Betting that the Seventh Circuit would create a circuit split on the facts of the case before him, Bankruptcy Judge Jeffrey J. Graham of Indianapolis refused to expand the automatic stay to cover 3M Corp., the nondebtor parent of a company in chapter 11 dealing with the largest mass torts ever to hit the federal courts.
Judge Graham’s August 26 opinion could be read to mean that he might have protected the nondebtor parent with an expanded stay had pre-filing financial arrangements been written differently.
Beginning in 2000, the debtor made earplugs for the military. 3M acquired the debtor in 2008. Two years later, the debtor’s businesses were “upstreamed” to 3M in return for a $965 million payable to the debtor. Judge Graham said that 80% of the sales of the earplugs occurred before the upstreaming. He said it was “unclear” whether 3M assumed any liabilities as part of the upstreaming.
In settlement of a qui tam action, 3M paid $9.1 million to the government on account of allegedly defective earplugs.
Then, the lawsuits began. By the time the debtor filed a chapter 11 petition in late July, there were 290,000 claims covered by multidistrict litigation in Florida, where the debtor and 3M are co-defendants. In addition, Judge Graham said there are 2,000 more suits in state court in Minnesota, where 3M is headquartered.
The debtor, by the way, is also a Delaware corporation like 3M but is headquartered in Indianapolis.
Judge Graham said that the multidistrict litigation is the largest in history and represents 30% of all civil cases currently pending in federal courts.
There already have been several bellwether trials. 3M and the debtor won six of them, but the plaintiffs won 12, yielding verdicts ranging between $1.7 million and $77.5 million.
Before the subsidiary’s chapter 11 filing, independent directors for the debtor negotiated a financial arrangement with 3M. The complex arrangement committed 3M to a $240 million fund for the chapter 11 process plus an uncapped commitment to fund a trust to cover claims.
The debtor is obligated to indemnify 3M for whatever it spends, but the debtor can cover its liability by drawing funds from 3M. Judge Graham said that the “net effect to [the debtor] is zero.”
The P.I. Motion
On filing in chapter 11, the debtor began an adversary proceeding and sought a preliminary injunction. The debtor wanted Judge Graham to rule that the Section 362(a) automatic stay covered 3M or, alternatively, that the debtor wanted Judge Graham to protect 3M with an injunction made under Section 105(a).
Claimants objected to an expansion of the automatic stay. Judge Graham denied the initiative in a 37-page opinion.
Before delving into the merits, Judge Graham said the chapter 11 is not “the only avenue” for achieving a “global settlement.” [Emphasis in original.] He also said that he was not deciding whether the chapter 11 filing was in good faith.
The debtor and 3M are also facing a separate spate of lawsuits alleging that respirators made by the debtor were defective. The respirator lawsuits are substantial but pale in comparison to the earplug suits. Judge Graham barely mentioned the respirators.
By the way, the 3M parent was not a party in the debtor’s attempt at halting lawsuits against it.
Section 362(a)(1)
First, Judge Graham dealt with the debtor’s contention that Section 362(a)(1) automatically stopped lawsuits against the parent. The section halts the commencement or continuation of actions against the debtor.
Working from the proposition that the automatic stay “generally protects only the debtor,” Judge Graham said he was “reluctant to conclude that Section 362(a)(1), standing alone, offers sufficient statutory authority to conclude that the Pending Actions are stayed automatically as to 3M or to extend the protections of the stay to 3M.”
Citing the Fourth Circuit’s 1987 decision in A.H. Robbins, Judge Graham admitted “there is ample case law holding otherwise.”
Bound by precedent from the Seventh Circuit, Judge Graham said that his court of appeals “has not, to date, expansively discussed or formally adopted A.H. Robbins in this regard…. Nor has the Circuit actually extended the stay to a non-debtor party under that reasoning.”
“Without more guidance from the Seventh Circuit,” Judge Graham declined to extend Section 362(a)(1) to cover 3M.
Section 362(a)(3)
Next, Judge Graham turned to Section 362(a)(3), which bars “any action” to obtain property of or from the estate. It is “broader than just the debtor,” the judge said, and entails a two-step analysis. First, is property of the estate at issue, and, second, does the action threaten to obtain or exercise control over estate property?
Judge Graham assumed that insurance policies held by the debtor and 3M were estate property. On the question of obtaining property of or from the estate, he saw “no evidence” that the claimants were “proceeding directly against the insurance policies.”
