Asbestos: A final chapter?

by Matt Miller published in TheDeal.com.

In mid-June, U.S. Bankruptcy Judge Judith Fitzgerald of the Western District of Pennsylvania in Pittsburgh is scheduled to convene her court and hold confirmation hearings on a complex, $1 billion reorganization plan for Federal-Mogul Corp., the Southfield, Mich., auto parts manufacturer stuck for more than five years in a long and troubled Chapter 11. If successful—and it's still possible some insurance companies will oppose confirmation—Federal-Mogul would become the latest in a string of major companies to reorganize over the past year after seeking bankruptcy protection for asbestos-related liabilities.

A handful of companies, most notably Columbia, Md.-based specialty chemicals and materials maker W.R. Grace & Co., remain dug into the bankruptcy trenches, with no end in sight. And a few current cases, such as Congoleum Corp., are textbook examples of poorly crafted plans that can languish for years. Meanwhile, smaller asbestos-related potential bankruptcy cases remain in the pipeline, say legal practitioners. These companies could file for Chapter 11 over the next several months.

For all of that, the Federal-Mogul case may mark the tail end of the quarter-century arc of what the Rand Institute for Civil Justice once called "the longest-running mass tort litigation" in U.S. history. With many of the biggest cases out of the way, it's a good time for stock taking. Did the use of Chapter 11 to resolve huge, multigenerational liabilities—the death and disease wrought by the use of asbestos—make sense? Is there a better way to reward litigants in winning class actions without destroying the jobs of workers and crippling the companies so they're unable to pay those claims? Should bankruptcy play a role at all?

Interviews with lawyers representing various perspectives on the great asbestos experiment understandably reveal sharp differences. Yet most agree on the following: What for the better part of two decades was a messy, wasteful and by all accounts grossly unfair process has improved significantly over the past two years or so. Some of these cases have shown it's possible for companies to reorganize in a way that allows them to retain or regain financial health and still set aside large pools of money for victims of asbestos-related diseases, both current and future. These cases are gaining speed and efficiency. The trust administration of the settlement is more efficient, fairer and more rigorous in who gets what. The most needy are finally getting a bigger share of the pot, sometimes as much as 90% of the total, more commonly around 70% of the pool. The stock market is rewarding companies that emerge from bankruptcy to such an extent that they can afford large settlements. "What has happened is beneficial for everybody," says Roger Frankel, Washington-based co-chair of the bankruptcy and debt-restructuring group for Orrick, Herrington and Sutcliffe LLP.

And despite the extremely mixed record of the earlier years of the crisis, progress is undeniable. "Yes, there's been a tremendous amount of benefit," says Natalie Ramsey, a Philadelphia-based partner at Montgomery, McCracken, Walker & Rhoads LLP. Ramsey litigates on behalf of cancer victims. "But I don't think we're all the way there yet."

A few of the most recent asbestos-related cases provide a model for dealing with mass tort liabilities, many lawyers now believe. Frankel, for one, cites the ability in asbestos-related bankruptcies to come up with plans that have both "some degree of predictability" and results acceptable to all parties. "The victims, present and future, and the commercial players have done very well, and that's the way it should be," says Frankel, who has represented both debtors and future claimants.

The bankruptcy case most often cited as successful for debtor and creditor alike involves—amazingly enough, given other controversies—two Halliburton Co. subsidiaries, DII Industries LLC and KBR, formerly Kellogg Brown & Root. Both were reorganized in January 2005 after a little more than a year in Chapter 11. In a settlement worth $5.3 billion, asbestos claimants got 100 cents on the dollar. (This compares with 5 cents on the dollar victims received in the earliest asbestos-related bankruptcy case involving the Johns-Manville Corp.) And these claimants received their money quickly. Halliburton "paid $2.7 billion in cash," says Michael Rosenthal, a Dallas-based partner at Gibson, Dunn & Crutcher LLP, who represents the trust that administers the settlement. The trust "paid it out the next day."

A trust for future claimants is just as well funded. It received 13% of Halliburton stock, which it sold for $2.6 billion. "The company operated from a position of strength. It cut deals. It spread money around," says Mark Plevin, a Washington-based partner at Crowell & Moring LLP, who represents insurance companies and has often been critical of the bankruptcy proceedings.

What's more, adds Jeffrey Rich, a New York-based restructuring partner at Kirkpatrick & Lockhart Preston Gates Ellis LLP, Halliburton didn't base its settlement on insurance coverage but, rather, chose to work it out with its own funds after attempting to collect from insurers. "Rather than arguing for the last penny, they kept their eye on the bottom line," says Plevin.

