In Mass Torts Insider, Partners Eric Goodman and Gerard Cicero Examine Bankruptcy Code Protections for Non-Debtors

Partners Eric Goodman and Gerard Cicero co-authored an article for the current issue of Mass Torts Insider magazine entitled “Corporate Leverage and The Texas Two Step.”

The article examined the way the bankruptcy code has evolved in its protections of non-debtor affiliates.

“Whether it be a bankruptcy court’s authority to impose non-consensual non-debtor releases, most recently addressed by the Second Circuit Court of Appeals in Purdue Pharma, or preliminary injunctions in favor of non-debtor affiliates in Aearo Technologies, these issues have captured public and legislative attention,” they wrote. “Cases like Purdue Pharma and Aearo Technologies sought to invoke the Court’s general powers under Section 105(a) of the Bankruptcy Code.”

From 1994 to 2010, Section 524(g) of the bankruptcy code largely appeared to work to resolve asbestos-related bankruptcies, leading to dozens of asbestos trusts and confirmed Chapter 11 plans that were negotiated among debtors, non-debtors, and plaintiffs in good faith, the authors wrote. Unlike traditional Chapter 11 plans, however, Section 524(g) requires each affected class to vote by 75% in favor of the plan and its injunction. If the asbestos plaintiffs believe that the offered compensation is insufficient, then a group of plaintiffs exceeding 25% of plaintiffs can effectively block plan confirmation, they wrote.

These competing perspectives came to a head in 2014 in the bankruptcy proceedings for Garlock Sealing Technologies, an asbestos-related case filed in the Western District of North Carolina, a venue that looms large in the Texas two-step conversation.

Garlock filed for bankruptcy in 2010, facing substantial liability for asbestos claims. More than three years after the petition date, the court sided with the debtor, the authors noted.

The asbestos claimants overwhelmingly rejected the plan, leaving the debtor in Garlock with no viable path forward to confirm a Section 524(g) plan based on the funding of a trust with $125 million, they wrote.

“Garlock was likely not considered a complete success case for the debtor and non-debtors who had to eventually fund a trust four times what they urged (and the Court accepted) was the estimated liability,” the article stated. “However, there were attributes to Garlock that alleged corporate tortfeasors did find attractive. Chief among them was the complete stay of all litigation against the debtor, and the related stemming of defense costs and payments of settlements and verdicts for over half a decade, while the case malingered.”

Plaintiffs have argued that “Texas two-step” bankruptcy cases are intentionally designed to take the aspects of Garlock that are favorable to alleged corporate tortfeasors without any of the burdens on true debtors intended by the bankruptcy code. In brief, a “Texas Two-Step” involves a state law divisional merger and then a bankruptcy filing.

“The Texas Two Step is designed to provide the debtor and its non-debtor affiliates with all the benefits of bankruptcy — i.e., the multi-year stay of litigation that Garlock enjoyed — without any of the burdens of bankruptcy,” the article observed. “Because the debtor is a shell and not an operating company, the debtor does not need to reach a settlement, reorganize, or confirm a chapter 11 plan. In fact, to date, none of the Texas Two-Step cases have resulted in a negotiated settlement with tort claimants, nor have any of the Texas Two-Step cases resulted in a confirmable chapter 11 plan of reorganization.”

Read the full article here.