non-core proceedings, removal, and withdrawals of reference as well as questions whether the insured must satisfy deductibles or retentions as a pre-condition to accessing coverage or whether the deductible is an affirmative claim by the insurer that gets resolved at the end of the line in the bankruptcy with other unsecured claims against the estate. E.g., Amatex Corp. v. Aetna Cas. & Sur. Co., 107 B.R. 856, 871-72 (Bankr. E.D. Pa. 1989); Kleban v. National Union Fire Ins. Co., 2001 Pa. Super. 92 (2001); Columbia Cas. V. Federal Press, 104 B.R. 56, 62-64 (Bankr. N.D. Ind. 1989); Home Ins. Co. v. Hooper, 691 N.E. 2d 65 (Ill. App. 1998); Haisten v. Grass Valley Reimbursement Fund, Ltd., 784 F.2d 1392, 1403 (9th Cir. 1986)). Some carriers sought to litigate the coverage outside of the bankruptcy, but those ran into the rule that coverage actions (including “defensive” affirmative claims) outside of the bankruptcy court may not be initiated by insurers, due to the protections of the automatic stay. ACandS, Inc. v. Travelers Cas. & Sur. Co., (3d Cir. Jan. 19, 2006); Minoco Group v. First State Underwriters Agency, 799 F.2d 517, 519 (9th Cir. 1986).
This brings us to Fuller-Austin, a company that filed a pre-pack 524(g) bankruptcy that was confirmed in September 1998. Though it had commenced coverage litigation in 1994, the case suffered litigation interruptus due to the bankruptcy filing; the case picked up again with bench trials in December 2000 and September 2001, and a jury trial in November 2002. In May 2003, the jury returned a verdict in favor of Fuller-Austin awarding $188 million in damages. The jury further found that the value of Fuller-Austin’s asbestos stream exceeded $966 million. Following that trial loss, the insurers appealed, largely challenging the jury instructions formulated by the trial judge. As crushing a defeat that the trial court judgment was, the appellate decision was equally a vindication for the insurers. The insurers won virtually every issue on appeal. The appellate court was unequivocal in its rejection and criticism of the policyholder’s arguments.
The first question presented was whether the bankruptcy court’s confirmation of the plan constituted was a binding determination of the insured’s liability to the asbestos claimants. In other words, does the amount determined in the bankruptcy court constitute the amount to which the insurer’s duty to indemnify applies? The Fuller-Austin court ruled that the determination of the insured’s liability to the class in the bankruptcy proceeding was not sufficient to constitute an actual “adjudication” of the insured’s liability. There was no actual, adversarial process of factfinding such that would effectively bind the insurer by finally establishing the insured’s liability. Compare Hamilton v. Maryland Cas. Co., 27 Cal. 4th 718 (Cal. 2002).
The California court found that the bankruptcy-confirmation process, including the formulation of a plan, was a “settlement” of the insured’s liability, which presented the question whether the insurers had the right to refuse to consent to the settlement. While the insurers did not consent in fact to the plan, the court embraced the notion that insurers did not have the power to withhold consent unreasonably. In other words, so long as the settlement is reasonable, the question of the insurers’ consent vel non is academic. Because the insurers did not establish a lack of good faith by Fuller-Austin in the process leading to the plan, the court held that the insurers were permitted to object to the settlement only to the extent they could show that, as to them, the bankruptcy plan is “unfair, unreasonable or the product of fraud or collusion.” (slip op. at 34; 52-54)
The court next turned to the key question of acceleration, whether the coverage-trial jury could “estimate the aggregate sum of an insured’s liability for present and potential future asbestos claims for the purpose of accelerating [the] insurers’ obligations;” the court concluded that the estimation of the value of the claim portfolio did not “represent the amount that Fuller-Austin is legally obligated to pay.” Slip op. at 41. The court’s discussion, on this point, is not entirely focused. The issue (at least as I understand it) is whether the claim-estimation process in bankruptcy when combined with the discharge of the debtor and funneling of all claims to the separately established trust, constitutes a then-present release of the insured’s liability to the class. If so, then the plan-confirmation process results in an immediately indemnifiable judgment as against the insured (and concurrent assignment of the choses in action under the policies to the trust). In other words, rather than a claim-by-claim exhaustion of coverage as they are adjudicated (or settled) in the ordinary course, the bankruptcy process results in the equivalent of a class-action judgment against the debtor/insured. If like a class-action the claims are resolved en masse, it matters not that the payments for the individuals will occur over time. Relative to the insured, it has extinguished its liability, not as of the time that any individual claimant receives his or her money but when the judgment is entered (which the insured/debtor satisfies by establishing the trust).
The Fuller-Austin court does not frame the question this way, and it is unclear to me whether procedurally this is precisely how the issue was served up. But the court is unequivocal in declining the follow the Seventh Circuit’s UNR decision on this point, which concededly was decided prior to the enactment of 524(g). (Notably, there is no evidence of which I am aware that Congress in enacting 524(g) intended to overturn the UNR decision.) For future bankruptcies, the Fuller-Austin decision may be inapposite or at least unpersuasive on this point.
Relatedly, the court concluded that the value of the claims of the asbestos claimants were measured by the percentage recovery they obtain from the trust rather than the “full” value of their claims. In other words, because of the limited assets of the debtor-insured, the asbestos claimants were to receive only a percentage of the value of their claims (say, 45¢ on the dollar). The court paid little heed to the standard policy provision and statutorily imposed term that the insured’s bankruptcy or insolvency was not to reduce the insurer’s obligation. This policy provision was intended expressly to overcome decisions early last century where an insurer skated out of its obligations because its insured was (otherwise) impecunious and thus was not obligated to pay for the claimant’s full damages. The California court again declined to follow the UNR decision on this point. Excusing the insurers on this basis improperly favors their interests over that of the tort claimants and indeed other asbestos defendants, which will be exposed to the shortfall under joint-and-several liability principles.
The court further addressed issues dealing with the fairness of the trial-court’s jury instructions, including one that effectively presumed the existence of coverage and required the insurers to disprove that their policies were triggered or provided coverage.
What are the implications of Fuller-Austin for asbestos and mass-tort driven bankruptcies? First, it seems likely that the case will stand within the California court system because review by the California Supreme Court seems unlikely. Second, the parties upon retrial will be litigating whether the plan was a fair estimate of the insured’s liability. Assuming the settlement will be found to reasonably approximate the insured’s liability, the insurers will be required to perform only as and to the extent that claims are resolved by the trust. The likely finality of the appellate court’s ruling that the insurers’ obligations are not accelerated and are measured only by the actual payouts are the twin pillars of the excess insurers’ victory.
It’s fair to say the Fuller-Austin decision represents a major win for insurers, but the losers are the asbestos claimants (and their lawyers). The policyholder has received its discharge through the bankruptcy process and under 524(g) is protected against future asbestos-liability claims. The insurers have become increasingly aggressive and litigious in all the spate of asbestos-driven bankruptcies, and Fuller-Austin will not quell their enthusiasm for battle.