NEARLY THREE-QUARTERS of a million asbestos claims have been filed in US state and federal courts. About 100,000 were filed in 2003 alone, though as many as half of all new claimants have yet to suffer significant illness as a result of exposure to asbestos.
Lobbying group Asbestos Alliance says claims and costs have bankrupted more than 70 US companies. The total costs of settlements could reach $265 billion.
One case, which is winding its way through the English High Court in London and the US Bankruptcy Court in Delaware, shows what happens when the labyrinthine complexities of asbestos litigation combine with clashes of bankruptcy law and procedure. Precedents are being set for corporates, bondholders, banks, pension schemes, and insolvency professionals that find themselves tangled up in future cross-border insolvencies. And, according to one adviser, the case is burning around $10 million a month in fees.
In Delaware, New York Stock Exchange-listed Federal-Mogul Corporation and 22 US subsidiaries are subject to Chapter 11 bankruptcy proceedings. In the UK, 134 companies are in administration. Many are members of the Turner & Newall (T&N) Group, which Federal-Mogul bought in 1998. One of T&N’s businesses was making and installing building materials that contained asbestos.
“This is probably the most complicated cross-border insolvency ever,” says Robin Parsons, a London partner at Sidley Austin Brown & Wood, lawyers to Federal-Mogul. “It is absolutely extraordinary and the issues being raised are of huge importance.”
A silent epidemic
The word asbestos comes from the Greek for “inextinguishable”. Ancient chroniclers recorded that weavers who made asbestos cloth developed breathing problems.
A couple of millennia later, and companies that mined asbestos, or manufactured, sold or used asbestos products, must wish that they were as observant. In the 1960s, asbestosis, which scars the lung tissue, and mesothelioma, a fatal cancer, started triggering compensation claims from sufferers. As the number of asbestosis claims levels off, mesothelioma claims will rise in number. The “silent epidemic” that already kills 1,800 people in the UK annually will peak in 10 years.
T&N’s is the first large UK asbestos bankruptcy and may be the largest ever UK non-insurance insolvency. It highlights the problem of underfunded pension schemes, a recent big worry for UK companies. It is groundbreaking in the way the UK administrators have let T&N’s management carry on the day-to-day running of their business. It has established one of the first detailed protocols to synchronize the different US and UK insolvency procedures. And it could become the first restructuring where UK businesses are saved using the asbestos claim provisions of Chapter 11 of the US Bankruptcy Code.
Federal-Mogul is not a bad business. Nearly 45,000 employees make and distribute engine and vehicle parts worldwide. In 2003, net sales from continuing operations were around $5.5 billion.
Its difficulties are a direct result of asbestos litigation, mostly brought by US residents against both Federal-Mogul and T&N and their subsidiaries. In 1998, Federal-Mogul Group made asbestos payments worth $89 million; in 1999, $178 million; and in 2000, $351 million. Between 90% and 100% of all these payments were related to T&N liabilities.
By October 2001, the asbestos burden was unbearable:114,443 personal injury claims were pending against T&N. Federal-Mogul Corporation and T&N filed for Chapter 11 relief. The English companies applied for administration orders in the High Court and Kroll Buchler Phillips was appointed UK administrator. Federal-Mogul was the sixth major publicly traded company in 20 months to file for Chapter 11 protection because of asbestos litigation.
The big problem is future US claims. Nobody knows how many there will be, so the value of liabilities is hard to work out. In February last year, one actuary estimated the present cost of over 1.16 million future claims to T&N as $5.728 billion. However, elsewhere in the same memorandum, the same actuary states that the figure could be $10.497 billion.
Uncertain valuations
This higher potential exposure arises partly because T&N is no longer part of the Center for Claims Resolution, which has coordinated asbestos litigation on behalf of defendants and often achieved lower settlements. It is also because, if Federal-Mogul and T&N’s Chapter 11 reorganization plan is eventually implemented, individual asbestos claimants can expect larger awards, since the quality of the claims allowed to proceed would be higher.
