One of the most interesting panels at the always excellent “Cutting Edge Issues in Asbestos Litigation Conference” (relocated from Beverly Hills to Miami) was the bankruptcy panel “Recent Bankruptcies and the Impact on Asbestos Litigation”. It was interesting for what was said, but especially for what was not. The panel provided a plaintiff-side perspective on bankruptcy reorganizations—leaving me wanting to fill in the blanks from other perspectives. The panel was moderated by Perry Weitz, and he was joined by leading plaintiffs lawyers John Baden and Lisa Nathanson Busch (representing Weitz & Luxenberg, Motley Rice and Simmons Hanly Conroy respectively).  A slightly different perspective was added by the always respected David Molton, whose practice at Brown Rudnick is focused on representing creditors’ committees.

One of the refrains was that asbestos bankruptcies have failed for plaintiffs, including those that were pre-negotiated before filing, because payout percentages are so low. This is true. A quick look at the KCIC data for the nearly 70 active 524g asbestos trusts show that they have a payout rate of about 20% on average. The panel blamed light projections of future claims which failed to account for the volume of future filings.

But no one made the most obvious point which is this: the main reason payout percentages are so low is that the evidentiary standards of the trusts are low relative to the tort system. The trusts routinely pay out claims that would not stand a chance of being paid in the tort system and the plaintiffs’ bar have only themselves to blame for insisting on such lax trust distribution procedures (TDPs). A few statistics will illustrate this point.

Per KCIC’s Asbestos Report, approximately 3,700 asbestos-related complaints were filed in 2022. According to Combustion Engineering’s 524(g) PI Trust’s Annual Report, it received 20,414 claims in 2022. When comparing the tort system and Combustion Engineering’s overall filings, more than five times more than were filed in the tort system, and not every asbestos plaintiff has a claim that implicates Combustion Engineering.

The other reason that the trusts have performed so badly is the taxation of 524(g) trusts. Claim payments are not tax deductible and therefore investments are mainly restricted to tax-free municipal bonds with extremely low yields.

The panel discussed the uncertainties of important bankruptcy cases before the Supreme Court (such as Purdue Pharma), whether there is a future for the so called “Texas Two Step”, the different bad faith standard used in bankruptcy in the 4^th circuit, and whether there might be a return to pre-packaged bankruptcies in which the parties negotiate a plan of reorganization before filing. Mr. Weitz issued a dark warning to CertainTeed and Bestwall to be “afraid, very afraid” of returning to the tort system if their Texas Two Step bankruptcy reorganizations fail. I clearly picked up his frustration that Georgia Pacific has had a six-year holiday from the tort system during the pendency of the Bestwall bankruptcy.

Curiously the panel sent out a call for better communication with the plaintiffs’ bar. The Wellington Agreement and Center for Claims Resolution were praised as useful tools that were the fruit of good communication with the plaintiff’s bar. And the many unsuccessful attempts of bankruptcy reorganization by Johnson and Johnson were considered a result of missing a step by not involving plaintiffs.

But other than a very passing and veiled reference by Lisa Nathanson Busch, there was not a mention of an alternative to bankruptcy reorganization suitable for profitable manufacturing companies with a legacy liability problem in the tort system. Restructuring transactions are becoming increasingly common and accepted. KCIC alone has a number of clients that have successfully disaffiliated their legacy liabilities.

Restructuring transactions involve a similar first step to the Texas Two Step bankruptcy. Buzzwords such as “ring fencing” and “structural optimization” are used to describe the internal reorganization whereby all subsidiaries with a legacy liability taint are split into two. In one part the legacy liabilities and relevant insurance assets remain, and in the other part, operating businesses and non-insurance assets are transferred (to the extent that the legacy tainted part remains fully funded). The tainted parts of the affected subsidiaries are then organized under a common holding company in the corporate structure. 

Next, instead of a bankruptcy filing, the holding company and its legacy liability tainted subsidiaries are sold to an independent third party, typically private equity, but often insurance companies are interested too. The sales price is usually negative, i.e. the purchaser receives money, but it depends upon the level of capitalization of the legacy-tainted companies.

Why would counterparties be interested? The sales price may represent capital for them to use in their private equity operations, or they may be interested in a stream of fee income for managing the run-off, or they may have an eye to recapitalize it and take out equity down the road.

For the company selling, subject to audit sign off, they can “disaffiliate” and have a clean, profitable company without a legacy liability taint. Stock prices usually respond favorably to this news.

Bankruptcy is increasingly unattractive for profitable companies. The legal landscape has shifted, causing uncertainty. Fees charged by the typical army of necessary professionals can be astronomical. Even before the recent Purdue Pharma case, there was a high risk of the debtor losing control of the bankruptcy.

The alternative I have described has already been proven to be successful. For the plaintiffs’ bar, it is business as usual with every opportunity to negotiate inventory deals. For the defendant company, they get a clean slate without the drag on their stock price from uncertain future tort liabilities. And for the acquiror, they have the challenge of running off liabilities for decades into the future, and subject to pricing, an economic opportunity to profit.

The quality of the acquirer is very important because the new arrangements must be built to last for disaffiliations of the legacy liability to be effective. They also need experience in managing the run-off of legacy liabilities. And last, but not least, the logistics of a run-off require the expert resources of a company like KCIC!

I’m not sure why restructuring transactions merited such a short shrift by the panel, but with bankruptcy being such an unattractive restructuring method, I expect to hear much more about it in the future.