Third Circuit Weighs In On Scope Of Section 524(g)(4) Injunction

Summary: A recent Third Circuit decision has clarified the scope of the third-party injunction, including injunctions in favor of insurers that resolve insurance coverage in asbestos bankruptcy cases, that may be issued under Section 524(g) of the Bankruptcy Code. Liability covered by such an injunction must be "derivative" of the debtor, meaning that under state law, the third party's liability must depend on the debtor's liability. And it must be limited to liability that is "legally caused" by a statutory relationship (such as insurer, director, etc.) between the third party and the debtor.

Almost 25 years ago, Section 524(g) was added to the Bankruptcy Code to codify a procedure, pioneered by the U.S. Bankruptcy Court for the Southern District of New York in the Johns Manville bankruptcy case, to permit bankrupt companies faced with continuing liabilities because of their use or distribution of asbestos-containing products to resolve both their current and their future asbestos-related liabilities. A conventional chapter 11 bankruptcy case addresses only "claims" against the debtor, and it was argued that the rights of individuals who had been exposed to asbestos-containing products but who had not yet manifested any injury as of the date of the debtor's bankruptcy were not claims that were subject to the discharge. If the holders of such "demands" could bring suit, if and when they developed an asbestos-related disease, against the company that emerged from bankruptcy protection, it would be impossible for a company with asbestos liabilities to reorganize in bankruptcy.

This new section of the Bankruptcy Code allowed the bankruptcy plans of such companies to enjoin the holders of such future asbestos demands against the debtors from pursuing the reorganized company. The statute required, however, that the trust that would pay such creditors receive securities issued by the reorganized company. And it imposed procedural protections designed to ensure that the holders of future demands received the same treatment as current creditors did.

Significantly, although the Bankruptcy Code does not otherwise expressly authorize third-party releases, Section 524(g) also permits bankruptcy courts to grant such protection to certain categories of third parties that might be held derivatively liable for the conduct or claims against the debtors. Perhaps the paradigmatic candidates for such third-party releases are those that own (or that previously owned) the debtor, that might be held...