Others reckon these figures are too high. In the UK, the T&N pension scheme has around 37,000 beneficiaries. By the end of March last year, it had an estimated deficit of £97 million. In any winding up of T&N, it would have the largest single claim. An actuary commissioned by the pension fund trustees puts the cost of future US liabilities at between $2.1 billion and $5.5 billion.
In most transatlantic workouts, a Chapter 11 restructuring, once agreed by different parties and given US court approval, is implemented in the UK via schemes of arrangements and company voluntary administrations (CVAs).
Federal-Mogul isn’t like most transatlantic workouts.
Early on, the administrators and the US and English companies in Chapter 11 took the unusual step of entering into a cross-border insolvency protocol. Adopted in January 2002, it will “promote the orderly and efficient administration of the Insolvency Proceedings to… reduce the costs” for the benefit of all debtors and creditors.
“Communication between courts is difficult,” says Susan Hazledine, a litigation partner at Allen & Overy, the law firm advising the T&N pension trustees. “You can’t effectively have two judges sitting together and producing a judgement. One issue is how on earth would you appeal it?”
The administrators, meanwhile, agreed to let the directors of the UK companies continue to exercise their powers, subject to the administrators’ veto. “That’s a novelty,” says one lawyer. “The administrator has let the management run the UK business while it tries to do a deal with the asbestos creditors.” T&N’s is in effect the first debtor-in-possession administration.
Lastly, the protocol provides for the preparation of a reorganization plan for all US and UK companies in Chapter 11. This was submitted to the US court on June 4.
The plan
A Chapter 11 debtor is protected against creditor actions while it seeks creditor and court approval for its reorganization plan.
Federal-Mogul’s unsecured creditors hold notes issued by Federal-Mogul Corporation worth approximately $2.2 billion. The major bondholder is US billionaire investor Carl Icahn. Collectively, the noteholders set up a creditor committee, as did one UK and eight US asbestos claimants.
The key to the reorganization plan is a resolution of US asbestos claims. Under section 524(g) of the US Bankruptcy Code, debtors can set up asbestos trusts. An s524(g) trust must assume the debtor’s asbestos liabilities and it must use its assets or income to pay asbestos claims.
S524(g) trusts are vital to the success of Chapter 11 reorganization plans because those asbestos creditors whose claims they assume must approve any plan by a 75% majority. In exchange for their approval, the plan demands that all present and future asbestos claims are made against the trust, not the debtor.
A viable trust, and therefore a viable reorganization plan, needs agreement between Federal-Mogul’s noteholder creditors and its asbestos creditors. If the plan were implemented, the trust would receive 50.1% of the common stock of the reorganized Federal-Mogul. The noteholders would get the remaining 49.9%. The noteholders get the right to appoint a majority of Federal-Mogul directors and so effectively control the group’s management.
“In the US, you get a horse trade between the bondholders and asbestos creditors,” says one lawyer involved. “The asbestos creditors get access to the trust and its insurance assets. The bondholders get rid of the liabilities and get the business.”
In Federal-Mogul, this horse-trading has created a stand-off between on the one side the reorganization plan’s proponents – the official committees of the noteholders and the US asbestos claimants, a representative of future asbestos claimants, Federal-Mogul’s bank creditors, and the US and UK debtor companies themselves – and on the other side the UK administrators and UK creditors.
To get court approval, a Chapter 11 reorganization plan must treat all unsecured creditors equally. Kroll Buchler Phillips feels that the proposed plan treats the different creditors of the UK companies unfairly. The stumbling block is the valuation of future US asbestos liabilities.
The value of Federal-Mogul’s common stock is between $1.8 billion and $2.2 billion. This gives the noteholders a likely recovery rate of at least 38% of the face value of their bonds when they receive their 49.9% of the stock. The 50.1% of the common stock that goes into the s524(g) trust would be divided by the estimated value of asbestos claims to give asbestos claimants their recovery rate. Because of the huge potential value of future claims, that rate is far lower. Using the $10.497 billion estimate of future US liabilities gives them an estimated recovery of 7.2% of the value of the claims they have filed. If they approve the plan and take the money, other unsecured creditors can be bound to a similar recovery rate of around 7%. The T&N pension trustees think this is too low.