In all, 80 companies filed for Chapter 11 and cited asbestos liabilities as the reason, according to a report in Mealey's Asbestos Bankruptcy Report. Almost 30 of those filed during a three-year period from 2000 to 2002. After years of frustration and relatively few reorganizations, the logjam finally broke last year. Since early 2006, the following companies have all successfully reorganized: USG Corp., Owens Corning, Armstrong World Industries Inc., ABB Lummus Global Inc., Porter Hayden Co., Kaiser Aluminum Corp., J.T. Thorpe & Son Inc., Babcock & Wilcox Co., Combustion Engineering Inc., Plibrico Co. LLC and the non-U.S. subsidiaries of Federal-Mogul Corp.

"There is no question that the acme of Chapter 11 asbestos cases seems to have passed," says David Heiman, a Cleveland-based restructuring partner at Jones Day. "Winding down may be an apt way to put it."

It's been a long, hard slog. By the late 1970s, there was irrefutable evidence that exposure to asbestos could lead to debilitating and sometimes deadly diseases, including a particularly nasty form of cancer called mesothelioma, which is almost always fatal. But the gestation time between exposure and sickness could take years, if not decades, for symptoms to occur. Johns-Manville was the largest U.S. asbestos producer and supplier. By 1982, according to one estimate, the pace of litigation had so quickened that three cases per hour were being filed against the company.

That year, Johns-Manville became the first to declare bankruptcy in an unsuccessful—some would say disastrous—attempt to manage asbestos lawsuits. Those fashioning the reorganization completely underestimated the number and cost of claims. Johns-Manville reorganized in 1988. The fund it set up for victims lasted two years before it was depleted. The company was forced to re-enter bankruptcy. The second attempt wasn't much better. Even the sickest victims ended up getting pennies on the dollar in claims. "Manville ended up paying 5 cents on the dollar, so people were fighting over a limited pie," says Plevin.

In 1994, Congress amended the Bankruptcy Code to include a special provision on dealing with asbestos-related mass torts, Sec. 524(g), which provided a permanent injunction against asbestos-related liabilities as part of a reorganization plan.

The injunction came with a huge catch, however. Ostensibly to ensure justice for all litigants, Sec. 524(g) requires approval of 75% of all claimants, a supermajority. The unintended consequence: a small, but powerful cabal of lawyers representing thousands of healthy individuals, some with no symptoms and little evidence of exposure, could dictate terms and hold up proceedings. "524(g) is a killer because it gives the plaintiffs' lawyers total control," says Harvey Miller, a partner at Weil, Gotshal & Manges LLP and one of the deans of the bankruptcy bar.

"It was a badly written law," another lawyer says bluntly.

So just about everybody found themselves between the proverbial rock and hard place. If companies chose to defend each claim, the attorneys' fees climbed more rapidly than the national debt. According to one estimate, USG was spending $1 million a day in defense costs, roughly equivalent to its Ebitda.

The claimants who needed the money most fared no better. The courts were overwhelmed by claims, the vast bulk of which dealt with individuals who showed no signs of illness.

Early bankruptcy settlements were a cruel joke. According to information culled from "Mealey's Litigation Reporter: Asbestos," the 1996 reorganization of Amatex—now Norristown, Pa., specialty textiles producer Amatex-Norfab Corp.—called for mesothelioma victims to receive a mere $925 each.

About the only winners in this phase were lawyers—those representing tens of thousands of alleged victims and those defending corporations—and other legal and financial advisers.

What's happened in recent years reflects both judicial and legislative intervention, which has effectively reduced the clout of those plaintiffs' lawyers representing thousands of nonimpaired claimants, making the process more productive and timely. "As courts gained more experience with 524(g) and more certainty in their interpretations, they have strengthened a number of issues that needed to be addressed," Ramsey says.

Lawyers cite several judicial rulings, especially in the 3rd Circuit Court of Appeals in Philadelphia, that clarify corporate obligations, creditor priorities and, in general, establish guidelines for what can and can't be done. One such ruling, for example, made in December 2004 involved Combustion Engineering and a so-called two-trust model. The company, a subsidiary of Zurich-based ABB Ltd., formed a prepetition trust with assets enough to settle most claims, then filed for Chapter 11, hoping to establish another trust that deals with what remains, including future claims. The court nixed such a structure as being inherently unfair to claimants, who had yet to be compensated. ABB ended up putting an additional $232 million into the fund, and the reorganization was approved.

Several states, including former havens for lawsuits such as Mississippi, have passed laws that tighten medical standards and criteria that dictate where cases can be filed. The result: Plaintiffs' lawyers can no longer overwhelm the system with supposed victims who show no signs of illness, the so-called unimpaired claimants.

