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Third Circuit Affirms Assignment of Debtor’s Rights Under Asbestos Insurance Policies

Article

The Business Advisor

February 21, 2013

Toward the end of 2007, after nearly six years in bankruptcy, Federal-Mogul Global, Inc., and its affiliates exited bankruptcy by reaching a novel agreement with some of their asbestos insurance carriers, which carved out from the confirmation process the issue of whether the Bankruptcy Code preempts state law and authorizes the assignment of a debtor’s rights under its insurance policies to an asbestos trust, notwithstanding the terms of any anti-assignment provisions in such insurance policies. In an unanimous decision, on May 1, 2012, a three-judge panel of the Third Circuit Court of Appeals (the “Court”), affirming the decision of the district court below and its earlier decision in In re Combustion Eng’g, 391 F.3d 190 (3d Cir. 2004), answered that question in the affirmative. The Court ruled that Section 1123(a) of the Bankruptcy Code expressly preempts an insurer’s contract rights under state law and thus, assignment of policy proceeds to an asbestos trust is not prohibited by anti-assignment provisions in insurance policies. In re Federal-Mogul Global Inc., et., al., 2012 U.S. App. LEXIS 8814 (3d Cir. Del., May 1, 2012).

Section 524(g) of the Bankruptcy Code, which is unique to the asbestos context, permits a debtor, through a confirmed plan of reorganization, to consolidate and channel all of its asbestos-related assets and liabilities into a single personal injury trust for the benefit of present and future asbestos claimants. 4 Collier on Bankruptcy 524.07 (Alan N. Resnick & Henry J. Sommer eds., 16th ed. 2011). Included among a debtor’s assets are the debtor’s rights under insurance policies covering the debtor’s asbestos-related liabilities. Generally included in such policies are standard provisions prohibiting a debtor from transferring the policies or its rights under the policies without the insurer’s consent. However, under Federal-Mogul’s plan, Federal-Mogul’s rights to recovery under insurance liability policies were assigned to the trust.

The insurers objected, asserting that the assignment violated the anti-assignment clauses contained in the policies. In response, Federal-Mogul argued that the anti-assignment provisions were preempted under Sections 541 and 1123(a)(5) of the Bankruptcy Code, which identifies assets of the debtor’s estate and permits transfer of those assets to the Section 524(g) trust. Both the bankruptcy court and the district court agreed with Federal-Mogul, reasoning that section 541(c) of the Bankruptcy Code, which provides that when a chapter 11 bankruptcy case starts, “an interest of the debtor becomes property of the estate. . . notwithstanding any provision in an agreement, transfer instrument, or applicable nonbankruptcy law . . . that restricts or conditions transfer of such interest by the debtor,” permitted the assignment. In re Federal-Mogul Global Inc., 385 B.R. 560, 566-57 (Bankr. D. Del. 2008); In re Federal-Mogul Global, Inc., 402 B.R. 625, 630-38 (D. Del. 2009). In addition, the lower courts found that Congress expressly preempted conflicting state law through the “notwithstanding” clause in Section 1123(a) of the Bankruptcy Code. Id.

In affirming the lower courts, and finding that Federal-Mogul’s insurance rights can be assigned to the trust, the Court rejected the insurers’ contention that the disputed issue was one of first impression and reiterated that the Court meant exactly what it said the first time it ruled on this issue in Combustion Eng’g, although the preemption of anti-assignment provisions had not been one of the paramount issues on appeal in that case. In Combustion Eng’g, the Court held in a footnote that “Section 541 [of the Bankruptcy Code] effectively preempts any contractual provision that purports to limit or restrict the rights of a debtor to transfer or assigns [sic] its interest in bankruptcy. . . The Bankruptcy Code expressly contemplates the inclusion of debtor insurance policies in the bankruptcy estate.” Federal-Mogul, 2012 U.S. App. LEXIS 8814 at * 26-27 (citing Combustion Eng’g, 391 F.3d at 219 n. 27). The Court also clarified that not only did the “notwithstanding” clause of Section 1123(a) expressly preempt conflicting state law on the issue but the “plain wording” of Section 1123(a) of the Bankruptcy Code also confirms Congress’ express intent to preempt the insurers’ private contract rights under the insurance policies. Id. at *44-46.

The Court concluded by noting that preemption of anti-assignment clauses in insurance policies furthers the fresh start purpose of the Bankruptcy Code as well as Congress’ intent in enacting Section 524(g) of the Bankruptcy Code-to alleviate a debtor’s crushing asbestos liability and to maximize the trust’s assets to pay asbestos claimants. Id. at *71-73.