“Future US asbestos liabilities are anywhere between $1.6 billion and $10.5 billion, and the plan proponents have put forward the higher figure,” says Hazledine. “Indirectly, that gets every other creditor a worse deal. If the asbestos claimants are willing to accept 50.1% of a business worth X, that tells you what their acceptable recovery rate is. That’s fine if other creditors think that $10.5 billion is valid and that 50.1% is what the asbestos creditors should get. If views on those figures vary, you disagree.”
Another London-based lawyer says: “US management is onside because of debtor-in-possession. Over here, Kroll looks at the deal from the perspective of what creditors get in a liquidation. That’s what they do as administrators.”
Under English law the administrators probably don’t have to implement the plan if and when it gets US court approval. They could opt for a process of controlled realization, including selling the UK businesses, if they feel it will do better for UK creditors.
“There may be questions as to whether the administrator can be forced to implement the plan,” says Hazledine. “I don’t think that’s arisen before.”
The plan anticipates this. As one lawyer paraphrases it: “The plan proponents say: ‘If the UK administrator thinks it can get more through a liquidation, go for it.'”
This is where other differences between US and UK law could make things even more complicated. US successor liability means US asbestos creditors can try to sue buyers of companies with liabilities. Estimates of the value of a controlled realization range from $448 million from the plan proponents to $1.116 billion from the administrators. But who will buy T&N with US asbestos claims knocking around?
No quick fixes
“It will be a long time before laws are harmonized and I’m not sure there’s a satisfactory solution to T&N,” says one lawyer.
So, where does that leave the plan?
The latest instalment in the saga should have come on December 9 2004, when the Delaware court was due to give an estimation of the value of future asbestos liabilities. This could then be used to work out a confirmable reorganization plan. But estimation was delayed until this month, and it is unclear if a deal acceptable to UK administrators can be built around a US estimation. “The High Court can’t use it,” says one UK lawyer. “The liquidator needs to look at individual cases in the event of a winding up.” This problem is currently being discussed under the protocol.
“We still do not have a system that enables courts in different jurisdictions to cooperate on a global restructuring so as to produce the best outcome for all creditors,” says Parsons. “If one single court had been given authority this would be over more quickly, and a quick outcome is best.” In Federal-Mogul, where the biggest asbestos claims are by US claimants against UK companies, giving the workout to a single court would be difficult.
Meanwhile, Federal-Mogul has withdrawn its offer to keep paying the minimum funding requirement contributions to the T&N pension scheme. “Because they are contingent creditors, the view is that they should have to bear some of the pain equally with other unsecured creditors,” says Parsons. “Various proposals were made to make sure that they didn’t have to suffer unless there was a winding up of the scheme.”
But the status of the pension scheme is still critical. Under the UK’s new Pensions Act, if T&N does go into liquidation, the pension deficit can be valued by working out how much it would cost to buy every member an annuity at current rates. This gives a figure of over £800 million, significantly more than if T&N avoids liquidation. None of the plan proponents wants a deal that is subsequently unpicked by the UK pensions regulator.
As things stand, it’s hard to see which creditors will get what, and when Federal-Mogul will come out of Chapter 11. Nobody doubts the sincerity of all parties trying to get a deal done. The problems remain the clash of law and procedure, and possibly a failure to appreciate these on the part of the plan proponents. “The UK administrators were appointed following a competitive tender in which all the plan proponents took part,” says another lawyer. “US creditors have found to their shock that the administrators have exercised their rights and obligations regarding T&N as officers of the court.” And the plan proponents must understand the restrictions under which the High Court operates.
This is not arcane jurisprudence. Another lawyer says: “A deal depends on whether the UK courts reject what the administrators pitch as an attempt to force US procedures on a UK company.”
“There are real issues about decisions being made in another country affecting UK businesses with UK creditors,” says Hazledine. Given US value investors’ interest in European debt, how those issues are dealt with will shape more and more cross-border workouts.
