By Michael G. D’Alba
Background
Imerys mined, processed, and distributed talc. As of 2019, more than 14,000 claimants had sued Imerys, alleging bodily injuries from talc exposure. Imerys would inevitably face more of such lawsuits because talc injuries often manifest long after exposure.
Accordingly, Imerys considered relief under chapter 11 of the Bankruptcy Code. In particular, Imerys wanted a trust that would compensate both present and future talc claimants, and an injunction to protect the reorganized debtor from future talc liability. Such relief is available under section 524(g) of the Bankruptcy Code, where a debtor is defending actions “for damages allegedly caused by the presence of, or exposure to, asbestos or asbestos-containing products.”[1]
Section 524 recognizes the conflict between present and future claimants over supervision of an asbestos trust. Persons already suffering from exposure want compensation now and have less concern that unwarranted or fraudulent claims might be paid. However, persons who will not begin to suffer from their exposure until a later date want careful supervision of the trust so that it is not depleted early on by payment of undeserving claims. Such persons may be unknown when the trust is created. Therefore, for the injunction under section 524 to be enforceable, the bankruptcy court must “as part of the proceedings leading to issuance of such injunction” appoint a “legal representative” to protect the rights of persons “that might” assert “demands” to recover damages for personal injury, wrongful death, or property damage after the reorganization plan is confirmed.[2]
Imerys’s Future Claims Representative
In preparing for its chapter 11 case, Imerys engaged a “proposed future claimants’ representative,” or “Proposed FCR.” The Proposed FCR was James Patton, a partner in the law firm of Young, Conaway, Stargatt & Taylor, LLP (the “Conaway Firm”). Patton retained the Conaway Firm to represent him as Proposed FCR.
Even though Imerys paid the fees and costs of Patton, Patton’s “sole responsibility and loyalty” ran to the future personal injury claimants.[3] Patton’s engagement as Proposed FCR ended when Imerys commenced its bankruptcy case.
Once before the bankruptcy court in Delaware, Imerys sought appointment of Patton as Future Claimants’ Representative. An application was also filed for the Conaway Firm to serve as Patton’s counsel. The applications disclosed that the Conaway Firm represented many insurers in coverage disputes relating to environmental liabilities, including asbestos claims. The applications also disclosed that, since 2010, the Conaway Firm had represented the Continental Insurance Company and the National Union Fire Insurance Company of Pittsburgh, PA in an ongoing insurance coverage dispute in the Delaware Superior Court over whether pump makers had coverage for asbestos-related injury claims alleged against them. Such matter is known as the “Warren Pumps litigation.”
A group of five insurers that included Continental, but not National Union, filed a limited objection to Patton’s proposed appointment. The insurers were to fund the trust under section 524(g).[4] They expressed concern not over the Warren Pumps litigation but over Patton’s independence from Imerys in view of Patton’s pre-petition work as Proposed FCR. The proposal to engage the Conaway Firm drew no objections.
At the hearing on Patton’s proposed appointment as FCR, the objecting insurers had the opportunity to cross examine Patton. Even though their own attorney had worked on the Warren Pumps litigation, he opted not to pursue a line of questioning based upon the Warren Pumps litigation. The bankruptcy court, however, requested additional disclosures before ruling on Patton’s appointment because it believed that the Conway Firm’s representation of certain insurers in the Warren Pumps litigation regarding asbestos claims coverage did raise concerns about whether Patton—a Conaway Firm partner—was independent and able to act with “undivided loyalty to demand holders.” The bankruptcy court rejected the notion that Patton’s pre-petition service as Proposed FCR affected his independence, which had been the basis of the insurers’ objection to Patton.
Patton responded by disclosing that Continental and National Union, in the engagement letter for the Conaway Firm to represent them in the Warren Pumps litigation, had agreed to a prospective waiver of certain conflicts of interest that might stem from the Conaway Firm’s bankruptcy work. Patton also revealed that the Conaway Firm had screened those involved in representing Patton as FCR from the firm’s work in the Warren Pumps litigation.
Only after these supplemental disclosures by Patton did the insurers, now joined by National Union, object to the proposed appointment on the grounds that the Conaway Firm’s representation in the Warren Pumps litigation presented a concurrent conflict of interest. National Union was one of the two in this group, the other being Continental, that had actually been represented by the Conaway Firm in the Warren Pumps litigation.
The bankruptcy court decided that the prospective conflict waiver by National Union and Continental was valid and that Patton met the appointment standard for a legal representative, as set forth by the bankruptcy court. Patton was appointed as FCR and authorized to retain the Conaway Firm as his counsel. The six insurers appealed to the district court, which affirmed the bankruptcy court. The matter then arrived at the Third Circuit.
