Channel 1 – Thorpe Insulation Addresses Insurer Standing to Object to Plan and Assignability of Insurance Contracts to Plan Trusts

Bottom Line:

Our first case discusses whether provisions of a chapter 11 plan were “insurance neutral” and, as such, whether insurers had the right to be heard in contesting the asbestos-liability channeling injunction of the plan.  The Ninth Circuit held that the lower courts improperly excluded the insurers from participating in the Chapter 11 case, finding that the insurers could be economically affected by the terms of the plan and the accompanying 524(g) injunction, and therefore enjoyed party-in-interest standing under Code section 1109(b) to object to both.  But, the decision also invalidates anti-assignment provisions in the insurance policies, holding that these provisions were preempted by section 541 of the Bankruptcy Code and thereby allowing the debtor to transfer its policy interest to the 524(g) trust.  Motor Vehicle Cas. Co. v. Thorpe Insulation Co. (In re Thorpe Insulation Co.), No. 10-56543, 2012 U.S. App. LEXIS 1272 (9th Cir. Jan. 24, 2012).

What Happened:

Thorpe Insulation Company, along with its debtor-affiliate Pacific Insulation Company, distributed, installed, and repaired asbestos insulation products throughout the middle of the twentieth century.  By the time the debtors filed for chapter 11 protection in late 2007, they had faced more than 10,000 claims and suits for personal injury or wrongful death arising from asbestos exposure, of which roughly 2,000 were pending at the time of bankruptcy.  Id. at *3-5.

In December of 2009, the debtors filed a plan of reorganization that contemplated the issuance of a section 524(g) injunction channeling existing and future claims into a dedicated asbestos trust.  In the process of establishing the trust, Thorpe reached settlements with most of its asbestos-liability insurers by which those insurers would contribute cash to the trust in exchange for full protection from further asbestos-related liability.

Not all of the debtors’ insurers settled, however.  Those that did not were not afforded the same injunctive protection under the plan as the settling insurers, such that future claimants would be permitted to bring claims against them under certain circumstances. As the court explained:

The Asbestos Insurer Injunction prohibits actions against [non-settling] asbestos insurers without permission by the trust; the trust may not allow such actions unless asbestos claimants agree to the same judgment reduction that is binding on the trust before proceeding against non-settling insurers.

Id. at *10.

In other words, the trust could permit actions to proceed against non-settling insurers provided that the insurers would not be forced to pay more per claim than the trust itself would have.  The trust thus stepped into the shoes of the original policyholders, with the power to divert claims brought against it to the insurers.

In spite of endowing the trust with the debtors’ preexisting rights vis-à-vis the non-settling insurers, the plan was approved as “insurance neutral” by the bankruptcy court, which found that the insurers’ own rights under the respective policies were preserved when the policies were assigned to the trust.  See In re Thorpe Insulation Co., No. 10-1493, 2010 U.S. Dist. LEXIS 104196 at *6-8 (C.D. Cal. Sept. 21, 2010).  Put simply, the bankruptcy court held that the insurers were not injured because the trust had no power to bind them – rather, its role was limited to directing claims against them pursuant to the terms of the policies, which they would be free to defend as before.  The bankruptcy court then followed precedent established by other courts in finding that, because the plan was insurance neutral, the non-settling insurers lacked standing to oppose confirmation.  Thorpe, 2012 U.S. App. LEXIS 1272 at *27-29 (9th Cir.).

The Ninth Circuit overruled this determination, revisiting the bankruptcy court’s ruling that the insurers were not “parties in interest” under section 1109(b) of the Bankruptcy Code with the right to be heard in connection with plan confirmation.  Noting that 1109(b) was intended to provide standing for “anyone who has a legally protected interest that could be affected by a bankruptcy proceeding,” the court reasoned that the insurers’ standing would hinge on whether the plan was in fact insurance neutral.  Id. at *28-31 (quoting In re James Wilson Assocs., 965 F.2d 160, 169 (7th Cir. 1992)). 

The court declared that “[a] plan is not insurance neutral when it may have a substantial economic impact on insurers.”  Id. at 31.  Because, among other things, the trust followed its own internal valuation procedures with respect to claims brought against it – which valuation could then affect the insurers’ liability if the trust directed the claim against them – the court held that the plan could have a substantial economic impact on the insurers.  Id. at *32.   As the court noted, “[t]hough § 524(g) contemplates this kind of interference with insurers’ contracts,” this did not affect whether the insurers were parties-in-interest entitled to challenge the plan. *36.

Because the plan was not insurance-neutral, and therefore had the potential to make a substantial economic impact on the insurers, the insurers were entitled to party-in-interest standing under section 1109 of the Bankruptcy Code.  Id. at *37.  The insurers had Article III appellate standing to challenge the bankruptcy court’s standing determination, moreover, where they held “a financial stake in the outcome of the proceeding,” id. at *37, and where they were within the “zone of interest” created by section 1109(b), id. at *40. 

