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Third Circuit Sets Standard for Appointment of Future Claims Representatives in Asbestos Bankruptcy Cases

Unlike professionals retained in a chapter 11 case by trustees, debtors, or official committees, the Bankruptcy Code provides little guidance regarding the appointment of a representative for "future claimants" in a chapter 11 case involving the establishment of a trust to pay the claims of asbestos creditors. Only a handful of court rulings have addressed this question, and until recently, no circuit court of appeals had weighed in on the issue. 

The U.S. Court of Appeals for the Third Circuit considered the question as a matter of first impression in In re Imerys Talc America, Inc., 38 F.4th 361 (3d Cir. 2022). The court ruled that a future claims representative ("FCR") in an asbestos case must be more than merely a "disinterested person"—the standard applied to some other professional retentions in bankruptcy. Instead, like the members of official creditors' committees, an FCR must be not only free of conflicts of interest, but also fulfill fiduciary duties to future claimants, including duties of undivided loyalty and honesty.

Retention of Professionals in Bankruptcy Cases

Bankruptcy trustees or chapter 11 debtors-in-possession ("DIPs") are permitted to retain a wide variety of professionals, including lawyers, accountants, auctioneers, and investment bankers "that do not hold or represent an interest adverse to the estate, and that are disinterested persons" to represent them in connection with a bankruptcy case. 11 U.S.C. § 327(a). A professional is not disqualified from such employment solely because the professional has represented a creditor, unless another creditor or the U.S. Trustee objects to the retention, and the court concludes that the professional has an actual conflict of interest. See 11 U.S.C. § 327(c). Under section 327(e), a trustee or DIP may also retain a lawyer that has previously represented the debtor for a "special purpose" other than acting as general bankruptcy counsel (e.g., in connection with discrete litigation, real estate, or labor matters).

Section 101(14) provides that the term "disinterested person" means a person that—

(A) is not a creditor, an equity security holder, or an insider;

(B) is not and was not, within two years before the date of the filing of the petition, a director, officer, or employee of the debtor; and

(C) does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason.

Under section 328(c), a court may deny compensation for services if, during a professional's employment by the estate, the professional "is not a disinterested person, or represents or holds an interest adverse to the interest of the estate with respect to the matter on which such professional person is employed."

Pursuant to section 1103(a) of the Bankruptcy Code, official committees appointed in a chapter 11 case may also, with court approval, retain professionals to perform services on their behalf. Any such professional may not represent any other entity having an interest adverse in connection with the bankruptcy case. However, representing one or more of the committees' constituent creditors does not per se represent an adverse interest. See 11 U.S.C. § 1103(b).

The Bankruptcy Code does not specify a standard to be applied to the retention of an FCR in a chapter 11 case involving the creation of a trust to pay present and future asbestos claims.

Asbestos Trusts in Bankruptcy

Section 524(g) of the Bankruptcy Code establishes a procedure for dealing with future personal injury asbestos claims against a chapter 11 debtor. The provision was added to the Bankruptcy Code in 1994 in the wake of the historic Johns-Manville and UNR Industries chapter 11 cases, where the courts, relying on various Bankruptcy Code provisions, including a bankruptcy court's broad equitable powers under section 105(a), implemented procedures upon which section 524(g) was later patterned. See In re Johns-Manville Corp., 36 B.R. 743 (Bankr. S.D.N.Y. 1984); In re UNR Indus., Inc., 46 B.R. 671 (Bankr. N.D. Ill. 1985). The provision was enacted in response to lawmakers' concerns that a mechanism established in bankruptcy to pay asbestos claims could be depleted by the payment of present asbestos claims before future claimants manifest any signs of illness. Section 524(g) of the Bankruptcy Code, therefore, was designed to protect future claimants, while also recognizing that future asbestos claimants would be ill-served if asbestos companies are forced into liquidation.

Section 524(g) contemplates the creation of a trust under a chapter 11 plan to pay asbestos claims and the issuance of an injunction—sometimes referred to as a "channeling injunction"—to prevent asbestos claimants from suing the debtor and certain related parties, such as its insurance companies. All claims based upon asbestos-related injuries are channeled to the trust.

