A dissenter in the Fourth Circuit is the latest example of an Article III judge antagonistic to idea of allowing large, solvent companies to fend off their own mass tort liability by putting an affiliate into chapter 11.
Espousing a new strategy for precluding the use of the bankruptcy court in obtaining the release of tort liability for non-debtors, Circuit Judge Robert Bruce King would have ruled that the use of a so-called Texas divisional merger manufactured federal jurisdiction in violation of 28 U.S.C. § 1359.
On the last page of the opinion in which he “respectfully” dissented, Judge King quoted an amicus brief filed in the Seventh Circuit on behalf of six U.S. senators and two representatives, urging the appeals court to uphold denial of non-debtor injunctions in the chapter 11 reorganization of a subsidiary of 3M Corp. The amici said:
[I]n recent years, the Bankruptcy Code has increasingly been manipulated by solvent, blue-chip companies faced with mass tort liability and is becoming a font for abuse by mammoth corporations with billions on their balance sheets. Through dubious readings of the Bankruptcy Code that Congress never intended, financially healthy corporations and those that control them have invented elaborate loopholes enabling them to pick and choose among the debt-discharging benefits of bankruptcy without having to subject themselves to its creditor-protecting burdens — and without ever declaring bankruptcy themselves.
In re Aearo Techs., LLC, No. 22-2606, at 3-4 (7th Cir. Feb. 1, 2023), ECF No. 89.
Upholding the lower courts’ conclusions that the bankruptcy court had “related to” jurisdiction, the Fourth Circuit majority found no abuse of discretion in issuing a preliminary injunction barring suits against non-debtor affiliates.
The Georgia-Pacific Divisional Merger
The facts were similar to those where Johnson & Johnson employed a Texas divisional merger to segregate mass tort liability into a subsidiary that would file a chapter 11 petition to obtain an injunction barring suits against the entire non-debtor corporate family.
In 1965, Georgia-Pacific merged with Bestwall Gypsum, which made products containing asbestos. Thousands of lawsuits ensued.
In 2017, GP underwent a Texas divisional merger. The “old” GP ceased to exist. Two companies were created in its place. Bestwall became solely responsible for mass tort liability, while a newly created company, that we shall refer to as New GP, received all of the assets of “old” GP but was not responsible for any asbestos liability.
Both Bestwall and New GP became wholly-owned subsidiaries of a holding company. Just like the J&J, Bestwall could draw on a funding agreement requiring New GP to pay any asbestos liabilities, in bankruptcy or outside of bankruptcy.
Following the divisional merger, Bestwall filed a chapter 11 petition in Charlotte, N.C. Immediately, the debtor filed an adversary proceeding and sought a preliminary injunction to halt lawsuits against New GP.
Finding “related to” jurisdiction under Section 1334, the bankruptcy granted the preliminary injunction. On appeal by the official creditors’ committee and the future claimants’ representative, the district court affirmed. The committee and the representative appealed to the Circuit.
The Majority Opinion
The appellants argued on appeal that the bankruptcy court lacked jurisdiction to impose the preliminary injunction.
For the majority, Circuit Judge G. Steven Agee said that the Fourth Circuit uses a “broad test” for “related to” jurisdiction under Section1334(a). He said that the asbestos claims against New GP are “identical” to those against Bestwall and that the claims against New GP could have an “effect” on Bestwall.
Judge Agee quickly found “related to” jurisdiction and devoted the remainder of his opinion countering the dissenter’s contention that New GP “manufactured” federal jurisdiction in violation of 28 U.S.C. § 1359. The section provides that a “district court shall not have jurisdiction of a civil action in which any party, by assignment or otherwise, has been improperly or collusively made or joined to invoke the jurisdiction of such court.”
Judge Agee said that the companies “did not manufacture jurisdiction via their Texas divisional merger.” Absent the merger, he said that the claims would have been asserted against Old GP. If Old GP had filed bankruptcy, there would have been jurisdiction. He therefore reasoned that the bankruptcy court had the same jurisdiction as though the merger had never taken place.
Judge Agee rejected the creditors’ reliance on the Third Circuit’s dismissal of the chapter 11 case filed by LTL Management, a subsidiary of Johnson & Johnson. See In re LTL Management LLC, 58 F.4th 738, 64 F.4th 84 (3d Cir. Jan. 30, 2023). The Third Circuit, he said, dismissed for a lack of good faith given the absence of “financial distress.” To read ABI’s report on LTL, click here.
The Third and Fourth Circuits have different “good faith” standards. Judge Agee recounted how the Third Circuit “recognized” that the Fourth Circuit employs a “more comprehensive standard” requiring both subjective bad faith and an objective futility of any possible reorganization.
The creditors, Judge Agee said, “made no showing to this Court of either required element.” He held that the district court “correctly rejected” the idea that the companies “manufactured jurisdiction.”
Judge Agee ended his majority opinion by finding that the bankruptcy court had employed the proper standard for a preliminary injunction.
According to Judge Agee, the debtor had shown the likelihood of success on the merits by demonstrating a “realistic likelihood of successfully reorganizing” and was not required to make a clear showing of the ability to reorganize.
For the majority, Judge Agee upheld the preliminary injunction.
The Dissent
In the first paragraph of his dissent, Judge King quoted the Supreme Court for saying that bankruptcy is for “insolvent” or “bankrupt” companies. In “recent years,” he said,
major and fully solvent business corporations have managed to skirt that debtor-centric objective and obtain shelter from sweeping tort litigation without having to file for bankruptcy themselves. It is precisely that sort of manipulation of the Bankruptcy Code . . . that lies at the heart of this important appeal.
Before explaining the legal grounds on which he would have denied the injunction, Judge King said that the companies “manufactured the jurisdiction of the bankruptcy court in these proceedings, in an unmistakable effort to gain leverage over future asbestos claims against New GP.”
Judge King said that the divisional merger “was designed [for New GP] to receive bankruptcy protection despite its non-debtor status, with no need to submit to the bankruptcy court’s oversight or to suffer the burdens appurtenant to a Chapter 11 filing.”
Conceding that the claims against New GP were “related to” the bankruptcy, Judge King pointed to Section 1359 and said that “the entire factual basis for invoking the bankruptcy court’s ‘related-to’ jurisdiction was contrived.”
Explaining the applicability of Section 1359, Judge King said that Old GP “reformed its corporate existence precisely so that its principal successor entity, New GP, could be afforded bankruptcy relief without ever having to file for bankruptcy.” He therefore would have held that the bankruptcy court was without jurisdiction to enter the injunction, because “jurisdiction consistently flows from an orchestrated endeavor to fabricate it.”
Judge King would have reversed with directions to vacate the injunction, saying that the injunction runs “directly counter to the purposes of the Bankruptcy Code.”
A dissenter in the Fourth Circuit is the latest example of an Article III judge antagonistic to idea of allowing large, solvent companies to fend off their own mass tort liability by putting an affiliate into chapter 11.
Espousing a new strategy for precluding the use of the bankruptcy court in obtaining the release of tort liability for non-debtors, Circuit Judge Robert Bruce King would have ruled that the use of a so-called Texas divisional merger manufactured federal jurisdiction in violation of 28 U.S.C. § 1359.