Just like the lack of “financial distress” prompted the Third Circuit to dismiss the first chapter 11 filing by Johnson & Johnson subsidiary LTL Management LLC, Bankruptcy Judge Jeffrey J. Graham of Indianapolis dismissed the chapter 11 case of a subsidiary of 3M Corp. for lack of “financial distress” and no demonstration of a “valid reorganization purpose.”
In his June 9 opinion, Judge Graham said that the filing by 3M subsidiary Aearo Technologies LLC was “fatally premature” and that the debtor was employing chapter 11 to “solve problems that Congress did not design or intend the [Bankruptcy] Code to fix.”
Judge Graham found the Third Circuit’s logic to be “persuasive” in LTL Management LLC, 64 F.4th 84 (3d Cir. Jan. 30, 2023). In LTL, the Philadelphia-based appeals court held that “resort[ing] to Chapter 11 is appropriate only for entities facing financial distress.” Id. at 111. To read ABI’s report on LTL, click here.
The June 9 opinion was not 3M’s first disappointment. In August 2022, Judge Graham found no jurisdiction to impose an injunction stopping lawsuits against nondebtors, like the parent 3M. In re Aearo Tech. LLC, 642 B.R. 891 (Bankr. S.D. Ind. Aug. 26, 2022). To read ABI’s report, click here.
Aearo took a direct appeal to the Seventh Circuit from the order refusing to enjoin lawsuits against nondebtors. The appeal was argued in early April. Unless Aearo successfully appeals the June 9 dismissal order, the appeal from injunction denial may be moot.
The Faulty Earplugs
Aearo began making earplugs for the military in 2000. 3M acquired Aearo in 2008. Two years later, Aearo’s businesses were “upstreamed” to 3M in return for $965 million payable to Aearo. Judge Graham said that 80% of earplug sales occurred before the upstreaming. He said it was “unclear” whether 3M assumed any liabilities as part of the upstreaming.
After 3M paid $9.1 million to settle a qui tam action, a deluge of lawsuits were filed alleging that the earplugs were defective. Aearo filed a chapter 11 petition in July 2022 that stopped lawsuits against Aearo but not against 3M and nondebtor affiliates. Central to the reorganization, the Aearo subsidiary had uncapped funding from the 3M parent to pay judgments or settlements, whether arising in bankruptcy or not.
Immediately after filing, Aearo attempted to spread the Section 362 automatic stay to cover 3M and other nondebtor affiliates, but Judge Graham denied the initiative last August.
Today, more than 250,000 earplug suits are consolidated in multidistrict litigation in Florida, where the debtor and 3M are co-defendants. Judge Graham said that the multidistrict litigation is the largest in history and represents 30% of all civil cases currently pending in federal courts.
So far, there have been 18 bellwether trials. 3M and the debtor won six, but the plaintiffs won 12, yielding verdicts ranging between $1.7 million and $77.5 million.
3M called the multidistrict litigation a failure and proffered chapter 11 as the best method for resolving all earplug liabilities.
Perhaps emboldened by the Third Circuit’s dismissal of the case by the J&J subsidiary, the earplug plaintiffs filed a motion asking Judge Graham to dismiss the Aearo case under Section 1112(b) for “cause.” A separate committee representing plaintiffs who used allegedly defective respirators wanted Judge Graham to appoint a chapter 11 trustee instead.
Judge Graham took the matter under advisement after a five-day hearing concluding on April 25, and issued his 49-page opinion six weeks later dismissing the case without prejudice.
The Financial Condition of the Debtor and 3M
The financial condition of Aearo and 3M was central to Judge Graham’s legal conclusions. The debtor’s expert estimated that the total earplug liability was less than $1 billion and that 3M has the ability to pay. Currently, Judge Graham said that Aearo is solvent on a balance-sheet and cash-flow analysis.
3M has book equity today of $14.7 billion and cash and cash equivalents of more than $3.6 billion. In 2022, 3M paid over $3.2 billion in dividends and bought back $1.4 billion in stock, Judge Graham said.
The Law on Dismissal
On finding “cause,” Section 1112(b) directs the court to convert to chapter 7 or dismiss, unless appointment of a chapter 11 trustee or an examiner is in the best interests of creditors. In addition to the 16 statutorily defined grounds for finding cause, Judge Graham said that “most courts generally agree that a case should also be dismissed under § 1112 if it was not filed in good faith.”
While there is “no universally accepted definition of good faith” in the Section 1112 context, Judge Graham said it is also “unclear” in Seventh Circuit caselaw “whether it is bad faith for a financially healthy debtor to seek Chapter 11 relief.” Of course, being insolvent is not a prerequisite for chapter 11, he said.
