Bankruptcy Newsletter

Injunction Protecting Insurers Couldn't Be Attacked
On appeal from an order in which a bankruptcy court clarified its earlier orders enjoining lawsuits against insurers for a Chapter 11 debtor-asbestos manufacturer, the Court of Appeals could not reach the issue of whether the bankruptcy court had had subject matter jurisdiction to issue the earlier orders, the United States Supreme Court has ruled.

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On appeal from an order in which a bankruptcy court clarified its earlier orders enjoining new or continued lawsuits against the insurers for the Chapter 11 debtor-asbestos manufacturer, the Court of Appeals could not reach the issue of whether the bankruptcy court had had subject matter jurisdiction to issue the earlier orders, the United States Supreme Court has ruled. Under res judicata principles, the finality of the earlier orders, after direct review, precluded a jurisdictional challenge to the enforceability of the bankruptcy court's injunction, and the case did not present one of the rare instances in which jurisdiction could be collaterally attacked. In addition, the Supreme Court held that the injunctive provisions of the earlier orders precluded state-law claims against the insurer for its alleged wrongdoing in its role as insurer or for its alleged misuse of information obtained in that role.

The Chapter 11 debtor was generally acknowledged to have been the country's largest supplier of raw asbestos and manufacturer of asbestos-containing products from the 1920s to the 1970s. For much of that time, one insurer was the debtor's primary liability insurer. That insurer worked closely with the debtor to learn about and assess the dangers of asbestos exposure as asbestos began to be linked by studies to respiratory disease and lawsuits were filed against the debtor. When the debtor sought Chapter 11  protection in 1982, it was due to the prospect of overwhelming asbestos-related liability.

The focus in the debtor's bankruptcy case was the formation of a reorganization plan providing for payments to holders of present and future asbestos-injury claims. The plan formulated created a personal injury settlement trust to pay all asbestos claims against the debtor, which were to be channeled to the trust. Prior to the debtor's reorganization, litigation arose between the debtor and its insurers, the debtor's primary insurer was sued by third parties seeking compensation under the debtor's insurance policies, and the insurers litigated among themselves. A settlement was reached under which the insurers were to provide most of the settlement trust's initial corpus, with a $770,000,000 payment to the bankruptcy estate, $80,000,000 of which was paid by the primary insurer.

This payment, the Supreme Court explained, would not have occurred but for the challenged injunction. The bankruptcy court approved the insurance settlement agreements in 1986, entering an order which provided that, upon the settling insurers' payment of the settlement funds to the trust, "all Persons are permanently restrained and enjoined from commencing and/or continuing any suit, arbitration, or other proceeding of any type or nature for Policy Claims against any or all members of the Settling Insurer Group." The order defined "Policy Claims" as including "any and all claims, demands, allegations, duties, liabilities and obligations (whether or not presently known) which have been, or could have been, or might be, asserted by any Person against...any or all members of the Settling Insurer Group based upon, arising out of or relating to any or all of the Policies." The insurance settlement order was incorporated by reference in the plan confirmation order, and both orders were affirmed on direct appeal by the district court and the Second Circuit Court of Appeals.

More than a decade later, plaintiffs started filing actions against the debtor's primary insurer in various state courts, asserting claims under state consumer protection statutes as well as common-law claims. The statutory claims alleged that the insurer conspired with other insurers and with asbestos manufacturers to hide the dangers of asbestos and to raise a fraudulent "state of the art," or "no duty to warn," defense to personal injury claims. The common-law claims alleged that the insurer violated a duty to warn the public about the dangers of asbestos or by acting to keep its knowledge of those dangers from the public. Thus, many plaintiffs sought recovery for the insurer's own alleged misconduct, not the alleged misconduct of the debtor.

In 2002, the insurer moved, in the bankruptcy court, to enjoin 26 actions pending in state courts, citing the injunctive terms of the 1986 orders. The bankruptcy court entered a temporary restraining order and referred the parties to mediation, which resulted in a settlement between the insurer and three sets of plaintiffs. The settlement obligated the insurer to pay more than $400,000,000 to compensate plaintiffs in pending actions, contingent on the bankruptcy court entering an order clarifying that the pending actions were, and remained, prohibited by the 1986 orders. The bankruptcy court approved the settlement and entered a clarifying order that the 1986 orders barred the pending actions after concluding that the claims against the insurer were based upon acts or omissions arising out of and relating to the insurance policies issued to the debtor.