The Third Circuit’s Decision
Of the six insurers who had appealed Patton’s appointment, only two—National Union and Continental—were clients of the Conaway Firm in the Warren Pumps litigation. Their standing was unquestioned. The other four insisted that even if Patton’s appointment did not prejudice them, they still had standing to raise the conflict of interest “on behalf of the future claimants.”[5] They cited In re Congoleum Corp., 426 F.3d 675 (3d Cir. 2005), in support of their standing. The Third Circuit rejected their argument and clarified that Congoleum had not eliminated the restrictive “person aggrieved” standard for appellate standing in bankruptcy cases that had been set forth prior to the Congoleum opinion in Travelers Insurance Co. v. H.K. Porter Co., Inc., 45 F.3d 737 (3d Cir. 1995). Unlike Congoleum, it was unnecessary to expand standing because National Union and Continental had been afforded “ample time and opportunity” to present the conflict to the bankruptcy court. Because they found no need to do so, the Third Circuit viewed their later assertion of the purported conflict as just a tactic to delay the confirmation of Imerys’s reorganization plan. In addition, the appointment of a legal representative differed from the proposed employment of special insurance counsel that was at issue in Congoleum. The bankruptcy court is required to appoint a legal representative as part of issuing a channeling injunction meaning that the court, itself, rather than third parties, is responsible for considering conflicts of interest. The judge in Imerys did so, and sought supplemental disclosures from Patton before ruling on his appointment as FCR.
The panel next considered whether the insurers had waived the purported concurrent conflict of interest by failing to raise it in their initial objection to the applications to appoint Patton as FCR. Patton and the Conaway Firm had disclosed the Warren Pumps litigation at the inception of Imerys’s effort to appoint them. However, the insurers waited until after the deadline to object to the proposed appointment had passed before they raised a purported conflict based upon the Warren Pumps litigation. Notice was given, and an opportunity to present the issue in an objection was provided, as well. Rather than do so, the insurers instead asserted that Patton could not be independent because of his pre-petition work as the Proposed FCR. The result was that there was little in the record about whether the Conaway Firm’s involvement in the Warren Pumps litigation was a basis to deny Patton’s appointment. In particular, there was nothing in the record to show that the Conaway Firm had gleaned information from representing Continental and National Union in the Warren Pumps litigation such that their position in Imerys’s chapter 11 case would be at risk from having Patton serve as FCR and the Conaway Firm be his counsel in that role. On this basis, the Third Circuit concluded that there were reasons to find that the conflict had been waived by the insurers while before the bankruptcy court. The appellate case could have been dispatched based upon waiver of the conflict, alone. However, the Third Circuit decided the merits.
Imerys and Patton argued that a legal representative need only be a “disinterested person” under section 101(14). The insurers argued that a legal representative had to be independent and have undivided loyalty to demand holders—the standard adopted by the bankruptcy court—and also be subject to the per se disqualification required by section 327 when a professional holds a conflict of interest.
“Disinterested person” is the standard in at least 11 sections of the Bankruptcy Code, but not section 524(g). The Third Circuit presumed its absence to have been intentional and noted that the absence fitted the statutory scheme: the “disinterested person” standard governs professionals who owe duties to the bankruptcy estate or the court and bars those who represent interests that are adverse to the bankruptcy estate, while a “legal representative” charged with protecting the interests of future demand holders by definition represents an interest that is adverse to the bankruptcy estate. Similarly, the Third Circuit presumed that by including the term of art “legal representative” in section 524(g), Congress intended to adopt the fiduciary duty standard that legal representatives are understood to owe their clients. The text and structure of the Bankruptcy Code suggested that the standard exceeded “disinterestedness.”
While the insurers contended that Congress’s amendment of the Bankruptcy Code after certain lower court decisions had used the “disinterested person” standard to appoint legal representatives constituted legislative acquiescence to such standard, the Third Circuit determined that those decisions were not sufficient in number or type to find acquiescence.
In addition, the standard applied to creditors’ committees guided the standard that should be applied to legal representatives. Even though the Bankruptcy Code requires only that members of a committee be “adequate” representatives, decisional law has established that they owe fiduciary duties to the committee’s constituents. The Third Circuit concluded that such a standard is “equally appropriate” with respect to a “legal representative” under section 524(g).