Having established their standing, the insurance companies challenged the bankruptcy and district court determinations that both (i) the contractual anti-assignment provisions contained in their policies with the debtors, and (ii) California common law holding that assignment of insurance benefits may violate an anti-assignment provision if the claim against the policy “has not been reduced to a sum of money due or to become due under the policy,” were preempted by federal bankruptcy law. Id. at 41 (citing Henkel Corp. v. Hartford Accident and Indemnity Co., 29 Cal. 4th 934, 944 (2003)).  The operation of these provisions under California law would have thus rendered the assignment of the policies to the trust invalid.

On this point, however, the Ninth Circuit sided with the lower courts, ruling that the protections afforded the insurers under state law were expressly preempted by section 541(b) of the Bankruptcy Code, which provides that an “interest of the debtor in property becomes property of the estate . . . notwithstanding any provision in an agreement, transfer instrument, or applicable nonbankruptcy law . . . that restricts or conditions transfer of such interest by the debtor.”  Id. at *43; 11 U.S.C. § 541(b).  As such, the court held that section 541 “expressly contemplates the inclusion of debtor insurance policies in the bankruptcy estate.”  Id.(quoting In re Combustion Eng’g, 391 F.3d 190, 219 (3d Cir. 2004)). 

Moreover, the Ninth Circuit held, irrespective of whether the anti-assignment provisions were expressly preempted by Code section 541, they were nonetheless impliedly preempted where they would stand as “an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.”  Id. at *46.  The court reasoned that enforcement of the anti-assignment provisions: 

[W]ould bar any company with significant insurance contracts governed by California law from taking advantage of 524(g).  For a plan to be approved, the trust must be sufficiently funded.  As here, companies usually can do so only by settling with insurers and putting those funds in the trust.  Yet, if we enforced the anti-assignment provisions, it would be to the detriment of the potential efficacy of a § 524(g) plan.  After a debtor had filed for bankruptcy, no insurer would settle, with the aim of funding a § 524(g) plan, because by refusing to settle, the insurer could position itself to claim forfeiture of the insurance if a plan proceeded and there was a consequent breach of the anti-assignment provisions.

Id. at *46-47.

The Ninth Circuit therefore remanded to the bankruptcy court with an order that the insurers be given a full opportunity to present their objections to the plan, while at the same time undercutting what was perhaps their principal source of objection.  Thus, the victory was somewhat hollow for the insurers: having established their right to posit a preemption argument in their favor, they were ultimately ruled against on that point.

Why the Case is Interesting:

The question of what makes a 524(g) plan “insurance neutral” is of great interest to parties to asbestos-related bankruptcies, as it affects the degree of involvement insurers may have in the formulation of future claims resolution procedures.

Insurance contracts contain anti-assignment clauses in part to prevent insurers’ loss of control over the resolution of claims that they may be forced to pay in the future.  In affirming the lower courts’ holdings that such anti-assignment provisions are preempted and therefore unenforceable in bankruptcy, the Ninth Circuit threw its weight behind an emerging trend of ignoring these provisions when parsing questions of insurance neutrality.

Moreover, Thorpe serves as an important reminder that, even though a Code section such as 524(g) may contemplate that certain parties’ rights will be impinged upon in a plan of reorganization, that does not mean that such parties are without standing to challenge the nature and extent of such impingements.

Channel 2 – Federal-Mogul Allows Assignment of Insurance Policies Under Broader Preemption Analysis

Bottom Line:

Our second case – issued roughly two months after the Ninth Circuit’s decision in Thorpe – held that, as in Thorpe, a debtor’s insurance rights could validly be assigned to a section 524(g) asbestos trust.  However, in spite of its favorable acknowledgment of the Thorpe opinion, the Third Circuit predicated its decision in Federal-Mogul largely on the basis of its own precedent (particularly Combustion Engineering), and focused its preemption inquiry on a broader statutory reading of section 1123, in addition to section 541.  In re Federal-Mogul Global Inc., Nos. 09-2230 and 09-2231, 2012 U.S. App. LEXIS 8814 (3d Cir. May 1, 2012).

What Happened:

Federal-Mogul Global, an automobile parts manufacturer, and its affiliates filed for chapter 11 under the weight of enormous asbestos liabilities and sought the creation of a section 524(g) trust to which future claims would be channeled.  As part of this structure, the debtors intended to assign their rights under numerous asbestos insurance policies to the trust.  Five groups of insurers objected that this mechanism violated the anti-assignment provisions of their policies with the debtors.  Id. at *2.

