The U.S. Court of Appeals for the Fourth Circuit issued an opinion today affirming Western District of North Carolina Judge Robert Conrad’s January 2022 decision
upholding a bankruptcy court-issued preliminary injunction in the Bestwall LLC Texas two-step case. The injunction prohibits asbestos-related actions against certain nondebtor affiliates including predecessor entity Georgia-Pacific Holdings LLC (Old GP), Georgia-Pacific LLC (New GP) and other affiliates of the debtor and New GP.
The preliminary injunction was issued
in July 2019 in the debtor’s injunctive relief adversary proceeding
, which Bestwall commenced on its Nov. 2, 2017, petition date. Bestwall’s official asbestos claimant committee, or ACC, and future claimant representative, or FCR, appealed the injunction and the subsequent district court ruling, arguing that the bankruptcy court lacked jurisdiction to issue the injunction or, alternatively, that the bankruptcy court applied the wrong standard for a preliminary injunction.
Circuit Judge G. Steven Agee authored the opinion, joined by district Judge Henry E. Hudson (sitting by designation), concluding that the district court correctly decided that the bankruptcy court had “related to” jurisdiction to issue the preliminary injunction and applied the proper legal standard.
Circuit Judge Robert B. King issued a dissenting opinion agreeing with the appellants that Bestwall, Old GP and New GP “manufactured the jurisdiction of the bankruptcy court in these proceedings, in an unmistakable effort to gain leverage over future asbestos claims against New GP,” despite that entity’s admitted ability to satisfy all asbestos liabilities with its “evidently bountiful assets.”
Judge King concludes that the preliminary injunction should be vacated because the parties’ “creative use of the so-called ‘Texas divisional merger’ and the creation of unorthodox contractual relationships between Bestwall and New GP … ran afoul of the foundational principle that parties may not artificially construct a federal court’s jurisdiction.” The dissent concludes that Old GP “reformed its corporate existence precisely so that its principal successor entity, New GP, could be afforded bankruptcy relief without ever having to file for bankruptcy.”
“In sum,” writes Judge King, “I would squarely reject Georgia-Pacific’s use of its 2017 restructuring - little more than a corporate shell game - to artificially invoke the jurisdiction of the bankruptcy court and obtain shelter from its substantial asbestos liabilities without ever having to file for bankruptcy.”
The majority and dissenting opinions outline the relevant background of Bestwall’s Texas two-step case, beginning with the July 2017 Texas divisional merger undertaken by Old GP, under which two new entities were created that ultimately became the debtor and New GP. Bestwall inherited Old GP’s asbestos liabilities and limited assets, while New GP received Old GP’s remaining assets and liabilities. In related transactions, the debtor became a payee to a funding agreement with New GP under which the debtor is entitled, to the extent its own assets are insufficient, to funding for all costs and expenses incurred in the normal course of its business and the funding of a section 524(g) trust. Bestwall also agreed to indemnify New GP for any losses relating to the debtor’s asbestos liabilities.
Agreeing with the district court that the bankruptcy court had “related to” subject matter jurisdiction to enter the injunction, Judge Agee “emphasize[s] that this conclusion is based on the specific circumstances of this case, including the involvement of thousands of identical claims against New GP and Bestwall and the fact that the claims against New GP are, or could be, pending in many state courts around the country.”
Judge Agee writes that the bankruptcy court correctly decided that the asbestos claims against Bestwall are “identical” to claims against New GP that were commenced prepetition or “are likely” to be commenced in future state court cases absent the injunction. Allowing litigation over the “same claims
” to proceed would undisputedly have an effect on Bestwall’s estate, says the opinion, concluding that “the possible effect on the Bestwall bankruptcy estate of litigating thousands of identical claims in state court is sufficient to confer ‘related to’ jurisdiction.”
In addition to affecting recoveries from the estate, state court judgments against New GP would introduce “issue preclusion, inconsistent liability, and evidentiary issues” into the bankruptcy case, which would also “inevitably” impact the estate, Judge Agee reasons. The opinion separately observes, without deciding, that Bestwall’s indemnification and related obligations to New GP “would also likely have a cognizable effect on the Bestwall bankruptcy estate in the absence of the injunctive relief.”
Judge King writes in his dissent that he “do[es] not necessarily disagree” that asbestos litigation against New GP “might conceivably ‘affect’ Bestwall’s bankruptcy estate,” but notes that “the problem remains that such ‘effects’ would arise only
because Old GP ensured that they would.”
