A New Paradigm: Claimant Opposition to Mass Tort Bankruptcy and Needed Reform

By: George Calhoun

Congress enacted Section 524(g) of the Bankruptcy Code in 1994. That statute requires a 75% supermajority of claimants to approve a bankruptcy plan binding on future claimants and containing injunctions protecting the debtor and other third parties. The statute handed veto power to prominent plaintiff law firms. Companies facing mass tort liabilities, primarily asbestos, were forced into Faustian deals with plaintiffs groups in which trusts were created that paid claims on scant evidence, insurer were forced into outsized settlements, and the company (or its parent) was released in exchange for some additional contribution. As a practical matter, this left insurers and plaintiff/debtor coalitions to fight over confirmation of mass-tort bankruptcy plans. But that paradigm has shifted. In the past three years, mass-tort bankruptcies have been marked by plaintiff opposition to the plans. In this post, I address what has changed and what might be needed to shift the paradigm to a more workable model.

The last few years have seen several of the largest and most prominent mass-tort bankruptcies ever, including Purdue Pharma, LTL/Johnson & Johnson, USA Gymnastics, and several Catholic Dioceses. None of these cases have been a straightforward asbestos bankruptcy, even though some of them have involved asbestos. In practice, that has meant the involvement of new counsel for the plaintiff groups. Some of these counsel, particularly in the abuse-driven bankruptcies, have publicly stated that they intend to drive up the average value of the claims involved. That plaintiff driven desire to increase claim values has caused hotly disputed cases in which the debtor and the plaintiffs are the primary litigants. The other driving force is similar, debtors have sought protection for large, solvent parent companies. Prominent plaintiffs’ attorneys have judged that they would rather take the gamble that they will recover more from judgments against those companies, even if most claimant are left with nothing.

This new reality has lengthened bankruptcies. While most bankruptcy case are settled by agreement, the mediations ordered in many recent cases have lasted for years with little progress. Courts have been slow to recognize that the claimant constituencies are intentionally holding up cases and have relatively little leverage over obstreperous plaintiffs’ groups.

Another major factor has been the desire of the debtors in these cases to protect parent or affiliate companies. While that protection has always been something that the plaintiff groups have been willing to offer in exchange for bankruptcy protection, apparently the price is higher when the bankruptcy is the debtor’s idea. More to the point, several of the large recent cases have involved the so-called Texas Two Step. In the Two Step, the pre-petition debtor undergoes a “divisive merger” under Texas’ corporate merger statute (Tex. Bus. Orgs. Code § 1.002(55)(A)) to spin off the company’s liabilities to a new subsidiary. To date, plaintiffs have sought dismissal of and have refused to confirm any bankruptcy case that has employed that pre-petition maneuvering¹.  Nonetheless, the Texas Two Step has been a reaction, in part, to the first factor. Debtors are seeking ways to bring pressure to bear on a plaintiffs’ bar that is seeking increasingly larger payouts on untested or difficult to try torts.

To be sure, the ultimate goal is a deal, which means that debtor and claimants may eventually reach a deal and turn on insurers as a target. That’s exactly what happened in the Boy Scouts bankruptcy. There, the claimants could not even agree among themselves for years, with one faction creating an “coalition” of claimants to counter the official committee appointed by the court. But when a deal was reached with the BSA, the claimants shifted targets to the insurers. One plaintiff lawyer admitted incorrespondence that they were seeking the “holy grail” of trust distribution procedures that would be binding on insurers. As a result, despite the eventual agreement between claimants and the debtor, the BSA underwent a weeks long confirmation process and the plan that was eventually confirmed is still on appeal (with appeals filed by insurers and dissenting plaintiff groups).

These new developments have been good for lawyers. The fees in the LTL, Imerys, USA Gymnastics, Aearo Technologies, and other cases have been massive – exceeding $100 million in many cases. But its less clear that justice or claimants are being well served. If nothing else, the recent mass tort bankruptcy experience demonstrates that the bankruptcy process is not well designed to handle mass torts. Because the Supreme Court has prohibited class settlements in such cases, however, the bankruptcy courts are the only game in town. Congress has expressed interest in the scope of available third-party releases, but there hasn’t been meaningful movement towards real reform. The time is right for a fresh look at the Bankruptcy Code – even if the current Congress seems unlikely to agree on anything. In particular, two reforms are long overdue: (1) rules expressly addressing mass tort claims other than asbestos, and (2) the imbalance of leverage created by the super-majority vote requirement combined with the bankruptcy court’s inability to substantively address the merits of tort claims. Until those issues are addressed, mass tort bankruptcy will continue to be an expensive quagmire for all parties.

[1] Examples include In re LTL Management LLC, In re Bestwall LLC, In re DBMP LLC, and In re Aldrich Pump LLC among others.