In an important recent decision of the United States Court of Appeals for the Second Circuit, testing the outer reaches of a bankruptcy court’s jurisdiction, In re Johns Manville Corp., 06-2099 (2d Cir. Feb. 15, 2008), the court considered whether claims that are not derivative of a debtor’s liability, but rather seek to recover directly from an insurer for its own alleged misconduct, can be enjoined by the “channeling” mechanism developed by the bankruptcy court.

Johns-Manville Corporation (“Manville”) was a manufacturer of asbestos containing products and a supplier of raw asbestos in the United States from the 1920s through the 1970s. Manville filed for Chapter 11 protection in 1982, after becoming the target of numerous products liability lawsuits. Travelers was Manville’s primary insurer from 1947 through 1976, and paid nearly $80 million into the bankruptcy estate in exchange for a full and final release of Manville-related claims. Travelers’ settlement was predicated on the bankruptcy court’s issuance of an injunction barring suits against Manville’s insurers and channeling all claims based upon, arising out or related to Manville’s liability insurance policies to the Manville Personal Injury Settlement Trust. However,. various groups of plaintiffs subsequently filed lawsuits directly against Travelers and other insurers in several states based on statutory and common law claims (the “Direct Action Lawsuits”). The plaintiffs in the Direct Action Lawsuits alleged that the insurers acquired knowledge about the dangers of asbestos through early asbestosis claims as far back as the 1960s and allegedly influenced Manville’s purported failure to disclose its knowledge of asbestos hazards.

In response to the Direct Action Lawsuits, Travelers moved the bankruptcy court to enjoin a number of actions pending in state court pursuant to the order barring suits against Manville’s insurers. Subsequently, three classes of plaintiffs settled with Travelers, and the settlements were conditioned upon the entry of an order by the bankruptcy court clarifying that the Direct Action Lawsuits were prohibited by that court’s orders. The bankruptcy court approved the settlement agreements and entered a “Clarifying Order” with regard to the Direct Action Lawsuits. The United States District Court for the Southern District of New York affirmed the bankruptcy court’s findings, concluding that barring the Direct Action Lawsuits was a proper exercise of jurisdiction.

On appeal, the Second Circuit reasoned that the plaintiffs in the Direct Action Lawsuits do not seek to recover on the basis of Manville’s conduct but, rather, seek to recover under state law directly from Travelers for its own alleged misconduct. The court stated that the Direct Action Lawsuits pursue the assets of Travelers, raise no claim against Manville’s insurance coverage and are not against an asset of the bankruptcy estate. Thus, the bankruptcy court had no jurisdiction to enjoin the Direct Action Lawsuits against Travelers. The court stated “a bankruptcy court only has jurisdiction to enjoin third party non-debtor claims that directly affect the res of the bankruptcy estate.” Because the Direct Action Lawsuits are non-derivative and have no effect on the res, they are outside the injunction/channeling mechanism that the Manville bankruptcy court developed.

Click here to read the decision.