The Debtors argued in response that section 1123(a)(5)(B) preempted these provisions, and the bankruptcy, district, and circuit courts unanimously agreed.  By the bankruptcy court’s reasoning, section 541, which defines property of the estate, permitted the assignment of the Debtors’ prepetition insurance rights to the estate; then, section 1123, which governs the contents of a plan, permitted further transfer of these rights to the 524(g) trust pursuant to the plan of reorganization.  Id. at *24.

In Combustion Engineering, which featured heavily in the Federal-Mogul opinion, the Third Circuit had ruled in a lengthy opinion that certain non-debtor affiliates’ efforts to obtain the benefits of the debtors’ 524(g) trust violated the bounds of the bankruptcy court’s jurisdiction.  Id. at *29-30 (citing In re Combustion Eng’g, 391 F.3d 190 (3d Cir. 2004)).  In an ancillary ruling on certain insurers’ appellate standing, however, the court had held that “[w]ith respect to the anti-assignment provisions . . . even if the subject insurance policies purported to prohibit assignment of Combustion Engineering’s insurance proceeds, these provisions would not prevent the assignment of proceeds to the bankruptcy estate” under section 541.  Id. at *30-31 (citing In re Combustion Eng’g, 391 F.3d at 218).

This, the Federal-Mogul panel held, was already well established within the Third Circuit.  What warranted additional attention in Federal-Mogul was the operation of section 1123, not discussed at length in Combustion EngineeringId. at *36-37. 

Section 1123(a)(5)(B) provides, in relevant part, that “[n]otwithstanding any otherwise applicable nonbankruptcy law, a plan shall . . . provide adequate means for a plan’s implementation, such as . . . transfer of all or any part of the property of the estate to one or more entities, whether organized before or after the confirmation of such plan.”  11 U.S.C. § 1123(a)(5)(B).  The Third Circuit viewed the phrase “notwithstanding any otherwise applicable nonbankruptcy law” as reflecting a clear Congressional intent to preempt any state law that might interfere with the operation of section 1123.  In so ruling, the Third Circuit rejected, among other arguments, the insurers’ contention that “otherwise applicable nonbankruptcy law” did not encompass the terms of private contracts, but rather was limited to preemption of governmental enactions.  Id at *45.  Moreover, contrary to the insurers’ contentions, the “context and structure of the Bankruptcy Code” did not support a “narrow reading of preemption,” in spite of the insurers’ identification of other Code provisions that would ostensibly be rendered superfluous by an overbroad reading of section 1123.  Id. at *47.  As the court noted:

Other Code provisions that place specific limitations on the satisfaction of a lien, 11 U.S.C. § 1129(b)(2)(A), on the curing of a default, id. § 365(b), on the issuance of securities notwithstanding certain securities laws, id. § 1145, or on the use or sale of estate property, id. § 363(l), still operate to condition § 1123(a).  Had Congress wanted to limit the preemptive scope of § 1123 based on specific sections of the Bankruptcy Code, as Insurers suggest, it knew how to do so . . . .

But rather than addressing the relationship between § 1123(a) and the rest of the Code clause-by-clause, Congress unambiguously limited the scope of the “notwithstanding” clause in § 1123(a) to “nonbankruptcy law,” leaving other Code provisions intact.

Id. at *47-48.

The court was careful to note, in addition to its extensive textual analyses, that preemption in this context also furthers the policies inherent in the drafting of section 524(g) – namely, “to harmonize the interests of asbestos claimants and reorganized debtors alike” and to “help asbestos victims receive maximum value” while preserving a debtor’s going-concern viability.  Id. at *71.            

In response to the insurers’ counterargument that anti-assignment provisions “serve an important purpose in protecting [insurers] from covering a risk different from the one they bargained for,” id. at 73, the court expressed its doubt that transfer of policy rights would materially alter insurers’ risk – a view that could be interpreted as contrary to that espoused in Thorpe.  As the Third Circuit reasoned, “the bankruptcy here shifted debtor’s asbestos-related liabilities – based on events that had already occurred and for which the insurers were already potentially responsible – to the post-confirmation trust.”  As such, the insurers had failed to show that “the transfer here alters their risk except, perhaps, through the procedural shift that provides recovery through Trust Distribution Protocols rather than through the tort system.”  Id. at *75.

For all of these reasons, the Third Circuit concluded that anti-assignment provisions that would otherwise bar the transfer of policy rights to a section 524(g) trust are preempted by section 1123(a)(5)(B). 

Why the Case is Interesting:

The holding in Federal-Mogul adds a different layer of analysis to the preemption of anti-assignment provisions under federal bankruptcy law by characterizing the assignment right as one inherently authorized in the formulation of a plan of reorganization.  Where Thorpe held that a debtor’s insurance policy rights become property of the estate not subject to nonbankruptcy limitations on transfer under section 541, Federal-Mogul added the reasoning that anti-assignment provisions are also preempted wherever they would otherwise prevent enforcement of such a plan.