What You Need To Know Following the Supreme Court’s Recent Decision on Insurer Standing in Chapter 11 Cases

In Truck Insurance Exchange v. Kaiser Gypsum Company, Inc.,¹ the U.S. Supreme Court recently held that an insurer with financial responsibility for claims against a debtor, and who may directly and adversely be affected by the debtor’s bankruptcy, qualifies as a “party in interest” entitled to participate in the debtor’s Chapter 11 case. Prior to Kaiser, courts routinely employed the “insurance neutrality doctrine” to bar insurers from interjecting in the Chapter 11 plan process. Under the doctrine, a Chapter 11 plan was generally considered “insurance neutral” if it did not increase the insurer’s pre-petition obligations or impair the insurer’s pre-petition policy rights. If the plan was “insurance neutral,” courts held that insurers did not have standing to object to plan confirmation, except to dispute whether the plan was insurance neutral.

Kaiser rejected the insurance neutrality doctrine, broadly expanding the rights of insurers to participate in their insureds’ Chapter 11 cases. Going forward, to be heard in Chapter 11 cases, insurers no longer need to establish that the insured debtor’s reorganization efforts impact the insurer’s pre-petition obligations. Instead, to participate and raise objections in a Chapter 11 case, insurers need only show that they have financial responsibility for bankruptcy claims and will suffer a direct and adverse impact as a result. The decision will give insurers, sureties, and other third parties who are financially responsible for claims against the debtor more opportunity to protect their interests in a debtor’s Chapter 11 case.

Background

The unique nature of asbestos-related injuries, which can take up to 40 years to manifest, provides challenges as to the scope and timing of future liability resulting from asbestos exposure. To address this issue, Congress enacted Bankruptcy Code section 524(g). Section 524(g) allows a debtor with asbestos-related liability to channel those liabilities to a trust for the benefit of present and future claimants.² Section 524(g) applies exclusively to asbestos-related bankruptcies and enjoins claims against the reorganized debtor following the plan effective date and establishment of the trust.³ To establish an asbestos trust, certain conditions specified in the statute must be met, including: ensuring current and future claims are treated substantially the same, appointing a “legal representative for the purpose of protecting the rights of persons that might subsequently assert [asbestos-related] demands,” and requisite approval from 75% of present asbestos claimants voting on the plan.⁴

Kaiser Gypsum Company and Hanson Permanente Cement (together, the Debtors) manufactured and sold products containing asbestos. Facing thousands of lawsuits as a result, the Debtors commenced their Chapter 11 cases to address current and potential future asbestos-related liabilities. Prior to the petition date, the Debtors and their primary insurance carrier, Truck Insurance Exchange (Truck), executed a contract that obligated Truck to defend each asbestos-related personal injury claim and pay up to $500,000 per claim.⁵ In their Chapter 11 cases, the Debtors proposed a plan of reorganization (the Plan) that included a Bankruptcy Code section 524(g) trust (the Trust) to address their present and future asbestos-related liabilities. The Plan distinguished between insured and uninsured claims, providing that insured claims must be brought in the tort system and uninsured claims must be brought directly to the Trust. Moreover, the Plan required that claims brought directly to the Trust must fulfill certain disclosure requirements, including: (a) disclosing all claims relating to the alleged asbestos injuries; (b) allowing the Trust to obtain a claimant’s submissions to other asbestos trusts; and (c) authorizing audits to ensure the accuracy of information provided and claims paid by the Trust. These disclosure requirements — a common fraud-prevention measure used in Bankruptcy Code section 524(g) trusts — were designed to protect against duplicative or inflated recoveries. However, the Plan’s disclosure requirements only applied to uninsured claimants, not to insured claimants.

Truck objected to the Plan, asserting that it was not proposed in good faith, was a result of a “collusive agreement between the Debtors and claimant representatives,”⁶ and provided for disparate treatment between insured and uninsured claims. Truck further asserted that the Plan should not be confirmed because the Trust did not comply with various provisions of Bankruptcy Code section 524(g), including the requirement to deal equitably with claims and future demands.

The District Court for the Western District of North Carolina confirmed the Plan, holding that “Truck ha[d] limited standing to object to the Plan solely on the grounds that the Plan is not insurance neutral.”⁷ Truck appealed and the Fourth Circuit affirmed the District Court’s decision, holding that the Plan was “insurance neutral” because it neither increased Truck’s prepetition obligations nor impaired its rights and therefore lacked standing to challenge the Plan.⁸ Truck appealed to the Supreme Court.

