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February 2012

In re Thorpe Insulation Company - Insurers Have Standing to Challenge Asbestos Debtor Insured's Bankruptcy Reorganization Although Federal Law Preempts Policy's Anti-assignment Clause

(January 24, 2012) __ F.3d ___ ; 12 C.D.O.S. 939

The federal Ninth Circuit Court of Appeals reversed a district court's finding that non-settling insurers lacked standing to challenge an asbestos debtor insured's reorganization plan under 11 U.S.C.§ 524(g).  The Ninth Circuit found the plan has a financial impact on the insurers despite the bankruptcy court's decision the plan was "insurance neutral."  The Ninth Circuit also held the appeal was not moot even though the plan was already in force and operational.  However, the Ninth Circuit held California law upholding a policy's anti-assignment clause is preempted by federal bankruptcy laws.

Thorpe Insulation Company and its related companies ("Thorpe") distributed, installed and repaired asbestos insulation products.  Thorpe faced over 12,000 suits from plaintiffs over asbestos exposure claims.  Thorpe's insurers defended and settled many of the suits, paying more than $180 million in settlement before allegedly exhausting their aggregate limits.

Thorpe brought a state court action against its insurers alleging non-aggregate limits for "operations" claims remained under their policies.  Many insurers settled with Thorpe with the settlement proceeds being used to fund a trust established in a separate Chapter 11 bankruptcy proceeding that Thorpe filed pursuant to section 524(g).

Thorpe obtained bankruptcy court approval for its reorganization plan.  Non-settling insurers attempted to challenge the plan but were denied standing by the bankruptcy court.  Among other things, the plan purported to be insurance neutral and preserve all defenses of the non-settling insurers.  The non-settling insurers disagreed alleging the plan economically impacted them and, by allowing Thorpe to assign their policies to the trust, violated anti-assignment provisions in the polices. 

The district court confirmed the plan in September 2010.  The plan became effective and operational on October 22, 2010 and the trust began paying claims. 

The non-settling insurers sought an emergency stay challenging the plan which was denied.  They later appealed.  The Ninth Circuit reversed and remanded.

Standing

To have standing in bankruptcy court, a party must meet three requirements: (1) be a "party in interest" under 11 U.S.C.§ 1109(b) of the bankruptcy code; (2) have a traceable interest in the outcome as required by Article III of the U.S. Constitution; and (3) meet the federal court's prudential ("zone of interest") test.

The Ninth Circuit found the insurers met the "party in interest" requirement agreeing  with the insurers the plan could have a negative financial impact on them under several scenarios.  The plan vests the trustee with power to make liability decisions without input from the insurers on the reasonableness of the trustee's decision.  The plan authorizes the trustee to order claim payments from the insurers that may be higher than what they would pay absent the plan. 

The plan restricts the insurers' contractual right to seek reinsurance against settling insurers as well as impacting their potential to recover litigation costs in the event the plan's trust were to become insufficiently funded.  Finally, the plan allows asbestos claimants to file suits against the insurers, direct evidence the insurers are a party in interest to the bankruptcy proceeding. 
 
The Ninth Circuit also found the insurers met the constitutional and prudential standing requirements because they were able to show: (1) an injury in fact traceable to the challenged action; and (2) that they were within the prudential zone of interest as they were subject to the plan's payment structure.

Mootness

The Ninth Circuit rejected Thorpe's argument the appeal was moot since the plan was already operational and had begun to pay claims.  The Ninth Circuit held the appeal was not constitutionally moot because an appellate court was able to give effective relief to the insurers by reversing the plan confirmation or requiring modification of the plan to address the insurers' legitimate economic and contractual concerns.  (See Felster Publ'g v. Burrell (In re Burrell), 415 F.3d 994, 998 (9th Cir. 2005)).

The Ninth Circuit next held that the appeal was not equitably moot looking at four factors, whether: 1) the insurers sought a stay to fully protect their rights; 2) if sought but not gained, was the plan substantially consummated; 3) what effect would a remedy have on third parties not before the court; and 4) whether the bankruptcy court could fashion effective equitable relief without it being too unwieldy. 

The Ninth Circuit concluded the insurers satisfied these factors. The insurers had actively pursued their rights by seeking a stay that was refused by the Ninth Circuit and district court.  The plan had not been substantially consummated because only $135 million of the $600 million in settlement proceeds had been transferred to the trust with only a portion of trust proceeds distributed to claimants.  The bankruptcy court could fashion a remedy that adequately protects the rights of all parties.  The bankruptcy court could also modify the plan and devise a remedy that addressed the relief sought by insurers.

The Ninth Circuit held that the plan itself could not be overturned.  However, the plan could be modified to address the remedies sought by the non-settling insurers in a manner that was equitable to all the affected parties.   The Ninth Circuit listed the following potential modifications as examples.  First, Thorpe could be ordered to contribute more to the trust.  Second, the plan could be amended to make clear that trust distribution procedures were not binding on direct suits filed against the non-settling insurers.  Third, the bankruptcy court could allow the non-settling insurers to present evidence and argue for modification of the trust distribution procedure.  Finally, the bankruptcy court could place the trust under new governance if the non-settling insurers were able to show the trust was in the hands of biased parties.
 
Preemption

The Ninth Circuit upheld the district court's ruling that federal bankruptcy law preempted state law on the insurers' anti-assignment clause issue.  The bankruptcy code provides that a debtor's property becomes the property of the estate notwithstanding a contract provision that restricts transfer of the debtor's interest.  (11 U.S.C. § 541(c).)  This provision expressly contemplates the inclusion of a debtor's insurance policy in the bankruptcy estate.  The federal law conflicts with California law, which allows an insurer to enforce an anti-assignment clause requiring its consent before an insured may assign or transfer policy rights.  (Henkel Corp. v. Hartford Accident and Indemnity Co., 29 Cal. 4th 934, 944 (2003).)   The Ninth Circuit found that Congress expressly intended bankruptcy laws to preempt insurance policy anti-assignment rights, thus making the clause unenforceable.

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This opinion is not final.  It may be modified on rehearing or review may be granted by the United States Supreme Court.  These events would render the opinion unavailable for use as legal authority.

This and other case bulletins, as well as other publications of Gordon & Rees LLP, may be found at www.gordonrees.com.

Insurance

Arthur Schwartz


Insurance

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