The Third Circuit delved into the netherworld of so-called channeling injunctions protecting both companies that used asbestos and insurers that provided coverage.
The August 14 opinion by Circuit Judge Thomas L. Ambro explores the outer limits of channeling injunctions by defining when creditors cannot sue insurance companies and must collect their claims only from an asbestos trust created as part of a chapter 11 plan.
The appeal involved W.R. Grace & Co., whose bankruptcy soon will have kept platoons of lawyers fully employed for two decades. Grace confirmed a reorganization plan in 2011, 10 years after filing a chapter 11 petition.
The confirmed plan created a trust to pay asbestos claims and contained a channeling injunction protecting both the debtor and its insurers.
What is a channeling injunction? Judge Ambro described it as “an injunction that channels [asbestos] liability to a trust set up to compensate persons injured by the debtor’s asbestos.” He said it “can also protect the interests of non-debtors, such as insurers.”
Giving rise to the appeal, asbestos claimants had sued insurance companies that had provided Grace with workers’ compensation and employers’ liability coverage, based on the insurers’ right but not obligation to inspect the company’s facilities.
After the plaintiffs sued in Montana state court, the insurance companies sought a declaratory judgment in bankruptcy court in Delaware. The bankruptcy court granted the insurers’ motion for summary judgment and ruled that the channeling injunction enjoined the plaintiffs from suing the insurance companies.
Divining what he called “a befuddling maze of defined terms,” Judge Ambro upheld the bankruptcy court’s conclusion that the insurance companies’ policies were covered by the channeling injunction. However, that wasn’t the end of the story, because a channeling injunction can go only so far as Section 524(g) allows in protecting non-debtor third parties.
With respect to Section 524(g), Judge Ambro remanded the case to the bankruptcy court, where the result may be the same after another few years of litigation.
The remainder of this story is tedious and boring. We recommend turning to something more engaging unless you’re involved in asbestos bankruptcies.
For a channeling injunction to protect a third party, the claims must arise “‘by reason of’ one of four statutory relationships between the third party and the debtor,” Judge Ambro said, citing Section 524(g)(4)(A)(ii). Judge Ambro examined two of the four.
First, Judge Ambro examined whether the Montana claimants were seeking to hold the insurance companies “directly or indirectly liable for the conduct of, claims against, or demands on” Grace, as required by Section 524(g)(4)(A)(ii). Citing the Third Circuit’s decision in In re Combustion Engineering Inc., 391 F.3d 190, 234-235 (3d Cir. 2004), as amended (Feb. 23, 2005), he said that the statute limits the permissible scope of the injunction to claims based on derivative liability, meaning that the insurance companies’ liability must “arise by reason of” the provision of insurance to Grace.
Judge Ambro remanded the case to the bankruptcy court, saying that the “proper inquiry is to review the law applicable to the claim being raised against the third party (and when necessary to interpret state law) to determine whether the third-party’s liability is wholly separate from the debtor’s liability or instead depends on it.”
Judge Ambro said the circuit court could not rule on the question because it was not fully briefed.
Next, Judge Ambro analyzed the so-called statutory relationship requirement, also in Section 524(g)(4)(A)(ii). In that regard, he again remanded the case for the bankruptcy judge to review “the applicable law to determine the relationship’s legal relevance to the third-party’s alleged liability.”
Similar to the derivative liability requirement, Judge Ambro said the bankruptcy court should “examine the elements necessary to make [a claim under Montana law] and determine whether [the] provision of insurance to Grace is relevant legally to these elements.”
Again, he said the record was not sufficiently developed to make the determination on appeal.