Bankruptcy Court Holds Third-Party Successor Liability Claims Are Estate Property and Debtors May Pursue or Settle Those Claims for All Creditors

The Bankruptcy Court for the District of New Jersey recently held that third-party successor liability tort claims against various successors in interest (collectively, the Successors) to Whittaker, Clark & Daniels, Inc. and its affiliates (collectively, the Debtors) stemming from the Debtors’ production and sale of talc are property of the bankruptcy estate, and may not be asserted by third-party claimants against the Successors.¹ This decision adopts an expansive view of the bankruptcy estate insofar as such third-party successor claims would not otherwise be assertable by the Debtors in the absence of the bankruptcy case. While the result deprives third-party litigants of the ability to pursue their own claims against successors to the Debtors’ prior business, it affords the Debtors the ability to pursue or settle successor liability claims on an aggregate basis for the benefit of all creditors.

Background

The Debtors formerly operated one of the largest talc and industrial compound supply and distribution businesses in the United States. They sold their operational assets in 2004 to the Successors. Following the sale, the Debtors’ operations were limited to managing alleged asbestos and environmental liabilities.

On April 26, 2023 (the Petition Date), the Debtors filed for protection under Chapter 11 of the Bankruptcy Code to address (1) existing and future tort claims against the Debtors alleging injuries resulting from exposure to products containing talc, asbestos, or chemical compounds processed or distributed by the Debtors or their predecessors (the Asbestos Claims); (2) environmental litigation against the Debtors relating to the production or handling of hazardous materials which allegedly contaminated certain properties (the Environmental Claims, and together with the Asbestos Claims, the Tort Claims); (3) claims against certain non-Debtor entities seeking to establish such entities’ liability for Tort Claims on any grounds, including, without limitation, that such entities are successors to, or alter egos of, the Debtors (the Successor Liability Claims); and (4) indemnification or contribution claims against the Debtors with respect to any Successor Liability Claim (the Indemnification Claims). Indeed, as of the Petition Date, more than 1,000 lawsuits were pending against one or more of the Debtors and the Successors. The majority of the Successor Liability Claims at issue in Whittaker were based on the Product Line Exception, although some were based on the Mere Continuation Exception.²

The Debtors hoped that the automatic stay triggered by the commencement of their bankruptcy cases would provide the requisite breathing spell to negotiate and implement a consensual and comprehensive resolution of their liabilities. Instead, the commencement, continuation, and settlement of Successor Liability Claims against the Successors continued during the bankruptcy proceeding, resulting in an increased number of Indemnification Claims. As a result, on September 7, 2023, the Debtors commenced an adversary proceeding against the Successors and current and prospective talc plaintiffs, seeking, among other things, a declaration that the talc plaintiffs’ Successor Liability Claims are property of the Debtors’ estates and therefore the Debtors alone — not individual talc plaintiffs — possess standing to pursue the claims on behalf of all creditors. The following day, on September 8, 2023, the Debtors moved for summary judgment on their request for declaratory relief.

Property of the Debtors’ Bankruptcy Estate Includes Third-Party Claims Against the Successors

After a company files for bankruptcy, “creditors lack standing to assert claims that are property of the estate.”³ The “estate,” as defined in section 541 of the Bankruptcy Code, includes, among other things, “all legal or equitable interests of the debtor in property as of the commencement of the case.” The Third Circuit’s Emoral⁴ decision addressed whether property of the debtor’s estate under § 541(a)(1) includes successor liability claims asserted by creditors pursuant to the Mere Continuation Exception, and held that it does. Courts interpreting Emoral have further held more generally in assessing whether creditor claims constitute estate property that: (1) the claim must exist at the commencement of the bankruptcy filing and be one that the trustee could have asserted on his own behalf under applicable state law and (2) the claim must be general, with no particularized injury arising from it.⁵

Applying § 541(a)(1) and Emoral, Whittaker held that Successor Liability Claims brought pursuant to the Mere Continuation Exception belong to the Debtors’ estates “by their very nature, as they seek to hold non-debtor entities indirectly liable for the debtors’ tort liabilities, rather than remedy a harm that a Tort Claimant or creditor can directly trace to a non-debtor third party.” As a result, “[t]here can be little dispute that the bulk of such claims” fall within the scope of property of the estate under § 541(a)(1).⁶ According to Whittaker, “[t]he more challenging inquiry, by far, is whether such claims not expressly considered in Emoral can or should be seen through the same lens,” including Successor Liability Claims brought pursuant to the Product Line Exception.