To safeguard the due process rights of future claimants, section 524(g)(4)(B) provides that the bankruptcy court must appoint "a legal representative for the purpose of protecting the rights of" future claimants in the chapter 11 case—i.e., an FCR. It further directs the court to determine that the terms of the injunction are "fair and equitable" with respect to future claimants in light of the benefits provided to the trust by the beneficiaries of the injunction. See 11 U.S.C. § 524(g)(4)(B)(i) and (ii).

However, unlike professionals retained by estate representatives under sections 327 and 1104, the Bankruptcy Code does not provide any guidance regarding the standard for selecting an FCR under section 524(g).

Some courts have used the "disinterested person" standard applied to professional retentions under sections 327(a) and 1104 in this context. See, e.g., In re Duro Dyne Nat'l Corp., 2019 WL 4745879, *7 (D.N.J. Sept. 30, 2019) (citing cases and adopting a disinterested person standard); Fed. Ins. Co. v. Grace, 2004 WL 5517843, *9 (D. Del. Nov. 22, 2004) (rejecting the "appearance of impropriety" disqualification standard in favor of the disinterested person standard).

Other courts have applied a more stringent "guardian ad litem" standard requiring a "legal representative" appointed under section 524(g) to be a fiduciary independent of the debtor and other parties in interest and able to act with undivided loyalty to future claimants. See, e.g., In re Fairbanks Co., 601 B.R. 831, 841 (Bankr. N.D. Ga. 2019) ("[An FCR] effectively undertakes the role of a guardian ad litem. Appointment of an FCR thus involves the same considerations as appointment of a guardian ad litem… . [T]he standard for appointing [an FCR] requires that the individual not only be disinterested and qualified; the [FCR] must also be capable of acting as an objective, independent, and effective advocate for the best interests of the future claimants. The Court must be satisfied that, like a guardian ad litem, an FCR will provide representation that is diligent, competent, and loyal.").

The Third Circuit addressed the question of which standard should apply to the appointment of an FCR as a matter of first impression in Imerys Talc.

Imerys Talc

Imerys Talc America, Inc. and its affiliates (collectively, the "debtors") mined, processed, and distributed talc to third-party manufacturers for their products. The debtors had been sued by more than 14,000 claimants asserting asbestos-related talc exposure claims by the time they filed for chapter 11 protection in February 2019 in the District of Delaware.

In anticipation of the bankruptcy filing, the debtors retained James Patton ("Patton"), a partner at the law firm of Young Conaway Stargatt & Taylor ("Young Conaway"), to serve as a "Proposed FCR" in pre-bankruptcy negotiations. Patton, who had worked for decades in mass-tort bankruptcies and has served as FCR in many asbestos cases, hired Young Conaway as his counsel.

After filing for bankruptcy, the debtors sought court approval to retain Patton as FCR for the future claimant beneficiaries of a proposed section 524(g) trust that formed the cornerstone of their chapter 11 plan. In his retention papers, Patton disclosed that Young Conaway represented various insurers (the "insurers") that had issued policies to the debtors or their predecessors in coverage disputes related to environmental liabilities, including asbestos claims, "but unrelated to talc claims or the Debtors." In particular, Patton stated, Young Conaway represented two of the insurers—National Union Fire Insurance Company of Pittsburgh, PA ("National Union") and Continental Insurance Company ("Continental")—in a lawsuit filed in Delaware in 2010 involving coverage for asbestos-related injury claims (the "Delaware litigation"). Both National Union and Continental signed prospective conflict of interest waivers as part of Young Conaway's representation of them in the litigation.

None of the insurers objected to Patton's retention as FCR or to Patton's retention of Young Conaway on the basis of Young Conaway's involvement in the Delaware litigation. Instead, the insurers filed a limited objection to Patton's employment based on his pre-bankruptcy engagement as Proposed FCR, which they argued raised questions about his independence from the debtors.

The bankruptcy court, however, raised the Delaware litigation as a potential conflict of interest. In its initial May 2019 ruling approving Patton's retention as FCR, the court rejected the insurers' argument that Patton's prepetition employment as Proposed FCR undermined his independence, but expressed concerns about Patton's personal involvement in the Delaware litigation. The court directed Patton to provide additional information on that issue, and ultimately approved his retention as FCR, stating that "the standard for approval of a legal representative under section 524 is that he must be independent of the debtors and other parties-in-interest in the case and must be able to act with undivided loyalty to demand holders."

