United States: Third Circuit Ruling Provides Bankruptcy Plans With Broad Preemption Rights

Last Updated: September 5 2012
Article by Dov R. Kleiner

On May 1, 2012, the 3rd U.S. Circuit Court of Appeals ruled on an issue that is of particular importance to insurers, but it may also have wider application to the crafting of plans of reorganization in the asbestos arena and elsewhere. Specifically, the court held that debtor Federal-Mogul could transfer its rights to recover under liability insurance policies to a trust set up under its plan of reorganization for the benefit of asbestos victims, even though the policies contained provisions prohibiting their assignment. In re Federal-Mogul Global Inc., No. 09-2230, 2012 WL 1511773 (3d Cir. 2012).

The 3rd Circuit based its ruling on the preemption language contained in Section 1123(a) of the federal Bankruptcy Code, which provides for the implementa-tion of a plan of reorganization, including by the transfer of property to a non-debtor, "[n]otwithstanding any otherwise applicable non-bankruptcy law." The court dismissed the attempts made by insurer appellants to limit the effects of the preemptive language on the basis of theories of statutory construction and appeals to legislative history.

The circuit court's decision in Federal-Mogul put to rest a dispute relating to a critical component of a plan of reorganization that was confirmed four and a half years ago in a case that was, by then, already six years old. Although the long-awaited decision is narrow in focus, it establishes Section 1123(a) as broad in application.

BACKGROUND

The procedural and factual background of the Federal-Mogul decision is as follows:

The Federal-Mogul corporate group, dating back to 1899, is an original equipment and aftermarket automotive parts manufacturer and distributor. Today, it operates worldwide through 169 manufacturing, distribution and technical facilities with operations in 34 countries. In 2011, it had sales of $6.9 billion. See Federal-Mogul Corp. annual report pursuant to Section 13 and 15(d) (Form 10-K), at 12 (Feb. 28, 2012).

In 2001, however, Federal-Mogul faced significant asbestos-related litigation liability that resulted from the manufacture of asbestos and asbestos-related products at subsidiaries acquired in 1965 and 1998. Federal-Mogul claimed that 500,000 personal injury claims were pending at that time, with many more anticipated in the future, and the corporation asserted that it had spent more than $350 million in the preceding year defending and indemnifying asbestos claims. Federal-Mogul, 2012 WL 1511773 at *4.

In an attempt to finally resolve its asbestos-related exposure, on Oct. 1, 2001, Federal-Mogul Global Inc and more than 150 affiliates filed Chapter 11 bankruptcy petitions in the U.S. Bankruptcy Court for the District of Delaware.

In late 2007, after six years of bankruptcy court proceedings, including much negotiation on the resolution of asbestos-related claims and their treatment and multiple iterations, Federal-Mogul was finally able to present its fourth amended joint plan of reorganization (as modified) for confirmation.

A critical feature of the plan was that all asbestos personal injury and wrongful-death claims against Federal-Mogul and its affiliates under the plan were to be assumed by an asbestos trust created pursuant to Section 524(g) of the Bankruptcy Code1 and that the reorganized Federal-Mogul would be relieved of that responsibility. Critically, the asbestos trust was to be funded by, among other things, an assignment of the rights to recover under liability insurance policies that had been issued to Federal-Mogul prior to bankruptcy.

The insurers objected to the plan's confirmation, asserting that the plan violated the policies' anti-assignment provisions — standard clauses in liability policies that bar the insured from transferring the policies or insurance rights without the insurers' consent. Federal-Mogul, at *4.

Federal-Mogul argued the transfer was permitted because the anti-assignment provisions in the policies were preempted under 11 U.S.C. § 1123(a)(5)(B), which provides that a Chapter 11 reorganization plan shall provide adequate means for its implementation, including, if appropriate, the transfer of estate property, "notwithstanding otherwise applicable non-bankruptcy law."

The parties agreed to bifurcate the proceedings, permitting the plan to proceed toward confirmation on one track while the preemption issue was to be decided on a separate track.

On Nov. 8, 2007, with all other objections resolved, the Bankruptcy Court confirmed the plan, and the District Court affirmed. The plan went into effect Dec. 27, 2007.

Months later, on March 19, 2008, the Bankruptcy Court issued its preemption order and memorandum opinion, holding that the Bankruptcy Code preempted the anti-assignment provisions within the insurers' policies. In re Federal-Mogul Global Inc., 385 B.R. 560 (Bankr. D. Del. 2008). The District Court affirmed. In re Federal-Mogul Global Inc., 402 B.R. 625 (D. Del. 2009).

A number of insurers2 filed two appeals to the 3rd Circuit, which consolidated the appeals.