Accordingly, the Third Circuit required that a future claimants’ representative “be able to act in accordance with a duty of independence from the debtor and other parties in interest in the bankruptcy, a duty of undivided loyalty to the future claimants, and an ability to be an effective advocate for the best interests of the future claimants.” Even though a fiduciary standard applies, the court rejected the categorical approach of the insurers, which would require disqualification of a proposed legal representative based upon any technical conflict, standing alone. Instead, bankruptcy courts exercising their discretion in individual cases can properly evaluate whether an alleged ethical conflict requires disqualification. Also, if the insurers’ per se standard were to be deployed, it would reduce the pool of effective candidates for the position.
The Third Circuit then applied its standard to Patton. The alleged conflict arose from the Conaway Firm’s representation of insurance companies in the Warren Pumps litigation. The court found that the prospective waiver by the insurers in that case did apply to Patton’s proposed service in the Imerys case, and that the waiver was valid. While the insurers believed that they were entitled to decide whether they should consent to the specific conflict presented, a “second round” of consent is not available where there has been a valid prospective waiver. The insurers also argued that Patton would be an ineffective advocate for future claimants because the Warren Pumps litigation involved issues that were “substantially related” to those in Imerys’s case. The insurers were incorrect because “substantially related” would require that the two matters involve the same transaction, which they did not. Also, the insurers had not presented facts to show that Patton and the Conaway Firm would be able to use confidential information obtained from the Warren Pumps litigation matter to the detriment of the insurers in the Imerys case. Moreover, the bankruptcy court—unprompted by the insurers—had inquired about the alleged conflict. That inquiry suggested that the insurers’ position was purely tactical because the supplemental disclosures showed the use of screening at the Conaway Firm, that Patton had never been involved in the Warren Pumps litigation, at all, and that the Conaway Firm had done little work on the Warren Pumps case since 2016.
The belated and tactical press of a purported conflict of interest has yielded a fiduciary standard for the appointment of “legal representatives” for future claimants against asbestos trusts. It is not a guardian ad litem standard because the representative cannot bind future demand holders, but the heightened duties mean that debtors seeking the protections of a channeling injunction should seek to propose experienced and competent professionals for appointment as legal representative.
[1] 11 U.S.C. § 524(g)(2)(B)(i)(I).
[2] 11 U.S.C. § 524(g)(4)(B)(i).
[3] While section 524(g) requires a legal representative, that does not necessarily entail a formal attorney-client relationship between the representative and future claimants. Still, given the nature of Patton’s role, how the rules of professional conduct applicable to attorneys would regard the compensation arrangement between Patton and Imerys warrants comment. In California, such an arrangement is permissible where it complies with Rule 1.8.6 of the California Rules of Professional Conduct, which is entitled “Compensation from One Other than Client.” One of the Rule’s three requirements is that the attorney obtain the client’s informed written consent to compensation from another. Obtaining consent from the client is only possible when the client is known. In cases like that of a legal representative for future claimants, however, the identities of all of the clients will not be known because of the period between exposure and manifestation of injury. Rule 1.8.6 appears to recognize the problem by not requiring informed written consent if “nondisclosure . . . is otherwise authorized by law or a court order . . . .” Section 524(g) of the Bankruptcy Code might qualify as law that otherwise permits nondisclosure. Moreover, Comment No. 4 to Rule 1.8.6 provides guidance that appears to be relevant to the position of a legal representative under section 524(g) of the Bankruptcy Code: “In some limited circumstances, a lawyer might not be able to obtain client consent before the lawyer has entered into an agreement for, charged, or accepted compensation, as required by this rule. This might happen in certain commercial settings, such as when a lawyer is retained by a creditors’ committee involved in a corporate debt restructuring and agrees to be compensated for any services to be provided to other similarly situated creditors who have not yet been identified. In such limited situations, paragraph (c) permits the lawyer to comply with this rule as soon thereafter as is reasonably practicable.”
[4] An injunction issued under section 524(g) may bar actions against third parties that are alleged to be liable for claims and demands against the debtor based upon certain grounds, including the “third party’s provision of insurance to the debtor or a related party.” 11 U.S.C. § 524(g)(4)(A)(III).
[5] National Union and Continental could assert that their interests in Imerys’s bankruptcy case were somehow capable of being harmed as a result of the Conaway Firm’s ongoing representation of National Union and Continental in the Delaware Superior Court and the Conaway Firm’s representation of Patton as FCR. The other four insurers were raising the other side of the conflict. They were contending that the Conaway Firm’s and Patton’s loyalty to their insurance company clients would limit their advocacy on behalf of future claimants against the trust.