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Third Circuit Addresses the Due Process Rights of Asbestos Claimants

When there are large numbers of substantial individual tort claims against a debtor, potentially involving claimants unknowable to the debtor who themselves may not know they have a claim, the bankruptcy process faces special problems.  One objective of bankruptcy is to afford final relief to the debtor from the debtor’s debts, but discharging the claims of those unknown claimants without notice and a hearing poses due process problems.  A standard way to address this issue, which has arisen prominently in asbestos cases, is for the debtor to create and fund a trust to provide for tort claims brought in the future, with the court issuing an injunction channeling such claims to the trust rather than the reorganized entity.  See, e.g., 11 U.S.C. § 524(g) (providing for such trusts for asbestos-related litigation).  But are such trusts the only way to resolve such claims?  This question is raised by the Third Circuit’s recent decision in In re Energy Future Holdings Corp, No. 19-1430, 2020 U.S. App. LEXIS 4947 (Feb. 18, 2020).  The debtor instead devised a process reliant on Rule 3003(c)(3) of the Federal Rules of Bankruptcy Procedure, which authorizes a court to extend the time for filing a claim “for cause shown.”  In the circumstances of that case, and with publication notice to potential claimants, the Third Circuit held that this approach comported with due process.

The debtor, Energy Future Holdings Corporation (“EFH”), had four subsidiaries with substantial asbestos-related liability.  As part of its chapter 11 reorganization, EFH sought to sell certain assets, including those subsidiaries, to Sempra Energy, in a transaction ultimately structured as a merger.  In a bankruptcy case, a court will typically set a date by which all claims against the debtor must be filed, known as a bar date.  Sempra proposed to pay all the asbestos claims filed by the bar date using funds from inter-company loans between EFH and its subsidiaries.  Instead of setting up a trust under section 524(g), future claimants – whose claims would be discharged by the order confirming the chapter 11 plan – could obtain permission to file their claim after the bar date under Rule 3003(c)(3), and seek reinstatement of their discharged claims on due process grounds.  The bankruptcy court accepted this approach, set a bar date, and confirmed the plan, and the merger was consummated.  Several claimants who did not file by the bar date and later were stricken by mesothelioma (the “Appellants”) appealed the bankruptcy court’s confirmation order, arguing that it violated their due process rights.  The district court rejected the challenge under section 363(m) of the Bankruptcy Code, which bars appeals of an order authorizing a sale that affect the sale’s validity, unless the sale order is stayed.  The Appellants appealed to the Third Circuit Court of Appeals.

The Third Circuit held that section 363(m) partially barred, but did not entirely bar, the Appellants’ due process challenge.[1]  First, the Third Circuit rejected the Appellants’ argument that there is a due process exception to section 363(m), reasoning that the Appellants could have sought a stay of the sale, but failed to do so.  Second, the Third Circuit held that the confirmation order here was an order authorizing a sale, because it was inextricably intertwined with the merger with Sempra.  Third, the Third Circuit held that the challenge to the sale order affected the validity of the sale insofar as the Appellants sought to reverse the discharge of their claims and for EFH to set up a section 524(g) trust.  Such a remedy would disturb Sempra’s expectations and effectively increase its purchase price.  However, the Third Circuit held that section 363(m) did not bar the Appellants’ argument that Rule 3003(c)(3) cannot provide constitutionally adequate process to claimants filing after the bar date, since the parties to the sale contemplated that there would be a fair process post-confirmation for handling such claims.

The Third Circuit then considered whether the Rule 3003(c)(3) process comported with due process.  To successfully bring a due process challenge, claimants must establish that they were deprived of an individual interest within the “life, liberty, or property” protected by the Fourteenth Amendment, and that this deprivation happened without due process of law.  The Third Circuit agreed that the ability to pursue an asbestos claim was a protected property interest.  However, the Third Circuit held that the process afforded was constitutionally adequate because of the combination of the notice before confirmation and the hearing afforded after confirmation, which together afforded claimants the traditional requirement of notice and a hearing.

As to pre-confirmation notice, the Third Circuit noted that asbestos claimants had been afforded publication notice before the bar date.  EFH had published notices in consumer magazines, newspapers, union publications, and Internet outlets.  Under established law, claimants who are unknown at the time of discharge are only entitled to publication notice. 

As to the post-confirmation hearing, the Third Circuit reviewed the standard for filing a claim after the bar date under Rule 3003(c)(3).  Under Pioneer Investment Associates v. Brunswick Associates LP, 507 U.S. 380 (1993), a claimant must demonstrate “excusable neglect” when it seeks to file a late claim.  A claimant can satisfy this standard under Rule 3003(c)(3) when the danger of prejudice to the debtor is low, the claimant shows good reason for the late filing, and the length of the delay does not have an excessive impact on the judicial proceedings.  The Third Circuit reasoned that claimants would have the opportunity to demonstrate the absence of prejudice, since the prospect of post-confirmation claims was built into the merger agreement.  Likewise, as to the length of delay, the claimants would be able to argue that there was no impact on the judicial proceedings since the bankruptcy proceedings concluded with the confirmation order.  And to the extent claimants have a tenable due process argument that notice was inadequate for discharge, for example because of their lack of knowledge of exposure to asbestos or of the extent of harm they may incur, that would count as a good reason for their filing a claim after the bar date.  The Third Circuit thus reasoned that claimants would be able to obtain relief with a simple motion reciting why there is no prejudice to EFH and no impact on the bankruptcy proceedings, and attaching an affidavit explaining why notice of the bar date did not comport with due process as to them.  The Third Circuit emphasized in this respect the special care that courts must accord to pro se claimants.  The Rule 3003(c)(3) process was therefore held to comport with due process.

The Third Circuit concluded by characterizing this case as a “cautionary tale for debtors attempting to circumvent § 524(g).”  While EFH did not set up a trust under section 524(g), its approach resulted in claimants who did not receive proper notice still being reimbursed, but with additional litigation.  But the court noted that its charge did not extend to evaluating EFH’s strategic choices, and concluded that the process EFH had chosen was lawful. 

[1] The Third Circuit also rejected two other arguments raised by EFH against considering the due process claim on the merits, that the claim was not ripe and that the appellants had not timely appealed.