In his supplemental disclosure, Patton stated that National Union and Continental had signed prospective conflicts waivers for certain conflicts of interest that might arise out of Young Conaway's bankruptcy-related work. He also stated that he was not personally involved in the Delaware litigation and that Young Conaway had erected an "ethical wall" between Patton's FCR team and the firm's other insurance litigators.

Ten days after the bankruptcy court's initial ruling on Patton's retention application and two months after the objection deadline, the insurers filed an objection to Patton's appointment as FCR on the basis of an alleged conflict of interest arising from the Delaware litigation.

The bankruptcy court overruled the objection on its merits, concluding that the conflicts waiver was valid and that Patton satisfied the appointment standard articulated in its initial ruling.

The district court affirmed and the insurers appealed to the Third Circuit.

The Third Circuit's Ruling

A three-judge panel of the Third Circuit affirmed.

Writing for the panel, U.S. Circuit Judge Cheryl Ann Krause explained that, as an initial matter, the insurers other than National Union and Continental lacked standing to appeal because they were not involved in the Delaware litigation and were therefore not "persons aggrieved" by the bankruptcy court's decision. She also noted that it appeared the insurers were interposing their objection in a tactical bid to delay confirmation of the debtors' chapter 11 plan, which was "just the sort of bad-faith tactic" that the Third Circuit had cautioned against in its previous ruling in In re Congoleum Corp., 426 F.3d 675, 685–86 (3d Cir. 2005), where it addressed the "person aggrieved" standard in the context of an insurer's standing to object to the retention of special insurance counsel.

The Third Circuit panel also determined that the bankruptcy court correctly found that National Union and Continental waived their objections to Patton's retention. Even so, the court of appeals proceeded to address the merits of the appeal because, it said, the public interest would be better served by addressing arguments with "significant implications for bankruptcy law" and doing so would not prejudice the parties, who had fully briefed the issues before the bankruptcy court. Imerys Talc, 38 F.4th at 372.

The debtors and Patton argued that the "disinterested person" standard should apply to the retention of an FCR. The insurers advocated that the guardian ad litem test was more appropriate, but with the additional caveat that, in accordance with section 327(a), any actual conflict of interest should be per se disqualifying. In an amicus brief, the U.S. Trustee agreed with the bankruptcy court and the insurers that FCRs, like guardians ad litem, "should be held to the high standards applicable to fiduciaries who represent parties not before the Court." Id. at 374.

The Third Circuit ruled that "the FCR standard requires more than disinterestedness." According to Judge Krause, "[a]n FCR must be able to act in accordance with a duty of independence from the debtor and other parties in interest in the bankruptcy, a duty of undivided loyalty to the future claimants, and an ability to be an effective advocate for the best interests of the future claimants." Id. (footnote omitted).

The Third Circuit reached this conclusion after considering the text of the Bankruptcy Code and its legislative history, the standards traditionally applied to creditors' committees—which, the court explained, serve an analogous role in bankruptcy cases—and "the administrability of the fiduciary standard … in the bankruptcy context." Id. 

First, the Third Circuit reasoned, Congress specifically chose to use the "disinterested person" standard in 11 other provisions of the Bankruptcy Code, yet omitted it from section 524(g). Id. at 375 (citing 11 U.S.C. §§ 327(a), 328(c), 332(a), 333(a)(2)(A), 701(a)(1), 703(c), 1104(b)(1), 1104(d), 1163, 1183(a), 1202(a) and 1302(a)). This is not surprising, Judge Krause wrote, because the provisions containing the "disinterested person" standard "relate to professionals whose duties run to the entire estate or to the court, requiring that they remain impartial" and do not represent any adverse interest, whereas the FCR is the "'legal representative' for just such an adverse interest, having been appointed specifically 'for the purpose of protecting the rights of' future asbestos claimants." Id. (quoting 11 U.S.C. § 524(g)(4)(B)(i)). The Third Circuit accordingly concluded that this statutory omission "counsels against" adopting the disinterested person standard for the purpose of FCR appointments.

