May 9, 2011 

By: Michael A. Hamilton and Michael Murphy

This article is an interpretation of current law and is offered for informational purposes only. This material is not legal advice and should not be construed or used as a substitute for the advice of an attorney.

The United States Court of Appeals for the Third Circuit issued an important ruling that will have consequences for both insureds seeking relief from asbestos and other mass tort claims through bankruptcy reorganization as well as the insurers who provide their liability coverage. In re: Global Industrial Technologies, 2011 WL 1662792 (3d Cir. May 4, 2011). The case involved an insured, Global Industrial Technologies, Inc., and certain related entities filing for Chapter 11 Bankruptcy resulting from, in part a staggering number of asbestos related claims pending against them.

At a Bankruptcy Court confirmation hearing, various insurers objected to the proposed plan on the basis that the silica injunction and the silica trust were the products of collusion between the insured and the asbestos claimants, and were neither necessary nor appropriate for the debtors' successful reorganization. However, the Bankruptcy Court determined that the insurers did not have standing to object to the plan, concluding that the insurers had suffered no injury, including the assignment of their policies into the silica trust, because the Bankruptcy Code and state law rendered the "anti-assignment" provisions in their policies a nullity. The Bankruptcy Court further reasoned that any potential financial harm arising out of the assignment of their policies was too speculative because the insurers would still be able to assert their coverage defenses and contractual rights if called upon to reimburse the trust for silica-related claims.

On appeal, the insurers argued that they had a legally protected interest that could be affected by the plan because they were the "funding sources" that would have to address the liabilities of the silica trust, whereas the debtors argued that the plan was "insurance neutral" because it preserved the insurers' coverage defenses.

The Third Circuit openly questioned whether the plan could fairly be deemed "insurance neutral" given its promise of a silica trust appeared to have increased pre-petition liability exposure. The Third Circuit found that the plan's adverse effects on the insurers were not too speculative since the Supreme Court's decision in Clinton v. City of New York, 524 U.S. 417 (1998) established that an injury has a "contingent" aspect does not mean that the injury is not cognizable.

In its opinion, the Third Circuit was harshly critical of the appearance of a quid pro quo between the debtor-insured and the asbestos claimants' counsel in negotiating the silica channeling injunction and the creation of a trust to pay silica claims. In the words of the Third Circuit, the issue before the Court was whether the debtor sold out its insurers "by setting up a system in which they would pay for newly ginned-up silica claims" in exchange for the asbestos claimants casting their votes in favor of the bankruptcy reorganization plan. According to the Third Circuit, the insurers' credible allegations of collusion called into question the "integrity of the bankruptcy proceeding." In vacating the District Court's order, the Third Circuit specifically ordered the Bankruptcy Court, which had previously discounted the insurer's allegations of collusion between the debtor and counsel for the claimants, to make appropriate findings with respect to those allegations.

While the facts of this case are somewhat unique, the Third Circuit's decision is important for several reasons. First, it highlights a conflict that often arises in bankruptcy litigation where the resolution of large numbers of claims against an insured - to be funded by the insured's insurers - depends on the acquiescence of the individuals who are asserting claims against the insured. Second, it clarifies the test for determining whether an insurer has a "legally protected interest" for the purposes of standing under Article III of the Constitution. In this regard, the Court recognized that an insurer that is never required to provide indemnification may still suffer a cognizable injury where it incurs substantial administrative and/or investigative costs as a result of the insured's actions. Third, the Third Circuit's decision makes clear that a plan of reorganization that preserves the insurer's coverage defenses and contractual rights under its policies does not necessarily mean that the plan is "insurance neutral" for purposes of standing. Lastly, the Court acknowledged that in a situation where an insurer may be the only party sufficiently motivated to raise issues of possible collusion where the interests of the insured and the claimants align, the insurer has the right to be heard.

For further insight on insurance coverage issues, including the impact of policyholder bankruptcies on the insurance industry, please contact Michael A. Hamilton at 215.358.5172 or mhamilton@nldhlaw.com or Michael Murphy at 215.358.5113 or via email at mmurphy@nldhlaw.com.