Third Circuit Rules Future Claimant Lacks Standing to Object to Plan

Following the saga of asbestos-related bankruptcy cases, the Third Circuit Court of Appeals recently held that Garlock Sealing Technologies, LLC lacked standing to object to the confirmation of the chapter 11 plan of W.R. Grace & Co., because Garlock could not demonstrate it had an existing or imminent claim against Grace.  See In re W.R. Grace & Co., No. 12-2807 (3rd Cir. July 24, 2013).

Facts

For more than a century, Grace manufactured and sold specialty chemicals and construction materials.  Previously, many of those products contained asbestos and in the 1970s, Grace began to face personal injury lawsuits alleging harm from asbestos exposure.  In fact, by 2001, Grace was involved in over 65,000 asbestos-related lawsuits, which threatened the financial viability of the Company and ultimately forced the Company into bankruptcy.

In 2009, after almost a decade in bankruptcy, Grace and its various constituencies submitted a joint plan of reorganization, which would restructure all of Grace’s liabilities, especially the asbestos-related claims.  The main components of the chapter 11 plan were two trusts created for the benefit of personal injury and property damage claimants.  Pursuant to section 524(g) of the Bankruptcy Code, Grace’s chapter 11 plan provided that all existing and future asbestos-related claims against Grace would be channeled to the trusts and would be enjoined from being asserted against Grace after it emerged from bankruptcy.  These components were critical to Grace’s successful reorganization.

Section 524

As a chapter 11 debtor facing substantial asbestos liability, Grace was entitled to avail itself of special channeling injunctions under the Bankruptcy Code, provided its trusts complied with the various requirements under section 524(g).   Section 524 was added to the Code in the 1990s in response to the numerous companies facing substantial asbestos-related liabilities.  This section provides a special means in which such companies can restructure such liabilities and emerge from bankruptcy free from such liabilities.  Among other things, section 524 requires:

  • the asbestos-related trusts to be funded by securities of a debtor and a debtor’s obligation to make future payments to the trust;
  • the asbestos-related trusts to own, or upon future contingencies be entitled to own, the majority of voting shares of a debtor;
  • the asbestos-related trusts to operate through mechanisms that provide reasonable assurance that the trusts will be in a financial position to pay present and future claims in substantially the same manner;
  • the debtor to demonstrate that (a) it is likely to be subject to substantial future claims related to asbestos-related injuries and (b) such future claims cannot be determined;
  • a court to find that pursuit of asbestos-related claims outside of the chapter 11 plan process would threaten the plan’s purpose to deal equitably with such claims;
  • a chapter 11 plan to place all asbestos-related claims into a separate class entitled to vote for the chapter 11 plan, and 75% of the class members voting on the plan must accept it.

Under section 524, there also exist numerous requirements applicable to the injunctions that could be issued under an asbestos-driven, chapter 11 plan.  For example, the bankruptcy court is required to appoint a legal representative to represent future asbestos claimants well-before the plan formulation process and such representative does not object to the plan or its injunctions.  See 11 U.S.C. § 524(h)(1)(B).  The injunctions can only protect certain third-parties, like management, owners or insurance companies, who could be held liable for the same asbestos-related claims facing the debtor.  See 11 U.S.C. § 524(g).  The bankruptcy court must also determine that the injunctions are fair and equitable to future claimants, in light of the benefits provided to the trusts by the debtor or third-parties, e.g., insurance companies.

Needless to say, there are numerous requirements that must be met in order for debtors to avail themselves of the special channeling injunctions provided by section 524(g), and the foregoing discussion only serves to demonstrate the hurdles that a debtor must overcome in order to avail itself of such protections.  In Grace’s bankruptcy case, the bankruptcy court found that Grace met all of the requirements under section 524(g) and therefore it was entitled to its channeling injunctions with respect to all existing and future asbestos-related claimants.  Garlock disagreed and filed an objection to Grace’s plan.

Garlock’s Objection to Plan

Garlock was a manufacturer of engineered industrial products and it formerly used some of Grace’s asbestos-containing materials in its products.  As a result, Garlock itself was sued by thousands of asbestos-related personal injury claimants and was named as a co-defendant with Grace in numerous lawsuits.  Garlock similarly filed for bankruptcy in 2010, primarily to deal with its asbestos-related liabilities.

