This post is authored by Peter Tsoflias, Widener Law School Class of 2013:

Section 524(g) of the United States Bankruptcy Code purports to provide relief to debtors facing waves of asbestos, silica, benzene and other mass tort related claims. To be sure, section 524(g) allows Chapter 11 debtors to establish a trust and an injunction which channels present and future mass tort claims to the trust. As would be expected, liability insurance is often the primary asset funding such trusts. Due to the fact that insurers are affected by reorganization plans encompassing section 524(g) trusts, affected insurers often seek to challenge the confirmation of such plans.

In order to challenge the confirmation of a reorganization plan, an insurer must meet the standing requirements prescribed by the Constitution as well as the Bankruptcy Code. The Third Circuit’s jurisprudence is fairly well developed with respect to the issue of insurer standing in the bankruptcy context. To this effect, the Third Circuit first dealt with insurer standing in In re Combustion Engineering. After closely examining the reorganization plan at issue, the Combustion court noted that the plan adequately preserved the insurers’ pre-petition contractual rights and defenses; therefore, the plan was deemed “insurance neutral”. In so noting, the court held that the insurers faced no injury by the plan and, consequently, did not have standing to challenge the plan’s confirmation.

Subsequent Third Circuit decisions followed suit—closely examining each reorganization plan at issue to determine whether each plan’s language was insurance neutral. In a prior writing (found here), I took issue with the Third Circuit’s most recent holding concerning insurer standing in the bankruptcy context—In re Global Industrial Technologies (hereinafter “GIT”).

The debtors in GIT sought bankruptcy relief in order to address over 235,000 asbestos related claims and 169 silica related claims then pending against the debtors. The debtors’ plan, which included a section 524(g) trust, purported to preserve the insurers’ pre-petition rights and defenses post-confirmation (i.e., insurance neutrality language). Despite the plan’s insurance neutrality language, the Third Circuit reversed the lower court decisions and held that the insurers had standing to challenge the plan’s confirmation. Notably, the court did not base its holding on whether the debtors’ plan adequately preserved the insurers’ rights and defenses. Rather, the court focused on the “suspect circumstances” surrounding the silica claims. In particular, the Third Circuit found that the number of silica claims surged shortly after the debtors filed bankruptcy. The court found these claims to be “suspect” because they were allegedly products of collusion between the attorneys representing the asbestos and silica claimants. The Third Circuit held that investigating these suspect claims created a new class of administrative expenses that the insurers would be called to bear. Such an increase in administrative expenses increased the insurers “quantum of liability”, therefore constituting an injury sufficient for bankruptcy standing.

In my Note, Insurance Neutrality: Affecting an Insurer’s Right to Bankruptcy Standing, (see link above) I sided with the GIT dissent, arguing that the Third Circuit should not have focused on any increase in the insurers’ “quantum of liability.” Doing so frustrates the intent of the Bankruptcy Code and undermines basic principles underlying contract and constitutional law. Further, I articulated a two prong test for courts to apply when addressing the issue of insurer standing in the bankruptcy context. First, as a threshold matter, courts should determine whether the plan at issue adequately preserves insurer’s pre-petition rights and defenses (i.e., includes insurance neutrality language). In making this determination, courts should not look beyond the four corners of the plan (as the court did in GIT). Second, courts should determine whether the plan at issue threatens to undermine the integrity of the bankruptcy court. If this is found, a more searching look into the plan’s validity is warranted. This standard serves several objectives (as discussed in my Note)—most notably, it is in agreement with basic contract principles. To this end, I argue that if a plan adequately preserves an insurer’s pre-petition rights and defenses (as was the case in GIT) the insurer suffers no contractual injury. By granting an insurer standing in this context (as the Third Circuit did in GIT), the court is giving an insurer more rights than the insurer initially bargained for.

Despite the Third Circuit’s “quantum of liability” standard set forth in GIT, the Ninth Circuit in In re Thorpe Insulation Co. solely examined the express terms of the plan at issue. Similar to the plan in GIT, the debtor’s reorganization plan in Thorpe contained a section 524(g) trust and a provision stating that the plan is “insurance neutral” because it preserves all “Asbestos Insurance Defenses.” Notwithstanding this boilerplate language, the debtor’s plan contained four exceptions to the insurers’ otherwise preserved defenses. In light of these exceptions, the court held that the plan was not insurance neutral because it did not adequately preserve the insurers’ pre-petition contractual rights and defenses. Accordingly, the insurers were granted standing to challenge the plan’s confirmation.

The Ninth Circuit’s holding in Thorpe is consistent with the two prong test articulated in my prior Note. In particular, by focusing solely on the express terms in the debtor’s plan and the contract between the debtor and its insurers, the Ninth Circuit’s analysis was in accord with basic contract and constitutional principles. In order to promote consistency, reliability and efficiency in bankruptcy proceedings, courts should welcome the Ninth Circuit’s approach to analyzing the issue of insurer-standing. Two thumbs way up for the Ninth Circuit!