Supreme Court Upholds Application of Bankruptcy Court Injunction Barring Further Litigation or Recovery Directly from the Insurance Company of the Debtor

07/09/2009 / L. Kathleen Harrell-Latham

On June 18, 2009, the United States Supreme Court reversed the Second Circuit in Travelers Indemnity Co. et al. v. Bailey et al. and upheld the Bankruptcy Court’s decision to enjoin all litigation against the former insurance company of the debtor arising from breaches of its alleged independent statutory and common law duties to warn the public of the risks of asbestos.

Facts of the Case
Johns-Manville (“Manville”) was formerly the largest supplier and manufacturer of asbestos products in the United States. Travelers Insurance, as the primary liability insurer, worked closely with Manville to assess liability, defenses, and litigation costs as the link between asbestos and respiratory diseases emerged. Manville filed for Chapter 11 protection in 1982 as the mass of litigation swept across the country. Eventually, Manville’s insurance companies agreed to fund a trust that would distribute funds to all current and future asbestos related claimants arising under the debtor’s policies. A Plan of Reorganization contemplating appointment of a trustee to administer this multibillion dollar settlement to the claimants was subsequently confirmed and approved by the Court.

Approximately a decade later, a new wave of litigation asserting breaches of the state consumer protection statutes and common law duties were commenced directly against Travelers (“Direct Actions”). A settlement of the Direct Actions was reached in 2004 and returned to the Bankruptcy Court under the pretext of clarifying the Court’s previous orders. Some of the claimants objected to Travelers tactics in arguing that the Bankruptcy Court’s jurisdiction was confined to the bankruptcy estate and did not have authority to issue an injunction to protect a non-debtor where there was no potential harm to the estate. Alternatively, the Claimants argued that they were not provided sufficient notice and application of the previous orders would deny them due process. In support of the settlement, Travelers argued that the Bankruptcy Court inherently had jurisdiction to interpret its own orders. Travelers also argued that all of the alleged wrongdoings underlying the Direct Actions arose solely from its connection to the Debtor and invariably falls within the purview of the Bankruptcy Court.

Lower Court Rulings
After holding an evidentiary hearing, the Bankruptcy Court made a number of detailed findings of fact. Specifically, after finding a nexus between Travelers and Manville, the Bankruptcy Court held that the Direct Actions were and had always been barred under its previous Orders. The Bankruptcy Court proceeded to approve the 2004 settlement and entered an Order barring direct actions against Travelers for any claims arising under the Manville policies.

On appeal, the Second Circuit Court concurred that the bankruptcy court maintained jurisdiction to interpret and enforce its own Orders despite the substantial time lapse. However, the Second Circuit rejected Travelers arguments and held that the Bankruptcy Court was without jurisdiction to issue an injunction to protect an insurance company outside of bankruptcy where the potential recovery involved only non-estate assets. Thus, the Second Circuit held that the new wave of litigation may proceed as they could not be subject to the Bankruptcy Court’s injunction initially established in 1986.

Supreme Court Ruling
In reversing the Second Circuit’s decision, the Supreme Court also agreed that the Bankruptcy Court has inherent jurisdiction to interpret its own orders regardless of time passage. In a heavy reliance upon the lack of ambiguity in the fact findings, the Supreme Court concluded it was bound by the Bankruptcy Court’s findings that the direct actions were of a sufficient nexus with the claims against Debtors that they fell within the context of the injunction order. The Court then proceeded to reason that the Direct Action petitions could have and should have objected to the injunction when it was first issued in lieu of waiting over a decade. However, the Court then attempted to articulate the intended narrow application of its holding while expressly refusing to rule on the broader issue of whether any bankruptcy court may enjoin claims against a non-debtor insurer that is not derivative of the debtor’s conduct.

Justices Stevens and Ginsburg joined in the dissent and opined that the Bankruptcy Court exceeded its jurisdiction by enjoining claims against a non-debtor that were only seeking to recover non-estate property. The Dissent rejected the argument that any nexus between the parties warranted extension of the Bankruptcy Court’s jurisdiction beyond the Manville bankruptcy estate. In finding the previous orders ambiguous, the Dissent further reasoned that the Direct Action plaintiffs would have been without standing to object at the time the injunction was instituted. Ultimately, the dissent concurred with the Second Circuit and concluded that the Direct Actions were not and could not have been barred by the Bankruptcy Court.

What This Case Means For Our Clients?
The Court’s narrow ruling in this case has left an imprecise factual test as to when a Bankruptcy Court has jurisdiction to extend the protections of the Bankruptcy Code to an entity outside of bankruptcy.

Navigating the minutia of the automatic stay, bankruptcy jurisdiction, and the potential litigation claims in bankruptcy is complex in this evolving technical field. Moreover, in the context of today’s complex business and economic market, there are increasing circumstances where the ongoing viability of one business may be inextricably intertwined with a totally unrelated entity. At the same time, the Bankruptcy Court’s jurisdiction is narrowly tailored to protect only those who purposefully avail themselves of its remedies and obligations.

This issue is important not only to entities contemplating bankruptcy but also to those actively engaged in their business. Larkin Hoffman will continue to monitor this case upon remand to watch for any further determinations on notice and due process requirements that may result in further refinement. The attorneys in Larkin Hoffman’s Bankruptcy Practice Group have substantial experience in complex bankruptcy issues and are able to assist with any questions about this case or any other bankruptcy or insolvency questions that you may have.