Some individual claimants, as well as an insurer that was a co-defendant with the primary insurer in some of the pending actions, objected to the latest settlement and subsequently appealed. The district court affirmed with respect to the clarifying order, but the Second Circuit Court of Appeals reversed.

The Court of Appeals recognized the bankruptcy court's continuing jurisdiction to interpret and enforce the 1986 orders and to clarify its prior orders. It also said that there was "little doubt that, in a literal sense," the pending claims against the insurer arose out of the provision of insurance coverage to the debtor, and emphasized that the bankruptcy court's extensive findings regarding the debtor's "'all-encompassing presence in the asbestos industry and its extensive relationship'" with the insurer supported the notion that the subjects of the clarifying order fell within the scope of the 1986 orders. Nevertheless, the Second Circuit held that the bankruptcy court could not, in enforcing the 1986 orders, enjoin claims over which it lacked jurisdiction. The Second Circuit faulted the lower courts for failing to recognize the significance of the fact that the pending actions did not seek to collect on the basis of the debtor's conduct and instead sought to recover directly from the non-debtor insurer for its own alleged misconduct. The Second Circuit concluded that the bankruptcy court mistook its jurisdiction in enjoining claims against a third-party non-debtor based solely on its financial contributions to the debtor's bankruptcy estate, since the bankruptcy court only had jurisdiction to enjoin third-party non-debtor claims affecting the res of the bankruptcy estate. Certiorari was granted.

Justice Souter, writing for a seven-Justice majority, said that the bankruptcy court correctly understood that the pending actions fell within the scope of the 1986 orders, "as suits of this sort always have." The Second Circuit, however, erred in believing that it was free to look beyond the terms of the 1986 orders and treat the matter as, it said, one "'concern[ing] the outer reaches of a bankruptcy court's jurisdiction.'" Had the Court of Appeals  been conducting a direct review of the 1986 orders, it would have been required to consider whether the bankruptcy court had acted beyond its subject matter jurisdiction. The 1986 orders, however, became final more than two decades earlier, such that the issue of the bankruptcy court's jurisdiction and authority to enter the injunction in 1986 was not properly before the Court of Appeals in 2008, or the Supreme Court thereafter.

The Supreme Court first noted its agreement with the Court of Appeals that the pending actions were policy claims enjoined by the 1986 orders, as against the debtor's primary insurer, which applied to known and unknown claims, demands, allegations, duties, liabilities, and obligations against the insurer based upon, arising out of, or related to insurance coverage provided by the insurer to the debtor. The reach of this language was expansive, particularly given the inclusion of "allegations," which, the Supreme Court said, "clearly reaches factual assertions that relate in a more comprehensive way" to the insurer's dealings with the debtor. This point coincided with the bankruptcy court's uncontested factual findings, which basically indicated that the plaintiffs in the pending actions were seeking to recover against the insurer either for its supposed wrongdoing as the debtor's insurer or for an improper use of information obtained from the debtor as its insurer. The actions thus involved claims, as well as allegations, based upon, arising out of, or relating to the insurer's insurance coverage of the debtor. Although, at some point, the link between the complained-of actions and the insurance coverage would become too thin, that limit had not been reached. Arguments that this interpretation of the 1986 orders was "revisionism perpetrated by" the bankruptcy court's clarifying order, and that evidence before the entry of the 1986 orders showed that some parties to the bankruptcy case understood that the proposed injunction would extend only to claims derivative of the debtor's liability, were rejected. The Supreme Court noted that the plain language of the orders were to the contrary, and had to be given effect.

Having found that the clarifying order correctly interpreted the 1986 orders, the Supreme Court turned to the question of whether the bankruptcy court had subject matter jurisdiction to enter the clarifying order. Answering that question, the Supreme Court indicated, was easy, since there was no dispute that such jurisdiction existed. The Supreme Court noted, furthermore, that the bankruptcy court had retained jurisdiction to enforce its injunctions when it issued the 1986 orders.