Judge Graham next analyzed whether the suits were an indirect attempt at glomming the insurance policies. He found no violation of Section 362(a)(3) because the funding agreement signed just before bankruptcy means that “3M will fully fund any liability incurred” by the debtor. Given the uncapped backstop by 3M, tapping insurance policies would not affect how much creditors receive or cause an inequitable distribution among creditors.
Section 105(a)
The debtor was left with arguing that Judge Graham should expand the stay to cover 3M under Section 105(a), which gives the court power to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”
Citing the Seventh Circuit, Judge Graham said that the court may stay actions that may affect the amount of property in the bankrupt estate. But first, he said, the court must have “related to” jurisdiction to stay lawsuits pending in state court and in the multidistrict litigation.
Regarding “related to” jurisdiction, Judge Graham said that the Seventh Circuit has taken a “more constrained approach” and said that it must be interpreted “narrowly.” Again citing the Seventh Circuit, he said that “related to” jurisdiction requires “a direct effect” on either the estate or the distribution to creditors.
Looking for a direct effect on the estate, Judge Graham discounted the debtor’s obligation to indemnify 3M because the funding agreement “provides for an uncapped, non-recourse commitment from 3M to fund all of the [debtor’s] liabilities” and was not conditioned on obtaining a stay to protect 3M. He was therefore “unable to discern any financial impact to creditors.”
“A number of other courts have extended the stay notwithstanding the existence of an uncapped funding agreement,” Judge Graham said. “Respectfully, this Court cannot follow suit,” because the Seventh Circuit instructed courts to focus “on the actual economic effect” that continuation of the suits would have on the estate. [Emphasis in original.]
Judge Graham gave short shrift to the idea that continuation of the suits would be a “‘significant’ distraction.” He put “little stock on this claim.”
In short, Judge Graham saw no “related to” jurisdiction that would enable him to issue an injunction under Section 105(a). Even if there were jurisdiction, he said he “would reach the same conclusion” because a stay under Section 105(a) “should issue only in extraordinary circumstances” necessary to carry out other provisions of the Bankruptcy Code.
At the end of his opinion, Judge Graham admitted that a stay might give 3M and the debtor “additional leverage” to “negotiate a global settlement.”
“Alas,” Judge Graham said, “those questions are not things to be considered” under Section 362 or in deciding whether there is jurisdiction under Section 105(a).
Judge Graham sustained the objections and denied the motion for a preliminary injunction.
Note: The debtor is pursuing a direct appeal to the Seventh Circuit.
Observations
The opinion reminds this writer of basketball: no harm, no foul.
Further trials absent an expanded stay may well deplete insurance coverage and result in a clear effect on the estate, but Judge Graham saw no harm given 3M’s uncapped commitment. If it were shown as a matter of fact that 3M won’t be able to cover all damages, would Judge Graham have expanded the stay under Section 362(a)(3)?
Plaintiffs would not argue that 3M is insolvent and thereby open the door to a broader stay. To avoid damaging stockholders, 3M likewise would not claim insolvency.
So, 3M might have won an expanded stay were the commitment not uncapped, but uncapping the commitment would expose the debtor to a better argument about a bad faith filing. Thus, 3M was between a rock and a hard place.
The case raises the question of whether the U.S. legal system as currently configured — be it the tort system or bankruptcy — is adequately designed for dealing with massive tort claims threatening to destroy an otherwise profitable company employing thousands of workers. Were Congress to begin drafting a solution, any legislation would inevitably favor one side or the other. Proposing legislative action seems like voluntarily stepping on the third rail.
The fact that 3M won’t have an expanded stay at this juncture does not preclude the possibility of a settlement to be effected through a traditional class action. Perhaps we should sit back and wait to see whether companies like 3M can survive without an expanded stay.
The foregoing are this writer’s thoughts and do not represent the opinions of ABI.
Betting that the Seventh Circuit would create a circuit split on the facts of the case before him, Bankruptcy Judge Jeffrey J. Graham of Indianapolis refused to expand the automatic stay to cover 3M Corp., the nondebtor parent of a company in chapter 11 dealing with the largest mass torts ever to hit the federal courts.
Judge Graham’s August 26 opinion could be read to mean that he might have protected the nondebtor parent with an expanded stay had pre-filing financial arrangements been written differently.