Judges have also weighed in on this issue. Most notably, in a scathing June 2005 ruling, Janis Graham Jack, a U.S. District Court judge for the Southern District of Texas, excoriated certain plaintiffs' lawyers, doctors and medical screeners for techniques used to bring thousands of new and often-dubious asbestos- and silica-related claims to court. "These diagnoses were driven by neither health nor justice; they were manufactured for money," she wrote in her 249-page decision.

Jack described in detail a ludicrous process that would magically uncover thousands of cases by setting up mobile testing centers in random parking lots. "A golfer is more likely to hit a hole-in-one than an occupational medicine specialist is to find a single case of both silicosis and asbestosis," she wrote. Yet supposed independent screeners "parked a van in some parking lots and found over 4,000 such cases."

The effect of all this combination of legislative and judicial review has been a dramatic decline in the number of new unimpaired claimants. "There has been a sea change," Heiman says.

According to one estimate, by 2001, there were 400,000 individual claimants and as many as 8 million claims. ("A typical claimant files claims against approximately 20 defendants," wrote Michelle White, a University of California, San Diego, economist in a 2002 paper.) In 2001 and 2002, there were upwards of 80,000 new claimants annually, according to another estimate. The number of new claimants fell to about 5,000 last year. "It's much more difficult for the [lawyers of] unimpaired or nonsick to prosecute claims," says Rosenthal. "It's less and less profitable to file unimpaired claims," so lawyers recruit fewer unimpaired claimants. "It's not worth the money."

Add to this trust administration, which is getting better, as Ramsey puts it, "insuring appropriate procedures for the people who deserve to be paid from the trust and paid promptly."

Another factor in the resolution of bankruptcy cases was the collapse in February 2006 of federal asbestos-related legislation, which had been years on the docket. As last crafted, the law would have established a $140 billion trust fund for victims in return for toughened criteria for claimants. When the legislation appeared on track, several companies refused to settle, thinking they could get a better deal by waiting it out and becoming part of the overall pool. After the bill died, there was greater incentive to settle. While many companies used their time in bankruptcy to build up cash reserves, refinance debt and clean up other liabilities, being in Chapter 11 limited activities, especially those companies interested in selling themselves or their assets off.

Bankruptcy lawyers themselves have learned to work around the limitations of 524(g), and some of the more recent success among practitioners reflects a better attuned, more collegial and less divisive effort. "We've all learned a lot along the way, how to work together," says Laura Davis Jones, a Wilmington, Del.-based partner at Pachulski Stang Ziehl Young Jones & Weintraub LLP and a veteran debtor counsel in numerous asbestos-related bankruptcies.

All this has led to resolution. "Companies saw the handwriting on the wall," Rosenthal says.

That was certainly the case with USG, whose $6 billion settlement last year combined cash, shares and insurance proceeds. Had asbestos legislation passed Congress, USG's share of the pool might have been $2 billion less.

Even so, the settlement is widely considered a success. "Everybody was satisfied. Everybody got a great result," says Heiman, who acted as debtor counsel, and who may, admittedly, be biased. Bank and trade "creditors got paid in full, plus five-year's interest, and shareholders retained all their interest." Asbestos victims also received 100% of their claims.

Part of that settlement, says Heiman, reflects the strengthening of Chicago-based USG, a major manufacturer of building materials, while in bankruptcy. Profit margins widened. The company's cash grew significantly. "For the USGs of the world, it wasn't only asbestos," says Rosenthal. "They used the case effectively to deal with other unfavorable financial arrangements. Plus, they're not paying legal expenses [involved in litigation], so they can deliver the same product at a lower cost."

USG's bankruptcy took five years to play out, during which victims got nothing. It was a protracted and often-contentious fight. "Had we known it would take so long, would we have filed?" Heiman asks rhetorically. "I'm not sure. But that five years proved very useful to the company."

Despite the success of USG and Halliburton, certain companies remain obstinate about what they will offer up to settle a bankruptcy. Grace, for example, rejects what has become the standard formula for assessing liability through the use of outside experts and formulas and insists it is liable for only a fraction of pending claims. The company has embarked on its own estimation procedure, which is both lengthy and hugely expensive.

One lawyer believes it boils down to a simple formula: Grace won't agree to anything that would dilute shareholder equity. The disconnect is striking. In the vast majority of Chapter 11 cases, equity holders lose everything. Meanwhile, in the Grace case, cancer victims get nothing. "Present claimants have not been paid in the six years since Grace filed," says Frankel. "It's an example of where the result has not turned out well."

