The Third Circuit, Latent Tort Claims And Bankruptcy Code § 524(g)

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Fox Rothschild LLP

To give a reorganized debtor a “fresh start,” the Bankruptcy Code provides that the confirmation of a plan discharges the debtor from any debt that arose before the confirmation date.  However, if a potential claimant lacks sufficient notice of a bankruptcy proceeding, due process considerations dictate that his or her claim cannot be discharged by a confirmation order.

The most innovative approach to deal with this issue was adopted by the New York bankruptcy court as part of the Manville plan of reorganization.  See In re Johns Manville Corp., 68 B.R. 618 (Bankr. S.D.N.Y. 1986). The Manville Trust was the basis of Congress’ effort to deal with the problem of asbestos claims on a national basis by enacting Bankruptcy Code § 524(g). That section provides for the establishment of a trust to assume, and pay, present and future asbestos claims and a channeling injunction directing all future claims to the trust.

The Third Circuit has reviewed several bankruptcy cases addressing the issue of adequate notification of latent tort creditors of the debtor.

In 2000, the Third Circuit said.

[D]ue process considerations [of lack of sufficient notice of bankruptcy proceedings] are often addressed by the appointment of a representative to receive notice for and represent the interests of a group of unknown creditors.

Jones v. Chemetron Corp., 212 F.3d 199, 209 (3d Cir. 2000).

However, the court stated that it did not believe that a bankruptcy court was obligated to sua sponte appoint a representative to deal with future interests. Id. at 210.

Ten years later, in In re Grossman’s, 607 F.3d 114, 127 (3d Cir. 2010), the Third Circuit said that a § 524(g) trust was specifically tailored to protect the  due process rights of future claimants and was perhaps the best vehicle for addressing these concerns.

More recently, in In re Energy Future Holdings Corp, 949 F.3d 806, 825 (3d Cir. 2020), the Third Circuit concluded its opinion affirming the confirmation of a reorganization plan that did not provide for a trust or a representative for future claims, as follows:

Though we decline to upset the approach taken here, we share the Bankruptcy Court’s “regret” that “the debtors asked for [a bar date] in the first place,” both because the bar date might “adversely affect . . . [claimants] who have manifested injury . . . or will manifest injury based on prepetition exposure who have not filed proofs of claim” and because it “led to a lot of litigation and a lot of expense and a $2 million noticing program.”  Indeed, this case serves as a cautionary tale for debtors attempting to circumvent §524(g). The alternative route EFH has chosen for addressing its asbestos liability has produced a similar result as a §524(g) trust—reimbursement for latent claimants who either filed proofs of claim or did not receive proper notice of the bar date—but with added and unnecessary back-end litigation. Like the Bankruptcy Court, however, we have only “a limited role” in this case.  We are not charged with ensuring that EFH’s strategic choices were optimal or even advisable; we are merely asked to ensure that they satisfy the Bankruptcy Code and the Constitution. And in this limited role, we conclude that the post-confirmation process described above satisfies both.

Notwithstanding the Third Circuit’s “regret,” we think it unlikely that debtors with contingent liabilities to latent claimants will adopt the § 524(g) route for a number of reasons.

First, 524(g) is only available to deal with liabilities arising from exposure to asbestos or asbestos containing products. Second, the plan must be funded, at least in part, by securities of the reorganized debtor. Third, the trust must own, or be entitled to own, the majority of the voting shares of the debtor, its parent, or its subsidiary.  Fourth, the plan must be approved by a 75% vote of the claimants whose claims are to be addressed by the trust, that is, the present claimants (not the future claimants who are also beneficiaries of the trust). Fifth, the trust must pay present claims and future demands that involve similar claims in substantially the same manner.  Each of these requirements creates a disincentive for the entities affected to propose or vote in favor of a § 524(g) plan.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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