The Supreme Court Expands When Insurers Have Standing to Participate In Their Insureds’ Chapter 11 Cases, Rejecting the Insurance Neutrality Standard in Evaluating Insurer Standing

Bankruptcy Code section 1109(b) provides that a “party in interest” possesses a statutory right to appear and be heard in Chapter 11 cases, including the ability and opportunity to object to plan confirmation. The Bankruptcy Code provides a non-exhaustive list of parties who qualify as a “party in interest,” including the debtor, the trustee, a creditors’ committee, an equity security holders’ committee, a creditor, an equity security holder, or any indenture trustee. Generally, courts have broadly construed the meaning of “party in interest.”⁹ However, this broad interpretation has not been extended to insurers to the extent the plan is “insurance neutral.”¹⁰ Plans are generally considered “insurance neutral” where they do not “materially alter the quantum of liability that the insurers would be called to absorb.”¹¹

Recently, however, the Supreme Court considered whether “party in interest,” as used in Bankruptcy Code section 1109(b), includes a debtor’s insurer and held that an insurer qualifies as a “party in interest” if the insurer with financial responsibility may be directly and adversely affected by the plan of reorganization.¹² In reaching its decision, the Supreme Court examined the plain text, the historical context, and the purpose of Bankruptcy Code section 1109(b) and rejected the limited scope of the insurance neutrality doctrine which had been applied by lower courts.

First, the Supreme Court acknowledged the “capacious” nature of Bankruptcy Code section 1109(b), noting that the parties listed in the statute are “illustrative but not exhaustive.” However, according to the Court, the parties in interest listed in section 1109(b) share a common trait — each have a financial interest in the estate’s assets and therefore may be directly impacted by a plan. Looking to the ordinary meaning of the terms “party” and “interest,” the Court held that “party in interest” refers to entities potentially concerned with or affected by a proceeding, including insurers with financial responsibility for the debtor.¹³

Second, the Court considered the historical context of the statute. Before the Bankruptcy Code’s enactment, the Bankruptcy Act of 1898 provided that only debtors enjoyed the right to be heard on all issues. In contrast, creditors possessed limited rights and could only be heard on certain issues. However, Congress later passed the Bankruptcy Act of 1938, amending the law to allow for creditors to be heard on all matters. When Congress enacted the existing Bankruptcy Code in 1978, it expanded the right to be heard in bankruptcy proceedings to include “parties in interest” “to promote greater participation in reorganization proceedings.”¹⁴ As a result, the Court held that the progression of the law to include the participation of more parties supports the contention that the term “parties in interest” extends to an insurer.

Finally, the Court addressed the purpose of statute. Section 1109(b) aims to promote a fair and equitable reorganization process. According to the Court, Congress included section 1109(b) to prevent plans that only benefit the debtors, major creditors, or insiders from being confirmed. In doing so, Congress sought to expand the meaning of “party in interest” to include “a broad range of individual and minority interests to intervene in Chapter 11 cases” and prevent “dominant interests” from controlling the process.¹⁵ Therefore, the Court held that including those with a financial responsibility for bankruptcy claims, i.e., insurers, as “parties in interest” would be consistent with the statute’s purpose and should be permissible.

Since Truck faced financial responsibility for much of the Debtors’ asbestos-related liabilities funneled into the Trust, the Court reasoned that Truck could be directly and adversely affected by the Plan, qualifying it as a “party in interest.” While the Fourth Circuit focused on whether Truck’s contract rights or “quantum of liability” were altered, the Supreme Court observed that the insurance neutrality doctrine conflates the merits of an insurer’s objection with the threshold question of whether the insurer qualifies as a “party in interest.” Instead, according to the Court, the proper inquiry is whether a debtor’s Chapter 11 case might affect a prospective party (not whether the Chapter 11 will affect the party’s quantum of liability).

Conclusion

Kaiser’s impact will be felt in future mass tort bankruptcies and beyond, such as in cases involving the settlement of claims against the debtors’ estates with payments to be made on the debtors’ behalf by third parties financially responsible for those claims. Insurers, sureties, indemnitors, and other third parties with financial responsibility for claims against the debtors, as the debtors’ piggybank, now have a right to be heard concerning a debtor’s Chapter 11 plans if the plan has a real economic impact on them — and those financially responsible third parties will no doubt push for a bigger seat at the table to protect their interests. Going forward, insurers, sureties, indemnitors, and other similarly situated financially responsible third parties should monitor bankruptcies that implicate them and analyze the plans filed in those cases to ensure that claims against the debtor are being equitably treated. Future mass tort and other debtors should also consider the interests of their insurers and other financially responsible third parties and involve them in the early stages of negotiation concerning a bankruptcy plan to build consensus and prevent delays to confirmation and exit.

© Arnold & Porter Kaye Scholer LLP 2024 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.