Judge Agee further rejects the appellants’ (and Judge King’s) contention that Old GP “impermissibly sought to manufacture jurisdiction in the bankruptcy court” via the divisional merger, “which could prevent this Court from exercising ‘related to’ jurisdiction.” The majority opinion concludes that the parties did not manufacture jurisdiction because, absent the divisional merger, the asbestos liabilities would have stayed with Old GP, which could have commenced its own bankruptcy case, and the bankruptcy court would have had jurisdiction over the asbestos claims “as it does over the same claims here.” Judge Agee accordingly agrees with Bestwall and New GP that the divisional merger “leaves the jurisdictional result the same
Judge King contends in his dissent that the majority “misses the point” by “focusing on jurisdiction over claims instead of parties,” emphasizing that New GP, the party to be shielded from litigation, would not exist absent the divisional merger. Judge Agee counters that “there is no way to separate the parties from the claims here and, even if there were, we would decline to do so” because the bankruptcy jurisdiction statute (section 1334(b) of title 28) “requires us to analyze whether the claims
involving New GP are ‘related to’ the bankruptcy case” and “does not instruct us to consider the parties in isolation.”
The Third Circuit’s January decision
directing dismissal of LTL Management’s two-step case does not affect the “manufactured-jurisdiction analysis,” says the majority opinion. The LTL decision is not relevant because it focused on the debtor’s financial distress and lack of good faith in filing for bankruptcy, which are not at issue in the Bestwall appeal, Judge Agee writes, adding that “[a]s importantly,” the Third Circuit did not reach the “critical issue present here” of whether the bankruptcy court had jurisdiction to enter a preliminary injunction.
Judge King’s dissent agrees that the LTL decision is not applicable but says that case nonetheless “underscore[s] the very point at issue here - a healthy corporation’s placement of a liability-laden subsidiary into bankruptcy in order to avoid Chapter 11 reorganization for the balance of the healthy company is not guaranteed to result in smooth sailing.”
Judge Agee dismisses as a “non-starter” the appellants’ argument that Old GP manufactured jurisdiction by causing Bestwall and New GP to enter into the indemnification and funding agreements in connection with the divisional merger. The majority’s finding of jurisdiction “is not predicated on those agreements,” says the opinion, but is instead based on “the thousands of identical claims pending against New GP outside of the bankruptcy proceeding and the effect of those claims on Bestwall’s bankruptcy estate, which Old GP clearly could not and did not manufacture.”
Judge King counters in his dissent that Bestwall’s indemnification obligations to New GP were clearly intended to manufacture jurisdiction, calling the “supposed” indemnity obligations “wholly circular, essentially a legal fiction,” because Bestwall could only satisfy such obligations with cash obtained from New GP under the funding agreement.
Judge King’s dissent also contends that Bestwall was obligated to show that the divisional merger was “driven by an independent, legitimate business justification, and that those maneuvers were not ‘pretextual.’” According to Judge King, Bestwall failed to provide “any substantive explanation along those lines” and even concedes that the purpose of the restructuring was to “shield the corporation’s assets without the need for a wholesale declaration of bankruptcy.” As a result, the dissent “readily conclude[s]” that the parties “together ‘improperly or collusively made’ - from whole cloth - the bankruptcy court’s jurisdiction.”
The majority opinion declines to decide whether such a showing was needed but nevertheless concludes that “Bestwall did make that showing,” finding that the “record establishes that the restructuring was driven by Old GP’s desire to pursue its non-asbestos-related business apart from asbestos-related litigation or a bankruptcy proceeding while keeping its assets available to satisfy any asbestos-related liabilities, if required.”
Concluding the majority’s jurisdictional analysis, Judge Agee criticizes the appellants’ arguments as a “premature and improper” “back-door way” to attack the merits of the divisional merger and the yet-to-be-filed chapter 11 plan. According to the majority opinion, the “main interference” with a timely resolution of Bestwall’s case “appears to be” the appellants’ challenge to the preliminary injunction, “thereby prolonging the bankruptcy process and preventing the claimants from obtaining prompt relief.”
“It is not clear why Claimant Representatives’ counsel have relentlessly attempted to circumvent the bankruptcy proceeding,” Judge Agee continues, “but we note that aspirational greater fees that could be awarded to the claimants’ counsel in the state-court proceedings is not a valid reason to object to the processing of the claims in the bankruptcy proceeding.”
The majority finally agrees with the district court that the bankruptcy court applied the appropriate legal standard for a preliminary injunction. The court first rejects the appellants’ argument that under the first prong of the preliminary injunction test - likelihood of success on the merits - the bankruptcy court improperly focused on the likelihood of reorganization rather than the likelihood that a permanent injunction would be embodied in a confirmed plan. This argument “puts the cart before the horse,” Judge Agee writes, because proof of entitlement to a permanent injunction under Bankruptcy Code section 524(g) is not required until the plan confirmation stage.
Judge Agee next concludes that the appellants failed to provide any precedential support for their separate argument that the preliminary injunction standard requires a “clear showing” that the debtor will be able to reorganize rather than the “realistic possibility” standard applied by the bankruptcy court. Moreover, if such a showing were required before the plan confirmation stage, “chapter 11 proceedings would never get off the ground,” says the judge.