The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), analyzing a recent decision of interest:
In a split decision, the Fourth Circuit Court of Appeals (the Court) ruled that the bankruptcy court had related to jurisdiction to issue a preliminary injunction which prohibited asbestos claimants from pursuing non-bankruptcy court litigation against a non-debtor affiliate of the debtor. In re Bestwall LLC, 71 F.4th 168 (4th Cir. 2023).
To view the opinion, click here.
Georgia-Pacific LLC (“Old GP”) merged with Bestwall Gypsum Company (“Old Bestwall”) in 1965. Old Bestwall was a manufacturer of asbestos-containing products. As a result of the merger, Old GP faced thousands of asbestos-related lawsuits. In 2017 Old GP underwent a divisional merger under Texas law, often referred to as the Texas two-step. As a result of this restructuring, Old GP ceased to exist and its assets and liabilities were divided between two new entities as wholly owned subsidiaries of Georgia-Pacific Holding LLC. Bestwall received certain assets and undertook sole responsibility for the asbestos-related claims. New GP received other assets and became responsible for non-asbestos claims and it continued to operate the profitable aspects of the business. As part of the restructuring, Bestwall agreed to indemnify and hold harmless New GP from losses or claims arising from the liabilities assumed by Bestwall. New GP also entered into a funding agreement which required it to fund Bestwall’s indemnification obligations. Additionally, New GP agreed to indemnify Bestwall for the costs of administering a chapter 11 bankruptcy and the costs of funding a section 524(g) asbestos trust if Bestwall’s assets were insufficient.
After the restructuring, Bestwall filed a chapter 11 in North Carolina. By then, many asbestos-related lawsuits had named New GP as a defendant. Soon after filing, Bestwall filed an adversary proceeding seeking a preliminary injunction which would enjoin any asbestos-related claims against New GP. The bankruptcy court determined that it had related to subject matter jurisdiction under 28 U.S.C. § 1334 to enjoin the claims against New GP. The bankruptcy court granted the preliminary injunction for three reasons: (1) the purpose of the bankruptcy would be defeated without the injunction because Bestwall would not be able to address all claims in one forum; (2) Bestwall employees would need to spend time defending claims against New GP rather than performing reorganization tasks; and (3) Bestwall’s indemnification of New GP would make judgments against New GP actually judgments against Bestwall. In addition, the bankruptcy court found that Bestwall was likely to prevail on the merits because it had a realistic possibility of a successful reorganization.
The Claimant Representatives appealed to the district court, which affirmed, concluding that the present and future claimants had standing. It also found that the bankruptcy court had related to jurisdiction based on the same three elements weighed by the bankruptcy court in granting the preliminary injunction, which it also found proper. The claimants appealed to the Court, which affirmed.
The Court disposed of any standing issues by applying the “party aggrieved” standard, concluding that the present and future claimants were directly and adversely affected pecuniarily because they could not choose their litigation forum, being bound to resolve their claims in the bankruptcy court, which increased their burdens and impaired their rights.
It then turned to the appellants’ assertions that the bankruptcy court lacked related to jurisdiction to enter the preliminary injunction and that Old GP attempted to improperly manufacture jurisdiction. The Court followed the broad test for related to jurisdiction, based on the Third Circuit’s Pacor test: if the outcome of the proceeding could conceivably have any effect on the estate bankruptcy administration, the court has related to jurisdiction. The Court answered this question in the positive because litigating the claims against New GP and Bestwall in two different forums, including multiple state court actions around the country, would lead to far greater expense as well as the possibility of inconsistent findings of liability.
The jurisdictional inquiry did not stop there, however. In response to the claimants’ assertion that Old GP impermissibly sought to manufacture bankruptcy court jurisdiction by the restructuring agreements. The circuit had ruled in the past that “neither the parties nor the bankruptcy court can create § 1334 jurisdiction.” However, the Court concluded that jurisdiction had not been manufactured, because Old GP could have filed a chapter 11 if the asbestos claims remained with it. The restructuring left the jurisdictional result the same. There was no way to separate the parties from the claims in this instance and the claims involving New GP are related to the bankruptcy case. The Court distinguished the issues before it from those which compelled the Third Circuit to reject the bankruptcy of LTL Management LLC, arising from a similar Texas two-step restructuring. In re LTL Management, 64 F. 4th 84 (3rd Cir. 2023). The issue in that case was the lack of good faith in the filing, not the divisional merger, with the Third Circuit ruling that the debtor was not in financial distress. The Court also found that jurisdiction was not predicated on the indemnification agreement nor the funding agreement. In sum the Court concluded that any further challenges to the propriety of reorganization would best be addressed in the confirmation process.
Finally, the Court considered the standards for granting a preliminary injunction. Claimants had argued that the bankruptcy court committed legal error by considering evidence of the realistic possibility of reorganization instead of requiring a clear showing of a successful reorganization when considering the likelihood of success on the merits prong of the test for granting a preliminary injunction. The Court rejected this argument, citing a series of cases which had concluded that the realistic possibility was the proper test. Here, with all litigation claims to be dealt with in one forum, that realistic possibility was met. They also rejected the claimants’ assertions that the likelihood of success test should have looked at whether a permanent injunction would be issued. The Court concluded it was too early in the reorganization process to address those issues.
A lengthy and analytical dissent disagreed with the majority’s conclusion that the parties had not manufactured federal jurisdiction by the divisional merger. It focused on the wealth of Georgia-Pacific as an international business; if any entity had jurisdiction to file chapter 11 it was Old GP, which could not file its own chapter 11 bankruptcy in good faith because it was not in financial distress, hearkening to the Third Circuit decision in the LTL Management case.
This case highlights the two different views on the propriety of Texas divisional mergers, which generally result in the creation of two new related entities, one of which takes on mass tort liability and then files a chapter 11 to deal with the tort claims and the other of which remains operating with ample assets to run the profitable parts of the business. The Third Circuit dismissed LTL’s chapter 11, finding the newly created entity was not in financial distress because of the funding obligations of the other newly created sister company and other factors. The majority here found jurisdiction for the relief requested, in this case a preliminary injunction, but never addressed good faith because it was not argued. The dissent saw it differently and clearly was not enamored with the Texas two-step process, concluding it resulted in manufactured jurisdiction. Both views are analytically presented in this opinion. I would urge any practitioner involved in a Texas two-step bankruptcy to read both the majority and the dissent in full.
This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.). Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.