In 1984, the Third Circuit was the first court of appeals to examine the Bankruptcy Code’s new definition of “claim” in Avellino & Bienes v. M. Frenville Co. (In re M. Frenville Co.), 744 F.2d 332 (3d Cir. 1984). Focusing on the “right to payment” language in that definition, the court decided that a claim arises when a claimant’s right to payment accrues under applicable nonbankruptcy law. This “accrual” test was widely criticized by other circuit courts as contradicting the broad definition of “claim” envisioned by Congress and the Bankruptcy Code.

In June 2010, responding to the nearly unanimous criticism of its opinion in Frenville, the Third Circuit decided JELD-WEN, Inc. v. Van Brunt (In re Grossman’s Inc.), 607 F.3d 114 (3d Cir. 2010), and specifically overruled Frenville (as well as the 26 intervening years of precedent). In its en banc decision, the court adopted the “exposure” test, a version of the “conduct” test used by other courts. However, Grossman’s was fairly narrowly decided and failed to provide much guidance outside the asbestos context. Additionally, the court stressed that regardless of the applicable definition of “claim,” due-process considerations remained an important part of the determination of whether a claim had been discharged, and consequently it remanded the due-process analysis to the bankruptcy court.

Earlier this year, the Third Circuit addressed the effect of Grossman’s in Wright v. Owens Corning, 679 F.3d 101 (3d Cir. 2012), in an effort to clarify the impact its modified approach to the “claim” definition should have on the dischargeability of claims in a bankruptcy case that was filed before Grossman’s was decided. In Owens Corning, the court held that, although Grossman’s applies retroactively, due-process considerations mandated that the claims of certain unknown claimants not be discharged. The due-process determination hinged upon the definition of “claim” in effect at the time of the bankruptcy case, thereby resuscitating Frenville’s rule in certain circumstances and adding another layer of complexity to the analysis of discharged claims.

Background

In October 2000, Owens Corning and certain of its affiliates filed for chapter 11 protection in Delaware. In November 2001, the bankruptcy court set a claims bar date of April 15, 2002, requiring all claimants to file proofs of claim on or before that date. The court also approved a bar date notice, which was published in The New York Times, The Wall Street Journal, and USA Today, among other publications. The notice directed claimants to file proofs of claim that arose prior to the filing of the debtors’ bankruptcy cases. It specifically identified claims pertaining to “the sale, manufacture, distribution, installation and/or marketing of products by any of the Debtors, including without limitation . . . roofing shingles.” The bankruptcy court confirmed a plan of reorganization for Owens Corning in September 2006.

In late 1998 or early 1999, Patricia Wright hired a contractor who installed shingles manufactured by Owens Corning. In 2005, Kevin West likewise hired a contractor who installed Owens Corning shingles on his roof. In 2009, both Wright and West discovered leaks and determined that the shingles had cracked. In an attempt to recover for the alleged defects in the shingles, Wright filed a class action against Owens Corning in November 2009, and West was later added as a plaintiff.

At the time the plaintiffs filed their class action, Grossman’s had not been decided, and therefore Frenville applied. Under Frenville’s accrual approach, neither plaintiff had a “claim” subject to discharge because the claims did not accrue under applicable state law until the defects in the roofing shingles were manifested in 2009. Following the Third Circuit’s 2010 ruling in Grossman’s, however, Owens Corning filed a motion for summary judgment, arguing that the plaintiffs possessed pre-petition claims that had been discharged under the plan and confirmation order.

In response, the plaintiffs argued that: (i) the Grossman’s holding should be limited to asbestos cases; (ii) Grossman’s was not intended to apply retroactively; and (iii) the plaintiffs were not afforded due process because the notice in the bankruptcy case had been insufficient. The district court rejected these arguments and held that the plaintiffs’ claims had been discharged.

On appeal, the plaintiffs revised their argument and asserted that the test set out in Grossman’s was “unworkable” because, for a claim to exist under the test, the debtor and the claimant were required to anticipate a future tort action at the time of the bankruptcy case. The plaintiffs also continued to assert that they had not been afforded due process.

When a Claim Arises

After deciding that the plaintiffs had not waived their argument regarding the workability of Grossman’s by failing to assert it in the district court, a three-judge panel of the Third Circuit determined that Grossman’s applies retroactively and that Wright therefore held a “claim.” The court explained that the test in Grossman’s requires potential claimants to recognize that by being exposed to a debtor’s product or conduct, they might hold claims even if no injury was evident at the time of the bankruptcy. As to West, the court determined that, even though his exposure had occurred post-petition (but pre-confirmation), he also had a claim. The court noted that limiting the Grossman’s test to pre-petition exposure would “unnecessarily restrict” the Bankruptcy Code’s expansive treatment of claims and would “separate artificially individuals who are affected . . . prepetition from those who are affected after the debtor’s filing . . . but before confirmation of a plan.” The court therefore extended the test under Grossman’s to post-petition but pre-confirmation exposure.

Due-Process Considerations

Despite its determination that both plaintiffs had claims, the Third Circuit held that neither of the claims was dischargeable because each plaintiff had received inadequate notice in violation of his or her due-process rights. After conceding that, generally, notice by publication is sufficient for unknown claimants like the plaintiffs, the court went on to explain that, although the notice might have been sufficient to most unknown claimants, it was insufficient as to the plaintiffs because Frenville was still the governing law at the time publication notice was issued. In other words, if the plaintiffs had reviewed the publication notice, they could not have known that their rights would be affected in any way by the bankruptcy case. The court noted, “Due process affords a re-do in these special situations to be sure all claimants have equal rights.”

The Third Circuit held that “for persons who have ‘claims’ under the Bankruptcy Code based solely on the retroactive effect of the rule announced in Grossman’s, those claims are not discharged when the notice given to those persons was with the understanding that they did not hold claims.” In other words, the Third Circuit ruled that debtors could not use Grossman’s to discharge claims retroactively that may have failed to exist under Frenville’s more narrow definition of “claim.” Specifically with regard to the Wright class-action plaintiffs, the court held that neither plaintiff received due process and that such claims were therefore not discharged.

Implications of the Third Circuit’s Decision

The Owens Corning court’s decision raises additional questions going forward. It now appears to be the case that the result unanimously criticized in Frenville, and seemingly disposed of in Grossman’s, has been resurrected in part. Now, although pre-Grossman’s claimants in the Third Circuit will technically be deemed to have claims, those claims will not be dischargeable, and the result for reorganized debtors that confirmed plans prior to June 2, 2010, will remain the same as that under Frenville.

It is difficult to predict how courts in the Third Circuit will rule when confronted with Owens Corning-like situations in the future—that is, situations in which the claimant had no reason to believe that it had a claim at the time of the bankruptcy and in which it seeks post-confirmation relief. Indeed, both Grossman’s and Owens Corning suggest that courts should take a case-specific approach to due process, which will provide them with significant flexibility but may leave debtors with difficulty assessing which claims, if any, could pass through to a reorganized company or its successors.

In addition, the ramifications of Owens Corning regarding the sufficiency of publication notice to unknown creditors as a matter of due process remain to be seen. In a footnote, the Third Circuit specifically declined to address the issue:

Given our reliance on the exceptional circumstances created by the retroactive application of Grossman’s, we express no opinion on the broader issue of whether discharging unknown future claims comports with due process. . . . In this vein and consistent with our statements that whether due process has been provided depends on the circumstances of a particular case, our holding is not a bright-line rule that all persons with unknown future claims once governed by Frenville could not have been provided due process regardless of the adequacy of notice to those future claimants.