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Bankruptcy and U.S. Supreme Court watchdogs awaiting dispositive resolution of a long-standing circuit split on the power of bankruptcy courts to enjoin litigation against nondebtors under a chapter 11 plan were in for a disappointment when the Supreme Court finally handed down its ruling on June 18, 2009, in two consolidated appeals involving asbestos-related claims directed against former chapter 11 debtor Johns Manville Corporation. 

The cases - The Travelers Indemnity Co. v. Bailey and Common Law Settlement Counsel v. Bailey - have a long and tortuous history spanning a quarter-century. Manville was the leading producer of asbestos products in the U.S. for more than 50 years, many of which resulted in asbestos-related illnesses. Escalating liabilities from a blizzard of asbestos litigation propelled Manville into chapter 11 in 1982. Manville’s primary insurer was Travelers, which, together with other insurance companies, ultimately provided most of the $850 million in funding for a plan of reorganization confirmed in 1986 that set up a trust to pay all asbestos claims against Manville. The chapter 11 plan and the bankruptcy-court order confirming it released Travelers and the other insurers from all liabilities and enjoined all litigation against Travelers based upon asbestos claims against Manville, channeling all such claims to the trust. Specifically, the confirmation order prohibited all persons from commencing any action against any of the settling insurance companies “for the purpose of, directly or indirectly, collecting, recovering or receiving payment of, on or with respect to any Claim . . . or other Asbestos Obligation.” Recognizing that the bankruptcy estate’s greatest asset was the insurance proceeds, the court’s injunction channeled to the trust any and all claims that were “based upon, arose out of, or related to” Manville’s insurance policies. The Second Circuit Court of Appeals upheld the confirmation order on appeal in 1988.    

Despite the injunction, asbestos plaintiffs in droves began suing the insurance companies directly in the years following confirmation of Manville’s chapter 11 plan, alleging that the insurers themselves had engaged in wrongdoing by failing to disclose the dangers of asbestos exposure. On Traveler’s request, the bankruptcy court enjoined all of the actions, and in 2004 the court issued an order clarifying that the scope of the injunction contained in its 1986 confirmation order extended to direct actions by asbestos claimants against Travelers—in effect, staying an action by one nondebtor against another nondebtor. The district court affirmed the ruling on appeal in 2006.

However, the Second Circuit reversed in 2008, concluding that the bankruptcy court lacked jurisdiction to enjoin direct action claims against Travelers and the other insurers. According to the Second Circuit, a bankruptcy court has jurisdiction only to enjoin third-party nondebtor claims that directly affect the rest of the bankruptcy estate. “The bedrock jurisdiction issue in this case,” the court of appeals remarked, “requires a determination as to whether the bankruptcy court had jurisdiction over the disputed statutory and common law claims.”

The Supreme Court agreed to hear the cases on December 12, 2008, to resolve a long-standing circuit split on the issue. The Court handed down its ruling on June 18, 2009. Unfortunately, the ruling does not resolve the controversy.

Delivering the majority opinion, from which two justices dissented, Justice David H. Souter reversed and remanded the Second Circuit’s decision, concluding that it was error for the court of appeals to reevaluate the bankruptcy court’s exercise of jurisdiction in 1986, when it entered the order confirming Manville’s chapter 11 plan. Direct action claims, Justice Souter explained, including actions brought under state consumer-protection statutes or common law alleging that Travelers conspired with other insurers and with asbestos manufacturers to hide the dangers of asbestos or failed to warn the public about the dangers of asbestos, are “policy claims” expressly enjoined by the bankruptcy court’s 1986 confirmation order. Moreover, he emphasized, whether the bankruptcy court had jurisdiction to enter the injunction in 1986 was not an issue properly before either the Second Circuit in 2008 or the Supreme Court. As a consequence, Justice Souter concluded that the Second Circuit erred in holding that the 1986 confirmation order was unenforceable because the bankruptcy court exceeded its jurisdiction. Once the order became final on direct review, Justice Souter explained, the parties and those in privity with them were bound by its terms under principles of res judicata.

Finally and most notably, Justice Souter noted that the court was not resolving whether a bankruptcy court in 1986, or today, could “properly enjoin claims against nondebtor insurers that are not derivative of the debtor’s wrongdoing,” or whether any particular party is bound by the 1986 orders, which is a question the Second Circuit did not consider. A channeling injunction of the sort issued by the bankruptcy court in 1986, Justice Souter explained, would have to be measured against the requirements of section 524(g) of the Bankruptcy Code, which Congress added in 1994 precisely to address this issue. Thus, the circuit split on this controversial and important issue continues.

Justice John Paul Stevens, joined by Justice Ruth Bader Ginsburg, dissented, concluding that the injunction bars “only those claims against Manville’s insurers seeking to recover from the bankruptcy estate for Manville’s misconduct, not those claims seeking to recover against the insurers for their own misconduct.”

In other bankruptcy-related matters, the Supreme Court agreed on June 8 to review an appeals-court decision from September 2008 that invalidated part of the 2005 bankruptcy reforms prohibiting lawyers from advising their clients to incur more debt in anticipation of a bankruptcy filing. In Milavetz, Gallop & Milavetz, P.A. v. U.S., the Eighth Circuit Court of Appeals ruled that new section 526(a)(4) of the Bankruptcy Code violates the First Amendment’s right to freedom of speech by preventing “attorneys from fulfilling their duty to clients to give them appropriate and beneficial advice.” In addition to this issue, the Supreme Court will decide whether the court of appeals correctly held that the 2005 amendments do not violate the First Amendment by requiring bankruptcy lawyers to identify themselves in their advertising as “debt relief agencies.” The case will be argued sometime after the Supreme Court begins its next term in October.

After granting a temporary stay of the bankruptcy court’s May 31 order approving the sale of the bulk of U.S. automaker Chrysler’s assets to a consortium led by Italian automaker Fiat S.p.A. on June 7, the Supreme Court on June 9, in an unsigned, two-page ruling, held that certain Indiana pension and construction funds failed to meet the standards for a stay pending appeal of the sale order. The court did not decide the merits of the attempted appeal and said the stay ruling applied to “this case alone.” 

On June 15, the Supreme Court agreed to hear a bankruptcy case addressing whether the Due Process Clause of the Fifth Amendment is violated if a chapter 13 debtor gives notice by mail to a lender that a student loan will be paid under a plan and then discharged, rather than commencing an adversary proceeding seeking a determination that the loan is dischargeable absent payment in full upon a showing of “undue hardship.”

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The Travelers Indemnity Co. v. Bailey, 129 S. Ct. 2195 (2009).

 

Milavetz, Gallop & Milavetz, P.A. v. U.S., 129 S. Ct. 2766 (2009).

 

U.S. v. Milavetz, Gallop & Milavetz, P.A., 129 S. Ct. 2769 (2009).

 

United Student Aid Funds Inc. v. Espinosa, 129 S. Ct. 2791 (2009).

 

Indiana State Police Pension Trust v. Chrysler LLC, 129 S. Ct. 2275 (2009). 

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