THE 3RD CIRCUIT RULING

In an opinion written by Circuit Judge Anthony Joseph Scirica, joined by Circuit Judges D. Brooks Smith and Kent A. Jordan, the 3rd Circuit panel rejected the insurers' arguments and found that the preemptive lead-in language of Section 1123(a) was broad in scope, not limited by Section 1142 of the Bankruptcy Code, which governs implementation of a reorganization plan. The panel also found that the language applied to the transfer of the rights of the Federal-Mogul estate to recover under the policies.

ANALYSIS

Section 1123 of the Bankruptcy Code, titled "Contents of a Plan," sets forth certain elements that must be included in a plan of reorganization and certain elements that may be included in such a plan.

The lead-in to Section 1123(a), which describes what must be included in a plan, begins with this preemption language: "Notwithstanding any otherwise applicable non-bankruptcy law, a plan shall—." It then goes on to list a number of requirements for a plan. The fifth requirement under Section 1123(a) is that the plan must:

(5) provide adequate means for the plan's implementation, such as — ... (B) transfer of all or any part of the property of the estate to one or more entities, whether organized before or after the confirmation of such plan.

Federal-Mogul argued that the anti-assignment provisions of the policies, because they were part of a contract that required "applicable non-bankruptcy law" to enforce, were covered by the preemption lead-in language of Section 1123(a), just as the transfer of the estate's right to recover under the policies to the asbestos trust was the transfer of "part of the property of the estate to one or more entities" and thus squarely within Section 1123(a)(5)(B).

The insurers made two arguments related to statutory construction. First, they argued that the preemption lead-in language of Section 1123(a) applied to some of the requirements of Section 1123(a), but not to the various items listed as possible means of implementation under subsection (a)(5).

Second, the insurers claimed that the phrase "notwithstanding any otherwise applicable non-bankruptcy law" in Section 1123(a) should be read in conjunction with, and limited by, Section 1142 of the Bankruptcy Code.

Section 1142 provides for the implementation of a plan, and subsection (a) contains its own, but more limited, preemption language:

Notwithstanding any otherwise applicable non-bankruptcy law, rule, or regulation relating to financial condition, the debtor and any entity organized or to be organized for the purpose of carrying out the plan shall carry out the plan and shall comply with any orders of the court.

The insurers argued, therefore, that the "applicable non-bankruptcy law" preempted in Section 1123(a) should be understood to apply only to laws "relating to financial condition" as specified in Section 1142(a).

In addition, insurers argued that the anti-assignment provisions were not "applicable non-bankruptcy law," but rather were contractual provisions, which were not covered by the preemption language of Section 1123(a).

The 3rd Circuit panel rejected each of the insurers' various arguments.

[There is] no textual support to limit the scope of the "notwithstanding" clause only to part of Section 1123(a), to state enactments, or to the preemptive reach of Section 1142(a). The plain language of Section 1123(a) evinces clear congressional intent for a preemptive scope that includes the transactions listed under Section 1123(a)(5) as "adequate means" for the plan's implementation, including the transfer of property authorized by (a)(5)(B). The plain language also reaches private contracts enforced by state common law, and overcomes the presumption against preemption.

Federal-Mogul, at *11.

Apart from their arguments regarding statutory construction and interpretation, the insurers also tried to argue from legislative history and policy considerations that the preemption language in Section 1123(a) should be narrowly construed, since Congress, in enacting the 1984 revisions to the Bankruptcy Code that added the "notwithstanding any otherwise applicable non-bankruptcy law" language to Section 1123(a), intended only to make mere technical amendments. It did not intend to make a substantive change from the pre-Bankruptcy Code practice, which did not contain such broad preemption.

The 3rd Circuit rejected that view. "[W]hat-ever the proper characterization of prior practice, it deserves little weight here. We decline to rely on it, or on a thin and vague legislative history that says nearly nothing about the intended preemptive scope."

As a result, the 3rd Circuit found that Section 1123(a) overrode the anti-assign-ment provisions in the policies and that the plan could transfer the right to recover under them to the asbestos trust.

SCOPE OF THE DECISION

The 3rd Circuit's decision in Federal-Mogul delineates a broad scope for the pre-emptive effect of Section 1123(a). By refusing to import the limits of Section 1142's preemption to Section 1123(a), the 3rd Circuit made clear that Section 1123(a) preempts, generally speaking, all non-bankruptcy law, including contractual provisions.

Debtors therefore have great leeway in using a plan of reorganization to transfer property under circumstances that might otherwise be prohibited by applicable law or contract.

Thus, just as the anti-assignment provisions in Federal-Mogul's policies fell by the wayside, so too might other contractual provisions in other agreements (e.g., anti-merger provisions [Section 1123(a)(5)(C)] or restrictions on amendments to organizational documents [Section 1123(a)(5)(I)]).