The Debtors would not have been able to assert the Successor Liability Claims prior to the commencement of their Chapter 11 cases because there was no statutory, contractual, or common law basis for the Debtors retaining such claims. The commencement of a bankruptcy case, however, creates a bankruptcy “estate” that is endowed with certain rights a debtor would not otherwise have outside of bankruptcy. One such right is in § 541(a)(7), which provides that property of a debtor’s estate includes “[a]ny interest in property that the estate acquires after the commencement of the case,”⁷ including rights and powers acquired by the estate by virtue of the Bankruptcy Code, including § 544(a)(1).⁸

Bankruptcy Code § 544 provides that:

[t]he trustee [or debtor-in-possession] shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by [a hypothetical lien creditor.]

Focusing on the word “or” in § 544(a)(1), Whittaker held that § 544 unambiguously allows a trustee or debtor-in-possession to either “avoid a transfer or exercise the rights and powers of a hypothetical lien creditor” to bring claims, such as Successor Liability Claims.⁹ Whittaker followed a minority position and rejected the Official Committee of Talc Claimants’ (the Committee’s) and Future Claimants Representative’s argument (and the majority view) that § 544(a) applies only to avoidance claims and not other state law causes of action such as successor liability claims.

Having determined that § 544(a) may serve as a basis for a trustee’s or debtor-in-possession’s assertion of successor liability claims as a hypothetical lien creditor and that such claims constitute estate property under § 541(a)(7), the Bankruptcy Court turned to Emoral and addressed whether the Debtors could assert the specific claims at issue, i.e., Successor Liability Claims brought under the Product Line Exception and/or California state law.

Applying the second Emoral prong (whether the Successor Liability Claims stem from particularized and direct harm or whether the harm caused was general), Whittaker held that “direct claims are based upon a particularized injury to a third party that can be directly traced to a non-debtor’s conduct”¹⁰ and because the Successor Liability Claims at issue could not be traced to the Successors, but rather were based solely on the Debtors’ conduct, application of the second Emoral prong supported a finding that the talc plaintiffs’ claims were property of the Debtors’ estate. Notably, Whittaker failed to address that certain successor liability claims are necessarily dependent on the conduct of successors. Turning to Emoral’s first prong (whether the Successor Liability Claims existed as of the Petition Date and could have been asserted by the trustee/debtor under applicable state law), Whittaker held that “it is of no moment that the Debtors do not possess a state law right to pursue certain Successor Liability Claims” and further held that because “544(a)(1) affords the Debtors the opportunity to pursue any claim that a hypothetical creditor could bring for the benefit of all creditors,” the first Emoral prong had been satisfied.

Implications and Update

Whittaker and §§ 541(a)(7) and 544(a)(1) provide that debtors stand in the shoes of their hypothetical lien creditors and alone may bring any claims against third-party defendants that their hypothetical lien creditors could bring under state law, provided that such claims existed as of the petition date and resulted in general, non-particularized harm to the debtors’ creditors.

This decision provides an avenue for defendants in the future to argue that under certain circumstances, claims asserted against them by third-party plaintiffs who are also creditors of a debtor’s estate should have such claims dismissed for lack of standing. What is more, application of this decision may result in third-party plaintiffs losing control of their third-party claims; instead giving a debtor the authority to determine (1) whether to pursue such claims; (2) under which theories to pursue them; (3) on whose behalf they will be pursued; (4) the damages requested; and (5) whether and for how much to settle or release such claims. Notably, the standard for approval of a debtor’s settlement in a bankruptcy case is fairly deferential (i.e., the lowest range of reasonableness).

Since the Bankruptcy Court issued Whittaker, two new developments have occurred. First, the Debtors and the Successors reached a settlement consisting of a $535 million contribution by the Successors to resolve talc claims. The Debtors’ valuation expert estimates total liabilities for all talc claims will be between $474 and $571 million and nothing in the settlement will prohibit claimants from pursuing any other direct claims they might have, prohibiting only the Successor Liability Claims.¹¹ A hearing on the settlement is scheduled to take place in December. Opposition is anticipated.

Second, the Committee filed a notice indicating its intent to appeal Whittaker to the District Court for the District of New Jersey and then, following a joint request by the Committee, the Debtors, and the Successors, the Bankruptcy Court entered an order certifying direct appeal to the Third Circuit. The request for a direct appeal to the Third Circuit remains pending. The Bankruptcy Court’s decision in Whittaker is arguably a response to Purdue’s¹² limitations on non-consensual third-party releases as it allows a debtor and its bankruptcy estate to effectively grant a de facto non-consensual third-party release in respect of those causes of action that fall within the scope of sections 541 and 544 of the Bankruptcy Code. We will continue to follow this case and provide further updates on any material developments. It will be interesting to see if Purdue’s limitation on third-party releases causes the Third Circuit to re-evaluate its approach to claims of this type.

© 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.