In Grace’s bankruptcy, Garlock claimed that because of the prospect of facing joint liability with Grace in the numerous existing and future suits, it was entitled to (a) contribution claims against Grace for any amounts it paid to claimants that exceeded Garlock’s individual liability and (b) setoff claims against claimants who had already received a recovery from Grace, either through the trusts or otherwise.  Relying on this contingent harm, Garlock objected to Grace’s chapter 11 plan on the basis that it did not comply will all the requirements under section 524(g).  What Garlock was really after was more money from the Grace trusts to pay the personal injury claims asserted against Garlock in its bankruptcy case.

There were two fundamental problems with Garlock’s contention, however.  First, it had never filed a proof of claim for alleged amounts owed in Grace’s bankruptcy.  Second, there was no evidence that Garlock had ever asserted such contribution or setoff rights against Grace anywhere, inside or outside of bankruptcy.  The bankruptcy court thus held that Garlock did not have party in interest standing to object to Grace’s plan.  On appeal, the federal district court agreed with the bankruptcy court, finding that Garlock had “not articulated how it has suffered any injury.”

Third Circuit’s Ruling

On further appeal, the Third Circuit analyzed the standard under section 1109 of the Code  and Article III of the Constitution for a party to have standing to raise an issue in a chapter 11 case, and in particular, an objection to the confirmation of a chapter 11 plan.

Section 1109 provides that “[a] party in interest, including the debtor, trustee, a creditors’ committee, an equity security holders’ committee, a creditor, an equity security holder or any indenture trustee, may raise and may appear and be heard on any issue in a case under [chapter 11].”  11 U.S.C. § 1109(b).  Courts have generally found that the list of identified parties in section 1109 are not exclusive and that section 1109 includes anyone who has a legally protected interest that could be affected by a bankruptcy proceeding.  See In re Global Indus. Techs., Inc., 645 F.3d 201, 210 (3d Cir. 2011).

While the Third Circuit noted that any “specific, trifle of injury” will confer standing under section 1109, it found that Article III added additional requirements for standing.  Pursuant to Article III, a party must demonstrate some invasion of a legally protected interest that is “(a) concrete and particularized and (b) actual or imminent, not conjectural or hypothetical.”  In other words, allegations of possible future injury or an alleged injury that stems from an indefinite risk of future harm will not suffice to confer standing under Article III.

Garlock argued that it held standing because its contribution and setoff rights would be jeopardized under Grace’s plan, which was only able to pay 25% to 35% of the value of Grace’s liabilities owed to Garlock in the future.  However, the Third Circuit found, as did the prior courts, that Garlock had never asserted any contribution or setoff claims against Grace prior to Grace’s bankruptcy and Garlock could not show that it had ever suffered a judgment after Grace’s bankruptcy that entitled it to such claims.  While the Court noted that there was a theoretical possibility that future lawsuits might give rise to such claims, the Third Circuit held that such claims could only be considered speculative.  Therefore, the Third Circuit affirmed that Garlock lacked standing under Article III to object to Grace’s plan.

Insight

Garlock never filed a proof of claim in Grace’s bankruptcy demonstrating that it held an existing contribution or setoff claim against Grace for any of the thousands of lawsuits prior to Grace’s bankruptcy or even after the bankruptcy (when the automatic stay shielded lawsuits against Grace).  Instead, Grace conceded that no such claims existed because it had been able to settle such claims with plaintiffs.  Why then would any court believe that such claims could exist in the future, especially after so many lawsuits?  Section 502(e) of the Bankruptcy Code even provides grounds for disallowing such reimbursement or contribution claims that are merely contingent during a bankruptcy case.  In Grace’s case, it was abundantly clear that Garlock’s alleged contribution and setoff claims against Grace–even if filed–were contingent, at best, and therefore could never be allowed against Grace.  The Third Circuit’s opinion, while not discussing section 502’s grounds for disallowance, is in line with this logic.



Categories: Recent Case Law

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