Pittsburgh-Corning Corp. is another example. Parent PPG Industries Inc. tried to push through a plan that would absolve it not only of liabilities because of Pittsburgh-Corning, but of liabilities PPG had picked up on its own. Fitzgerald shot down that approach and nixed the reorganization plan. "The judge said, 'You can't do this,' " says Steven Kazan, whose Oakland, Calif.-based law firm, Kazan, McClain, Abrams, Fernandez, Lyons, Farrise & Greenwood PLC specializes in representing mesothelioma and asbestosis victims. "It was clear to everyone that Pittsburgh-Corning was doomed, with the parents trying to get a free ride."

The debtor asked the judge to reconsider. Assuming she doesn't reverse herself, the question now is whether various parties will negotiate a settlement quickly. Kazan isn't hopeful. "Now there will be another two to three years and God knows how many millions in court costs."

When it filed for Chapter 11 in December 2003, Congoleum touted its effort as a prepackaged bankruptcy. Instead, Congoleum provided an almost steady stream of miscues. Among other gaffes, the flooring materials manufacturer hired as adviser a firm that also represented asbestos claimants in the same case.

In January, Kathryn Ferguson, a U.S. bankruptcy judge in New Jersey, knocked back Congoleum's 11th effort to craft a reorganization. Practice didn't make perfect. That effort was rife with blatant loopholes and inequities. (The judge noted, among other problems, that mesothelioma victims would receive 5% of what similar victims negotiated with the company prepetition.) In addition to insurance coverage, the company offered a paltry $2.7 million promissory note. Congoleum's parent, American Biltrite Inc., would throw in $250,000 in cash. Congoleum also offered 3.8 million new shares to the trust, but only if bondholders voted their approval. If they didn't, bondholders and the trust would share. The exasperated judge pointed out that she couldn't even determine exactly what percentage of the reconstituted company those shares represented ? 22%, 31.5% or 67.5%.

What's more, Congoleum attempted to circumvent a provision within 524(g) that mandates a majority of shares in the reorganized company be pledged to the victims' trust or delineate certain contingencies that would trigger the transfer of those shares to the trust. In Congoleum's proposal, the only possible way the company could have defaulted on its promissory note is if the company was worthless. "There is no plausible scenario in which the plan trust would be able to convert the shares when they were still valuable," wrote Ferguson. "The debtors are freeing themselves of what they describe as crushing asbestos liability while offering what appears to be little more than insurance proceeds in return."

"It's a mess," says one lawyer not involved in the case.

While dynamics vary from case to case, the more successful reorganizations tend to be those companies whose health is fundamentally sound, with the exception of the asbestos overhang. The thinking goes something like this: Get rid of the liabilities once and for all, and the stock market will reward you. That certainly was the case in Halliburton.

Halliburton has no one to blame but itself for its asbestos-­related liabilities. The company, then run by Vice President Dick Cheney, spent $7.7 billion acquiring Dresser Industries Inc. in 1998, knowing that the companies faced asbestos lawsuits.

Federal-Mogul has a similar history. It bought asbestos-­laden companies in the belief that they were discounted more than potential liabilities would cost. Federal-Mogul, for example, acquired the publicly traded building supplies company T&N Ltd. in 1997. It was Britain's largest asbestos manufacturer and was being hammered by asbestos-related litigation. The strategy was disastrous on all counts. Federal-Mogul piled on billions of dollars in debt for acquisitions that turned out to be sinkholes of liabilities. Before the company went bankrupt, it spent more than $700 million settling more than 300,000 claims. "Federal-Mogul thought it had the magic formula for asbestos liabilities, buying companies no one else would buy," says Rosenthal. "They totally underestimated the claims."

The Federal-Mogul reorganization has an added twist. Under the plan, the victims get a tad more than half of the stock in the reorganized company. Carl Icahn, who owns a significant portion of the company's unsecured debt, also has an option under the reorganization plan to acquire from the asbestos victims' trust all the stock, save for 13% earmarked for U.K. victims. If he exercises his option, Icahn would pay $375 million in cash and $400 million in a note.

Not that Federal-Mogul is a model of bankruptcy efficiency. "Did you know the English manager billed more than was set aside for all British victims?" Kazan asks.

In his typically outspoken manner, Kazan begins a conversation about asbestos and bankruptcy by railing against some of the best-known debtor counsels, those in the plaintiffs' bar who have grown rich by representing unimpaired victims and the universe of professionals who have attached themselves to the bankruptcy cases. "Fee applications are so depressing, I stopped reading them," he says. "The amount of money spent is outrageous ? it's insane."

But even Kazan returns to the nonbankruptcy alternatives, which for years, he characterizes as "a race to the courthouse" pitting the very sick against a multitude of others. Some of the sickest victims, the kind he represents, could find themselves in line for trial for years. They may never live to see settlements.

"Bankruptcies suck. By definition, no one gets paid what he's owed," he says, then concedes that a few of the more recent reorganizations represent "the best of a bad situation."

That is something of an achievement all by itself.