The Bankruptcy Hotline

The Third Circuit has rejected a “pre-packaged” reorganization plan that purported to resolve all of the debtor's outstanding asbestos claims by establishing a $1.2 billion trust. The court found that although the debtor's plan was presented as a pre-packaged Chapter 11 reorganization, it more closely resembled a liquidation of the debtor with a post-confirmation trust funded in part by non-debtors. The court's ruling reverses decisions by the bankruptcy and district courts, which had both approved the plan. In re Combustion Engineering Inc., No. 03-3392, et al. (Dec. 2).

After defending asbestos-related litigation for nearly four decades the debtor attempted to resolve its asbestos problems by filing a pre-packaged Chapter 11. Under the plan, the debtor contributed half of its assets to a pre-petition trust to pay asbestos claimants with pending lawsuits for part, but not the entire amount, of their claims. The remaining, unpaid portion of these claims, known as 'stub claims' (that were ultimately impaired) provided pre-petition trust participants with creditor status. The centerpiece of the debtor's prepackaged plan was an injunction in favor of the debtor that channeled all of its asbestos claims to a post-confirmation trust created under ' 524(g). The plan also extended the asbestos liability shield to the non-debtor's two affiliates. After considerable negotiation, the plan won approval from the majority of the asbestos claimants over the objections of several insurers and certain persons suffering from asbestos related injuries. The bankruptcy court recommended confirmation of the Plan, but made two significant modifications. First, it added a 'super-preemptory' provision to protect the pre-petition rights of certain insurers. Second, it reconfigured the ' 524(g) injunction in favor of the two affiliates as an equitable injunction under ' 105(a). The district court adopted the bankruptcy court's findings of fact and conclusions of law and confirmed the plan with two changes. The district court modified the language of the 'super-preemptory' provision and added a 'neutrality' provision purporting to protect the debtor's and insurers' prepetition rights under certain insurance policies.

Although similar to other pre-packaged bankruptcy plans that were filed in the recent years, the appeals court here found that the plan's confirmation process may have been unfair because it was approved by a group of asbestos claimants who had already been paid the majority of their claims, but would provide only a fraction to some of the other claimants. 'This type of manipulation is especially problematic in the asbestos context, where a voting majority can be made to consist of non-malignant claimants whose interests may be adverse to those of claimants with more severe injuries,' the court stated. Because some of the asbestos claimants received as much as 95% of the full liquidated value of their claims, they had 'little incentive to scrutinize' the terms of the proposed plan. Instead, the court noted, 'their incentive appears to have been otherwise, given that the favorable prepetition settlements were conditioned, at least implicitly, on a subsequent vote in favor of the plan.'

While the court did not foreclose the idea of future approval of the plan, extensive hearings and fact-finding on issues related to the plan's fairness were ordered. A critical issue for the court was that as a condition of confirmation, at least one class of impaired claims must accept the plan. But, a claim is not impaired if the plan ”leaves unaltered the legal, equitable, and contractual rights to which such claim or interest entitles the holder of such claim or interest' or if the plan cures or compensates for past default.' On the other hand, 'artificial' impairment occurs when a plan imposes an insignificant or de minimis impairment on a class of claims to qualify those claims as impaired under ' 1124. This is problematic because 'it potentially allows a debtor to manipulate the Chapter 11 confirmation process by engineering literal compliance with the Code while avoiding opposition to reorganization by truly impaired creditors. While there is nothing in either ” 1129(a)(10) or 1124 expressly prohibiting a debtor from 'artificially impairing' the claims of creditors, courts have found this practice troubling. In the context of this asbestos-related bankruptcy, so do we,' the court concluded.