Reducing Product Liability Uncertainty in Bankruptcy Cases

Pre-petition product liability claims can be among the biggest challenges facing chapter
11 debtors. Not knowing how many people may have been injured by products sold
before the petition is filed and the aggregate amount of the claims made after the
petition greatly complicates the efforts to resolve a case. A bankruptcy product
liability insurance policy could be a solution to this uncertainty.

</p><p>A case in point: A toy manufacturer that filed for chapter 11 sold two products
before the filing that had the potential for long-term liabilities. Its snow sleds
for children and above-ground swimming pools could each have a useful life of more
than 30 years. Accordingly, the debtor needed a method to maintain reserves for
product liability claims that could appear for three decades. There were at least three
types of creditors: those who had sued before the petition was filed for claims that
were not yet resolved; those who might file a claim post-petition for a pre-petition
injury, and most uncertain were those who might be injured post-petition.

</p><p>While a review of the debtor's claims history for the sleds and above-ground pools
prior to the filing would be helpful, claims projections for 30 years following the
filing are speculative at best. Thus, it is extremely difficult to accurately determine
the number of product-liability litigants and the dollar amounts necessary to reserve
for these claims.

</p><h3>Creating an Insurance Mechanism to Fund Claims</h3>

<p>In this situation, the chapter 11 plan created a product liability trust to fund
the cost of claims and litigation. The foremost objective in establishing the trust
was to ensure that all current and future product liability creditors received a prompt
and equitable recovery. In the court-approved product liability trust agreement, a
clause allowed the trustee to purchase insurance for these product liability claims.

</p><p>An important aspect of the insurance plan in this case was the observation of loss
payments during a transition period to help clarify future loss payment patterns.
During the transition period, the debtor continued to be responsible for smaller
claims (in the form of a deductible), and the insurer would pay for large losses.
In this example, the product liability trustee set the transition period for three
years and decided to earmark up to $50,000 for each product liability claim.
Once a liability claim exceeded this self-insurance amount, the insurance policy became
operative.

</p><p>If a debtor or a trustee is concerned about the ultimate aggregate value of claims
within the self-insurance level, an alternative risk transfer plan can be considered.
This option allows the debtor or the trustee to fund unexpected immediate cash needs
for losses with insurance and reimburse the insurer for the time value of money over
the transition period. During that period, the debtor or trustee can also accrue the
expected interest gained from the asset pool.

</p><p>Establishing such a transition period allows the debtor or the trustee to evaluate
actual liability issues after the debtor files its petition and to better project the
ultimate value of such claims. Once the probability of continued liability claims is
patterned, the debtor or the trustee can explore the continuation of self insurance
or a complete insurance solution after the transition period.

</p><h3>Benefits to Both Debtors and Creditors</h3>

<p>A debtor with heavy product liability claims that files for chapter 11 will find
it difficult to pay back "sum-certain" creditors, such as suppliers. Once a chapter
11 petition has been filed, these creditors will cooperate with a debtor only if
they can be reasonably assured of a recovery that is reasonable in time and amount.
The ability to distribute funds equitably and quickly to sum-certain creditors is
impeded by the unknown volatility of actual product liability claims. Without the
protection of high-limits liability insurance, creditors can be left in limbo for
years. There is also the risk that product liability claims will eliminate any
meaningful recovery. This defeats the essence of the Bankruptcy Code: resolving
creditors' issues promptly and permitting the debtor a fresh start.

</p><p>Traditional pre-petition liability policies can help, but only in a limited way.
A debtor's product liability policy purchased before the petition is filed may provide
some protection. But problems, such as insufficient limits, unrenewed or canceled
coverage due to non-payment of premium or failure to report claims, can jeopardize
or nullify coverage.

</p><p>One remedy may be for the debtor or trustee to purchase bankruptcy product liability
insurance, a new type of insurance policy purchased after the petition is filed to
cover injuries caused by products sold pre-petition. A bankruptcy product liability
policy can bring more certainty to the cost and time of disposing of claims by injured
creditors. Based on actuarially sound forecasting methods and a cap on the compensation
an injured creditor may receive, a bankruptcy product liability policy can benefit all
parties with a fair, expeditious dissemination of funds.

</p><p>For companies striving for a turnaround, a bankruptcy product liability policy can
expedite the claims resolution process. Such a policy provides coverage for injured
claimants, but it is less costly than traditional policies. The policy frees funds
to pay back sum-certain creditors and to pay for the debtor's operating costs, both
critical to enhancing a debtor's chances for recovery. Conversely, without such a
policy, creditors may be reimbursed less because the level of claims reserves will need
to be conservatively high to respond to a severe claim, class action or numerous
moderate claims that may emerge. A bankruptcy product liability policy thus reduces
concern over the uncertainty of product liability claims. In essence, such a policy
shifts a burden of risk from the debtor and all of its creditors to the insurance
company.

</p><p>With a bankruptcy product liability policy, the debtor can proceed with confidence
in ensuring prompt and reasonable returns to the creditors without fretting over possible
liability claims that could cripple its recovery effort. In effect, such a policy
segregates the claims of product liability creditors, enabling the debtor to be in a
better position to allocate funds to other creditors.

</p><p>When considering the value of paying the bankruptcy product liability insurance policy
premiums, the important question is: What is the pain threshold for assuming and
paying product liability claims? If there is a real possibility of assets being
greatly reduced or eliminated as a result of product liability claims, then the
bankruptcy product liability insurance policy is an option worth exploring.

</p><h3>Final Considerations</h3>

<p>Finally, when considering a bankruptcy product liability policy, one should make
sure that:

</p><ul>
<li>The protection is global; that is, it does not have geographic restrictions that
could leave the policyholder vulnerable to an uninsured loss merely as a result of
where the loss occurred.

</li><li>It does not contain a cancellation clause that allows the insurer to cancel
coverage mid-term. Only a few insurance companies will provide such a
"no-cancellation" commitment.

</li><li>It offers sufficiently high limits over an appropriately long period.

</li><li>The insurer has strong claim paying and financial ratings from A.M. Best,
Standard &amp; Poor's and Moody's to support the high limit and long-term commitment.
</li></ul>

<p>Such a bankruptcy product liability insurance policy protects where other pre-petition
coverage is insufficient or non-existent. It can lower the hurdles to the successful
disposition of a bankruptcy case.

</p><hr>
<h3>Footnotes</h3>

<p>^{<small><a name="1">1</a></small>} John Cavanaugh is a vice president in the global liability practice of Chubb &amp; Son, Warren, N.J. He can be reached at (908)
903-3171. <a href="#1a">Return to article</a>

</p><p>^{<small><a name="2">2</a></small>} Earl Stamm, a member of the Pennsylvania Bar, is located in Wyncote, Pa., a suburb of Philadelphia. For 27 years, his practice
has concentrated on the representation of insurance companies and other parties in interest in commercial reorganization cases. He can be reached
at (215) 887-2612. <a href="#2a">Return to article</a>