Bankruptcy Code section 1109(b) gives a “party in interest” the right to raise, and appear and be heard on, any issue in a chapter 11 case. Two recent cases involving insurers of debtors in mass tort asbestos-related bankruptcies came to different conclusions as to whether insurers have standing to object to issues arising in the bankruptcies of their insureds. In In re Congoleum Corp., (2005 WL 2559715) (3d Cir., 10/13/05),the Third Circuit held that a debtor asbestos-manufacturer’s insurers had standing to challenge the retention of Gilbert, Heintz & Randolph, LLP as special insurance counsel under Bankruptcy Code section 327(e). Conversely, in In re A.P.I., Inc., (2005 WL 2630662) (Bankr. D. Minn., 10/15/05), the Bankruptcy Court found that the insurers lacked standing to object to confirmation of the debtor-insured’s asbestos-related plan because plan confirmation would not have any material collateral impact on pending state court insurance coverage litigation between the insurer and the debtor-insured.
It’s not easy to reconcile these two cases: the insurers in Congoleum are granted standing; the insurers in A.P.I. are not. Still, both opinions seemingly yielded the “better” result. In A.P.I., by denying standing to the insurers, 83 thorny objections to the plan were eliminated, thus clearing the way to confirmation. Conversely, in Congoleum, granting the insurers standing enabled them to expose cozy relationships among law firms on opposite sides of the table, thus giving the Third Circuit an opportunity to deliver a stern message regarding professional responsibilities in bankruptcy. Still, the A.P.I. case is so strong for asbestos debtors trying to prevent insurers from gaining standing in bankruptcy that one has to wonder whether this case will lead to Minnesota’s bankruptcy court becoming the “Delaware” (i.e., the preferred venue) of asbestos bankruptcies.
Summaries of these two cases follow:

In re Congoleum Corp., (2005 WL 2559715) (3d Cir., 10/13/05): A debtor asbestos-manufacturer’s retention of Gilbert, Heintz & Randolph, LLP (“Gilbert” or “GHR”) as special insurance counsel under Bankruptcy Code section 327(e) was reversed by Third Circuit. In granting the application to employ GHR, the Bankruptcy Court held that Bankruptcy Code section 327(e), rather than Bankruptcy Code section 327(a), applies. The bankruptcy judge distinguished between GHR’s pre- and post-petition representation, saying:

Whatever else may have gone on in the pre-petition negotiations, even if GHR was bad, bad, bad, now today, both the Debtor and GHR want to preserve and maximize the Debtor’s insurance assets. I’m not making a finding about whether GHR acted improperly pre-petition. I’m just saying that its pre-petition behavior cannot carry the day on a post-petition retention application for different services.

In affirming the bankruptcy court’s decision, the district court stated:

The insurers appealed the ruling on Gilbert’s retention. The District Court concluded that the bankruptcy judge was correct in her rulings on the alignment of interests and the application of section 327(e). The district judge commented that because the insurance companies were the primary source of funds to pay claimants, the carriers “have every interest in making it, to put it bluntly, difficult to confirm this bankruptcy, and that motivation is not lost on the Court.

In finding that the insurers had standing to object to GHR’s retention, the Third Circuit stated:

Article III standing need not be financial and only need be fairly traceable to the alleged illegal action. See Miller v. Nissan Motor Acceptance Corp., 362 F.3d 209, 221 (3d Cir.2004) (listing the elements of Article III standing). In the bankruptcy field, however, we have adopted a jurisprudential rule that limits appellate standing to persons or entities that are aggrieved by an order which diminishes their property, increases their burdens, or detrimentally affects their rights. Travelers, 45 F.3d at 742.
We cited the standing distinction in In re Combustion Engineering, Inc., 391 F.3d 190 (3d Cir. 2005). We recognized the acute need to limit appeals in bankruptcy cases which often involve a myriad of parties indirectly affected by every bankruptcy court order. Combustion Engineering involved a pre-packaged Chapter 11 plan similar to the one before us. We concluded that some of the insurers had appellate standing but only with respect to the limited group of issues that affected them. Id. at 217-18.
Here, the insurers are entitled to standing even under the more restrictive standard applied to bankruptcy proceedings. The retention of special insurance counsel is an important preliminary matter that will profoundly affect the determination of the validity of a proposed plan ab initio. It is an issue based on procedural due process concerns that implicate the integrity of the bankruptcy court proceeding as a whole. The retention of Gilbert as special insurance counsel will affect the resolution of issues that may directly affect the rights of insurers and fairness to the asbestos claimants.

In addressing the merits of the insurers’ objection to GHR’s retention, the Third Circuit held that GHR had an actual conflict because it represented the debtor in prepetition settlement negotiations and was also co-counsel prepetition with the plaintiff’s firm for those same asbestos personal injury claimants. According to the Court, the broad nature of the engagement required GHR’s retention under Bankruptcy Code Section 327(a), not Section 327(e) (which is more forgiving of a firm’s actual or potential conflicts and lack of disinterestedness). As such, the Court held, GHR’s retention would be more carefully scrutinized. In refusing to consider the firm’s retention as special counsel under Section 327(e), the Third Circuit stated that although GHR tried to distinguish between its insurance advice and other tasks it undertook, the firm’s efforts “might be likened to attempts at using a scalpel to carve a bowl of soup.”
In re A.P.I., Inc., (2005 WL 2630662) (Bankr. D. Minn., 10/15/05): Here, the Bankruptcy Court addressed an asbestos-related plan’s effect on insurers’ rights and on their standing to object to plan confirmation. Years earlier, while the debtor was fighting its insurers over coverage issues in state court, the debtor began negotiating the terms of a pre-packaged plan with its creditors and personal injury claimants. The parties, however, excluded the insurers from those negotiations. The debtor filed for bankruptcy relief in early 2005, and soon thereafter filed its pre-negotiated plan. The plan provided that all issues relating to insurance coverage would be resolved in the pending state court coverage action.
The insurers raised a total of 83 objections to the plan, but the debtor argued that the insurers lacked standing to object to the plan because they “had no interest cognizable under law that would be affected by [the plan] provisions or their performance.” The debtor stated that its “intent is to propose a plan that leaves all of the incidents of the relationship of insurer and insured in place post-confirmation, but for the assignment to the [claimant] trust, [whose] structure, rights, and long-term operations do not presuppose the availability of insurance coverage.”
The bankruptcy court ruled in the debtor’s favor on all issues, finding that confirmation of the plan would not have an inappropriate collateral effect on the insurance litigation and that the insurers had no standing to object to the plan.
Steve Jakubowski
© Steve Jakubowski 2005