MUCH-WATCHED CALIFORNIA CASE FINDS APPELLATE COURT OVERRULING POLICYHOLDER VICTORY AT TRIAL COURT LEVEL. ADOPTION OF SECTION 524(g) PRE-PACKAGED ASBESTOS BANKRUPTCY DOES NOT AUTOMATICALLY TRIGGER OR ACCELERATE COLLECTABILITY OF ASBESTOS-DEFENDANT POLICYHOLDER'S LIABILITY INSURANCE COVERAGE
Fuller-Austin v. Highlands Insurance Co. 135 Cal. App. 4th 958, 38 Cal. Rptr. 3d 716 (California Court of Appeal, 2d District, Jan. 19, 2006)
A California Court of Appeal panel (courts of appeal in California and elsewhere typically sit in panels of three judges) has reversed a ruling holding that liability insurers of an asbestos company had immediate obligations to perform in full once a trust was established through Section 524(g) of the bankruptcy code (11 U.S.C. §524(g)) that concurrently extinguished the liability of the policyholder vis-a-vis the asbestos claimant creditors. See Fuller-Austin v. Highlands Ins., 135 Cal. App. 4th 958, 38 Cal. Rptr. 3d 716 (Cal. App. Jan. 19,2006). (The California Court of Appeal is divided into districts for administrative purposes. The Second District encompasses Los Angeles, location of the trial of the Fuller-Austin case.) The "acceleration" of insurers' obligations that these §524(g) trusts might create has caused apoplexy (Marc's word; Jeff agrees; Randy thinks "great concern" is a more accurate description) in the insurance industry. The Fuller-Austin trial court had ruled that the creation of the trust meant the insurers had immediate obligations to perform for the total (nonbankruptcy) value of the future claim stream. When the Court of Appeals reversed, this no doubt produced a collective sigh of relief from the insurance industry (and their reinsurers).
There are two bankruptcy elements in these modern asbestos-driven bankruptcies that, when combined with prior rulings of courts dealing with bankruptcy effects on insurance, yielded an extraordinary result: obligations of insurers to pay the future asbestos obligations of the policyholder-debtor immediately and in full. Before turning to the Fuller-Austin decision itself, it is important to understand what debtors like Fuller-Austin were trying to achieve.
The first step in an asbestos-driven bankruptcy is to take the asbestos claims stream and estimate its value. The debtor then needs to satisfy this creditor claim in the bankruptcy. The debtor does this by setting up a trust and funding it with cash (from itself and sometimes its corporate parent), stock, and pre-existing insurance rights (under policies held by the debtor for years in which asbestos injury took place).
After establishing the trust, the debtor receives a channeling injunction that bars the assertion of any asbestos-related claim against itself (and sometimes against nondebtors (see Susan Powers Johnston and Katherine Porter, Extension of section 524(g) of the Bankruptcy Code to Nondebtor Parents, Affiliates, and Transaction Parties, 59 BUSINESS LAWYER 511-12 (2004)), and the injunction further funnels all claims to the trust. In other words, by paying "up front" to establish the trust, the debtor is able to emerge from bankruptcy shorn of its asbestos liabilities without fear of any future claims. The trust in turn is charged with resolving the asbestos claims and sets up an administrative compensation process, usually with relaxed standards of proof, to "adjudicate" the tort claims. The claimant may have the right further to bring an action in court, though punitive damages are typically barred.
This is the model that was used in the Johns-Manville bankruptcy. The model was confirmed, expanded, modified, and codified by Congress in 1994 when the bankruptcy code was amended with the addition of Section 524(g) (11 U.S.C. §524(g)), a provision specially designed to deal with asbestos-driven bankruptcies. While certain procedural and substantive changes were implemented in §524(g), from the debtor's perspective one key was that §524(g) made clear that future claims (claims by persons exposed to asbestos but who at the time of the bankruptcy filing had no legal claim) would have their claims channeled to the trust as well. …