To determine the relevance of the debtor’s financial condition, Judge Graham extensively analyzed a 1990 decision by retired Chicago Bankruptcy Judge Eugene Wedoff in In re N.R. Guaranteed Retirement Inc., 112 B.R. 263 (Bankr. N.D. Ill. 1990). Finding the filing to have been “unnecessary” was the “most basic” ground for dismissal, Judge Wedoff said. Id. at 262.
Unwilling to adopt an unweighted, multi-factor test for good faith, Judge Graham cited the Seventh Circuit’s opinion in In re Madison Hotel Associates, 749 F. 2d 410, 425 (7th Cir. 1984), for saying that the “better” measure is “whether the Chapter 11 case serves a ‘valid reorganization purpose.’” The “central” question, he said, is the “debtor’s ‘need’ for relief under Chapter 11.”
What’s a ‘Valid Purpose’?
Next, Judge Graham addressed the definition of “valid reorganization purpose.” He said that the need for chapter 11 is “inextricably tied” to bankruptcy “purpose.”
One purpose, Judge Graham said, is to preserve or create value that would be lost outside of bankruptcy. Citing the Third Circuit among other authorities, he reported how courts “have consistently dismissed chapter 11 petitions by financially healthy companies with no need to reorganize under the protection of Chapter 11.”
“When the debtor is solvent,” Judge Graham said, “we begin to stray from Congress’ intended application of the Code and valid bankruptcy purposes dwindle.” The “line of reasoning,” he said, “has arguably been most clearly articulated by the Third Circuit . . . most recently” in LTL, where the Court of Appeals found no “financial distress.”
Finding LTL “persuasive,” Judge Graham said that “the Court cannot conclude that the Aearo Entities’ cases serve a valid reorganization purpose.” The company “has been, and currently is, financially healthy.” He found “simply no compelling evidence that the Pending Actions have had or will have, at least in the near term, any substantial effect on Aearo’s operations. Aearo, simply put, is thriving even while living under the ‘overhang’ of the largest MDL in history.”
Naturally, Judge Graham said that the uncapped “Funding Agreement plays an obvious and significant factor in the Court’s conclusion that Aearo is financially healthy.”
Turning to the other aspect of reorganization purpose, Judge Graham said “there is no material value preserved, created, or lost outside of bankruptcy.” He could not “conclude that Aearo’s bankruptcy creates or preserves any value that would be lost if these cases were dismissed.”
Judge Graham found “cause” to dismiss the case under Section 1112(b).
No Trustee
The respirator committee wanted a chapter 11 trustee rather than dismissal. Judge Graham said that a trustee was not in the best interests of the estate or creditors, because he did not believe that “a trustee will necessarily add to or aid the process of reaching a global settlement.”
Furthermore, Judge Graham said that the “appointment of a trustee does not ameliorate or obviate the fundamental problem that these cases simply do not, at least presently, serve a valid reorganizational purpose.”
Conclusion
Judge Graham ended his opinion by finding a correlation between his decision to dismiss the case and his prior decision refusing to expand the automatic stay based on the lack of jurisdiction.
Although Section 1112(b) is not jurisdictional, Judge Graham said that requiring a valid bankruptcy purpose “protects this Court’s jurisdictional integrity.”
“Otherwise,” Judge Graham said, “a bankruptcy court risks becoming another court of general jurisdiction, which it most decidedly is not.” He added that allowing “an otherwise financially healthy debtor . . . to remain in bankruptcy . . . exceeds the boundaries of the Court’s limited jurisdiction.”
Judge Graham said that the chapter 11 filing was “fatally premature.” He dismissed the case without prejudice so as not “to forestall a repeat filing . . . should the circumstances warrant it.”
[Disclosure: This writer’s brother is counsel for the Aearo respirator committee.]
Just like the lack of “financial distress” prompted the Third Circuit to dismiss the first chapter 11 filing by Johnson & Johnson subsidiary LTL Management LLC, Bankruptcy Judge Jeffrey J. Graham of Indianapolis dismissed the chapter 11 case of a subsidiary of 3M Corp. for lack of “financial distress” and no demonstration of a “valid reorganization purpose.”
In his June 9 opinion, Judge Graham said that the filing by 3M subsidiary Aearo Technologies LLC was “fatally premature” and that the debtor was employing chapter 11 to “solve problems that Congress did not design or intend the [Bankruptcy] Code to fix.”
Judge Graham found the Third Circuit’s logic to be “persuasive” in LTL Management LLC, 64 F.4th 84 (3d Cir. Jan. 30, 2023). In LTL, the Philadelphia-based appeals court held that “resort[ing] to Chapter 11 is appropriate only for entities facing financial distress.” Id. at 111.