The United States Court of Appeals for the Second Circuit has ruled that the Johns-Manville bankruptcy court did not have jurisdiction to enjoin direct action claims asserted against Travelers entities that are predicted on an independent duty owed by Travelers, that do not claim against the res of the Manville estate, and that seek damages unrelated to and in excess of Manville's insurance proceeds. Johns-Manville Corp. v. Chubb Indemnity Ins. Co., --- F.3d ---, 2008 WL 399010 (2d Cir. Feb. 15, 2008).

The jurisdictional issue about the scope of the bankruptcy court's powers grew out of the historic Manville bankruptcy proceeding. In the context of that proceeding, Travelers, which was Manville's primary insurer from 1947-1976, entered a settlement under which it paid nearly $80 million into the bankruptcy estate in exchange for a full and final release of Manville-related claims. The settlement was predicated on the bankruptcy court issuing an injunction that barred suits against Manville's insurers and channeled them instead to the Manville Personal Injury Settlement Trust. An injunction was indeed entered barring "all persons" from commencing suit against Travelers (or other settling insurers) for the purpose of directly or indirectly recovering payment of, on, or with respect to any claim or other asbestos obligation. 

Since that order, despite the existence of the Manville channeling injunction, Travelers has been sued directly by various asbestos claimants for alleged statutory and common law bad faith claims in which the plaintiffs assert that Travelers improperly refused to disclose to the public, or caused Johns-Manville to refuse to disclose to the public, the dangers associated with asbestos. Travelers, contending that these suits arose out of its insurance relationship with Johns-Manville, asserted that these suits were barred by the channeling injunction. It moved the bankruptcy court to enjoin a number of such direct actions. After hearings, the bankruptcy court referred the matter to mediation. The mediation prompted a settlement with the various claimants, through which Travelers disposed of the suits in exchange for a payment of $500 million, contingent on the bankruptcy court entering a clarifying order stating that such direct action suits are barred by the channeling injunction. The bankruptcy court entered the order, asserting that it had jurisdiction to do so. The decision was affirmed in relevant part by the district court.

On appeal to the Second Circuit, various claimants asserted that the bankruptcy court lacked jurisdiction to enjoin the bad faith actions and that those actions were not governed by the Manville channeling injunction. The Second Circuit agreed. The court noted that some direct actions, like those permitted by statute in Louisiana, are mere surrogates for a suit against the policyholder and have as their target policy proceeds. Those suits stem from statutes that do not grant an independent cause of action against the insurer, but merely a procedural right of action against the insurer by a plaintiff with a substantive cause of action against its policyholder. These types of direct actions, the court noted, would be barred by the Manville channeling injunction and were within the bankruptcy court's jurisdiction. The court, however, distinguished those actions from the bad faith theories at issue in the direct actions in the appeal. In these suits, the court reasoned, the statutory and common law claims constitute independent tort actions against Travelers, for Travelers' own alleged breach of a legal duty to the plaintiffs, and are unrelated to the insurance policy proceeds. In other words, the plaintiffs seek to recover against a debtor's insurer for the insurer's own wrongdoing. Moreover, they raise no claim against the debtor's insurance coverage or any asset of the bankruptcy estate. Furthermore, the court rejected the bankruptcy court's reasoning that the settlement and clarifying order should be approved in order to help provide Travelers with finality. The court stated that the "ability to provide finality to a third-party is defined by [the court's] jurisdiction, not its good intentions." It concluded that the court's jurisdiction does not extend to any and all claims factually related to a bankruptcy if the debtor's res is not at issue.

Having ruled that the bankruptcy court was without jurisdiction over the claims to the extent Travelers owed an independent duty to these direct action plaintiffs, the court stated that "Section 524(g), enacted in response to the bankruptcy court's actions in earlier proceedings in this case, must be interpreted in the same manner." The Second Circuit reasoned that this result is necessary because the claims against Travelers did not derive from the rights or obligations under the insurance policies owned by Johns-Manville and because Section 524(g) "was not intended to reach non-derivative claims."

The Second Circuit's decision leaves settling insurers without complete protection from claims that, in a literal sense, plainly "arise out of" the provision of insurance to a policyholder. The significance of the gap in protection created by this ruling is somewhat unclear, since courts, to date, have not accepted the common law theories asserted in cases such as the independent direct actions brought against Travelers here. However, the determination that a bankruptcy court is without the authority to enjoin such suits against the asbestos debtor's insurer means that, at a minimum, insurers will incur substantial litigation costs in defending against such direct suits.