The Court of Appeals erred, however, when it considered whether the bankruptcy court had acted within its jurisdiction in issuing the 1986 orders, and concluded that, because jurisdiction had not then existed, the 1986 orders could not be enforced. The Supreme Court explained that challenges to the bankruptcy court's jurisdiction to enter the 1986 orders could have been brought on direct appeal of those orders; in addition, either the district court or the Court of Appeals could have addressed this question sua sponte. "But once the 1986 Orders became final on direct review (whether or not proper exercises of bankruptcy court jurisdiction and power), they became res judicata" to the parties and those in privity with them, Justice Souter wrote.

The orders did not lose their preclusive effect, moreover, as a result of being attacked based on subject matter jurisdiction. Having had a fair opportunity to challenge the bankruptcy court's jurisdiction, the parties and those in privity with them could not dispute jurisdiction by resisting the 1986 orders' enforcement. The case did not present one of those rare situations in which subject matter jurisdiction is subject to collateral attack. "The willingness of the Court of Appeals to entertain this sort of collateral attack cannot be squared with res judicata and the practical necessity served by that rule," Justice Souter wrote. "Almost a quarter-century after the 1986 Orders were entered, the time to prune them is over."

The Court's holding was narrow, Justice Souter declared. The Supreme Court was not resolving whether a bankruptcy court, in 1986 or today, could properly enjoin claims against non-debtor insurers that were not derivative of the debtor's wrongdoing, nor deciding whether any particular respondent was bound by the 1986 orders. The Court reversed the judgment of the Court of Appeals and remanded for further proceedings.

Justice Stevens, in a dissenting opinion in which Justice Ginsburg joined, opined that the 1986 orders barred only those claims against the debtor's insurers seeking to recover from the bankruptcy estate for the debtor's misconduct, not those claims seeking to recover against the insurers for their own misconduct. "Because the 1986 injunction has never meant what the Court today assumes," the challenge to that injunction was not an impermissible collateral attack, Justice Stevens stated. Travelers Indem. Co. v. Bailey, 2009 WL 1685625 (U.S.).

State-law homestead exemption rights of Chapter 7 debtors in proceeds from the sale of their residence were not effective against federal tax liens or the properly-noticed, prepetition tax liens possessed by the Montana Department of Revenue (DOR), even though neither the Internal Revenue Service (IRS) nor the DOR had objected to the state-law homestead exemption claimed by the debtors within the time allowed by Bankruptcy Rule 4003. Accordingly, the proceeds could not be released to the debtors. The debtors had neither objected to the tax claims nor initiated adversary proceedings to determine the validity, extent, or priority of the IRS's or the DOR's liens. In re Duncan, 2009 WL 1364807 (Bkrtcy.D.Mont., Judge Kirscher).

Although the verbal encouragement that an intoxicated passenger provided to the driver of a truck to attempt to drive over a log that was being used as a parking barricade was insufficient, without more, to place him in "actual physical control" of the vehicle, as that term was used in the Idaho driving-under-the-influence (DUI) statute, his conduct in placing the vehicle in all-wheel drive mode prior to directing the driver to drive over the log was a sufficient assumption of control, under Idaho law as predicted by a bankruptcy judge in that state, to place him in violation of the DUI statute and to make his resulting debt to a bystander struck by the dislodged log payable on tenth-level priority basis in his Chapter 7 bankruptcy case, as a debt for personal injury resulting from the operation of a motor vehicle, where that operation was rendered unlawful as a result of the debtor's intoxication. The bankruptcy judge impliedly found that there can be more than one operator of a single motor vehicle under the DUI statute, and that the statute is not necessarily limited in its reach solely to intoxicated drivers. In re Loader, 2009 WL 1561411 (Bkrtcy.D.Idaho, Judge Pappas).

A The provision of a bankruptcy statute allowing the dismissal of a Chapter 7 case for abuse applies only to cases filed under Chapter 7, and does not apply to a case converted to Chapter 7 from another chapter of the Bankruptcy Code, a Virginia bankruptcy court has ruled, recognizing a split of authority on the issue and following what it characterized as the minority view. The court concluded that this interpretation adhered to the statute's plain language, did not contravene congressional intention, and was consistent with the purpose of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). Moreover, it noted, a bankruptcy court retained the authority to dismiss, for "cause," cases filed by abusive filers that sought to avoid the Chapter 7 means test. In re Dudley, 2009 WL 1676031 (Bkrtcy.W.D.Va., Judge Krumm).