The question then, is what limits remain on preemptive power in a plan of reorganization under Section 1123(a). Certainly, the 3rd Circuit, recognizing that potential problem, tried to provide some guidance by pointing to the "good faith" requirement of the Bankruptcy Code:

But the scope of preemption under Section 1123(a) is not unlimited, and our holding does not suggest otherwise. Any reorganization plan must still comply with all aspects of the Bankruptcy Code and be approved by the bankruptcy court. In particular, it must satisfy 11 U.S.C. § 1129(a)(3), which provides that a court shall confirm a reorganization plan only if it "has been proposed in good faith and not by any means forbidden by law." We have stated that this good faith standard ensures that a plan will "fairly achieve a result consistent with the objectives and purposes of the Bankruptcy Code." In re PWS Holding Corp., 228 F.3d 224, 242 (3d Cir. 2000) (quoting In re Abbotts Dairies of Pa., Inc., 788 F.2d 143, 150 n.5 [3d Cir. 1986]).

Federal-Mogul, at *17.

Thin as the "good faith" limit may appear in practical terms,3 the 3rd Circuit also suggested that plan preemption may not be used to evade state and federal public welfare–related law, under the "the long-standing presumption against preemption of state police power laws and regulations rooted in federalism concerns and the historic primacy of state regulation of matters of health and safety." Federal-Mogul, at *17, quoting Medtronic Inc. v. Lohr, 518 U.S. 470 (1996), at 485.4

Although this does little to help private parties such as liability insurers, it does provide some comfort to regulators that bankruptcy plans will not override existing regulatory schemes. Surely, then, the preemption power of Section 1123 will have some limits. Nevertheless, given the power of the statutory argument adopted by the 3rd Circuit in Federal-Mogul, it remains to be seen how willing future courts will be to circumscribe a plan's preemptive authority outside of the narrow sphere of public welfare laws.

Footnotes

1 Asbestos trusts are a creature of Section 524(g) of the Bankruptcy Code, a statutory provision intended to help debtors resolve massive asbestos liability and to evaluate claims and allocate payments to current and future asbestos claimants. This provision was adopted in the wake of the Johns Manville bankruptcy that stretched through the 1980s. When the requirements of Section 524(g) are satisfied, including the affirmative vote of 75 percent of affected claimants, the bankruptcy court may issue an injunction channeling all current and future claims based on the debtor's asbestos liability to a personal-injury trust. This case centers on one of these trusts, and the importance of the asbestos context to the court's reasoning should not be underestimated. The 3rd Circuit panel devoted considerable space to discussing the history and implementation of Section 524(g) asbestos trusts. It explicitly noted that "Congress believed the transfer of a corporation's assets to a trust to ensure the equitable compensation of present and future claimants, in return for a release from future liability, served the 'fundamental' purposes of bankruptcy." Therefore, the panel said, it is consistent with the policy aims of Congress that Section 1123(a) preempt any non-bankruptcy law that would otherwise prevent the transfer of those assets to a trust for the benefit of claimants. Federal-Mogul, at *14.

2 The appellant insurers were Hartford Accident and Indemnity Co., First State Insurance Co., New England Insurance Co., Columbia Casualty Co., Continental Casualty Co., Continental Insurance Co., Fireman's Fund Insurance Co., National Surety Co., Certain Underwriters at Lloyd's of London and Certain London Market Companies.

3 There is, in fact, developed case law on the "good-faith" requirement for plans of reorganization under Section 1129(a)(3). Although a discussion of that case law is beyond the scope of this article, it is sufficient to note that it would provide little comfort to parties concerned about the preemption provisions of Section 1123 being used to override contractual provisions in connection with an otherwise purposeful reorganization.

4 Indeed, the panel noted that 18 states had filed an amicus brief on this same issue in the In re Global Industrial Technologies case, cautioning that an "overly broad reading" of Section 1123(a) "would destroy [their] ability to preserve their regulatory authority in the face of a bankruptcy filing." Federal-Mogul, at *17, referring to Br. and App. of amicus curiae states at 1-3, In re Global Indus. Techs., 645 F.3d 201 (3d Cir. 2011) (No. 08-3650), 2008 WL 8134099 at *1-*3.

First published in Westlaw Journal, August 2012

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Dov R. Kleiner
 
In association with
Related Video
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
Accounting and Audit
Anti-trust/Competition Law
Consumer Protection
Corporate/Commercial Law
Criminal Law
Employment and HR
Energy and Natural Resources
Environment
Family and Matrimonial
Finance and Banking
Food, Drugs, Healthcare, Life Sciences
Government, Public Sector
Immigration
Insolvency/Bankruptcy, Re-structuring
Insurance
Intellectual Property
International Law
Law Practice Management
Litigation, Mediation & Arbitration
Media, Telecoms, IT, Entertainment
Privacy
Real Estate and Construction
Strategy
Tax
Transport
Wealth Management
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.