Next, the Third Circuit reasoned that lawmakers' usage of the term "legal representative"—a term of art referring to someone owing fiduciary duties to absent constituents—in section 524(g) indicates they anticipated an FCR should "be able to fulfill the heightened duties owed by fiduciaries" rather than being merely disinterested. Id. at 376.

According to the Third Circuit, the legislative history of section 524(g), which does not address the issue, provides little support for applying the disinterested person standard to FCR appointments. The court acknowledged that the courts in Johns-Manville and UNR applied "something like" the disinterested person standard in approving "proto-FCRs," and Congress amended section 524 three times after it was enacted without clarifying what the standard should be, even though some courts had already adopted the disinterested person standard.

The court noted that the Johns-Manville and UNR courts never explicitly applied the disinterested person standard, and the "legislative acquiescence argument … tells us nothing," particularly because the amendments to section 524 were "specific and targeted" rather than comprehensive. Id. at 377.

The Third Circuit looked for guidance to the standard governing the appointment of the members of a creditors' committee, "an analogous player in the bankruptcy process." Although section 1102(a)(2) of the Bankruptcy Code mandates only that a committee be "adequate[ly] representat[ive]" of its constituents, Judge Krause wrote, "courts have long required each committee member not only to be free of conflicts of interest but also to fulfill fiduciary duties to the committee's constituents, including duties of undivided loyalty and honesty." Id. (citing Collier on Bankruptcy ¶ 1103.05[2] (16th ed. 2021)). Because an FCR effectively functions as a "creditors' committee of one," the Third Circuit reasoned, "that standard is equally appropriate … [and] that is the standard we adopt today." Id. at 378.

According to the Third Circuit, "that standard does not herald a categorical approach to an FCR's appointment." It further explained that, as in the context of creditors' committee appointments, whether a conflict exists in connection with the appointment of an FCR is less relevant than the nature of the conflict and its importance to the interests of future claimants. The Third Circuit also cautioned that "we do not today prescribe any particular process the bankruptcy court must follow in making that appointment." Id. at 379. Provided the bankruptcy court has adequate information to assess a proposed FCR's qualifications, the court wrote, "variations in the appointment process are otherwise within the discretion of the bankruptcy court." Id. 

Having articulated the standard, the Third Circuit concluded that Patton satisfied it and was properly appointed as an FCR. The court emphasized that no one questioned Patton's qualifications, undivided loyalty, or ability to effectively advocate for future claimants. Instead, the insurers argued that Young Conaway's representation of National Union and Continental in the Delaware litigation was a direct conflict of interest that required disqualification and tainted Patton's independence and ability to be an effective advocate for future claimants.

The Third Circuit rejected these arguments. First, the court found that the bankruptcy court correctly ruled that National Union and Continental, as "sophisticated parties who were represented by both an agent and that agent's insurance counsel," waived this conflict with full knowledge "that there was a material risk that Young Conaway would be involved in the future in § 524(g) proceedings that would also involve insurance company creditors." Id. at 380. Second, the Third Circuit concluded that the insurers' argument that Patton could not be independent and an effective advocate because the Delaware litigation involved issues "substantially related" to the issues that might arise in the debtors' bankruptcy did not stand up to scrutiny. In a "typical conflicts analysis," Judge Krause explained, "substantially related" refers not to similar legal issues but to substantially related transactions, which was not the case here because there was not a "substantial risk" that Patton and Young Conaway would use any confidential information Young Conaway obtained during the Delaware litigation in the debtors' chapter 11 cases. Id. at 381.

Outlook

The Third Circuit's ruling in Imerys Talc is notable for a number of reasons. First, the decision provides guidance at the appellate level on a question that is largely bereft of precedent from bankruptcy and appellate courts in published or unpublished opinions. Second, recognizing that many of the bankruptcy and district courts in the Third Circuit "had settled on the disinterested standard from which we now depart," the Third Circuit carefully explained why it found the standard it adopted to be the most appropriate one to govern the appointment of an FCR in an asbestos chapter 11 case. Finally, according to the Third Circuit, the "mere existence" of a potential conflict is not per se disqualifying, but requires a bankruptcy court to undertake a more detailed analysis in exercising its broad discretion. 

In the Third Circuit, therefore, a higher standard than the "disinterested person" standard applies to the appointment of an FCR. It remains to be seen whether courts in other circuits will adopt this approach.

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