Bankruptcy as MDL escape hatch? Not so fast, judge tells 3M in ‘surprise’ decision

The 3M logo is seen at its global headquarters in Maplewood, Minnesota, U.S. on March 4, 2020. Picture taken March 4, 2020. REUTERS/Nicholas Pfosi/File Photo

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(Reuters) – A federal bankruptcy judge in Indianapolis jolted 3M Co on Friday, ruling that scores of thousands of military veterans who claim hearing loss from 3M earplugs can continue to litigate their claims against 3M, despite the July 26 bankruptcy of several 3M subsidiaries. The company’s shares, as my colleague Dietrich Knauth reported, dropped 12% Friday and continued falling on Monday morning.

But the decision’s implications extend beyond 3M and the earplug multidistrict litigation. The ruling by U.S. Bankruptcy Judge Jeffrey Graham of Indianapolis should also be a warning to other MDL defendants: A subsidiary’s bankruptcy may not be the escape hatch you’re hoping for.

Graham’s ruling took even seasoned bankruptcy observers such as law professor Lindsey Simon of the University of Georgia School of Law by surprise, since courts frequently agree to extend litigation stays to the parents of bankruptcy subsidiaries. Reuters, for instance, has reported extensively on the so-called Texas two-step, in which solvent companies dump mass tort liability into a newly created subsidiary that then declares bankruptcy. That maneuver depends on halting litigation against the parent company in order to use the bankruptcy process to attain a global settlement.

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To be sure, Graham’s decision doesn’t preclude 3M and its subsidiaries from continuing to push for a global settlement through the bankruptcy process. 3M, which has lost 10 of 16 bellwether trials in the earplug MDL before U.S. District Judge M. Casey Rodgers of Pensacola but vehemently denies that its products were defective, has said repeatedly that it believes bankruptcy is the fairest and most efficient way to resolve its liability. 3M can still try to make that pitch to plaintiffs in the MDL — but as Graham noted in his opinion, the company and its bankrupt subsidiaries have substantially less leverage without a stay of the MDL litigation against 3M.

3M filed a notice of appeal of Graham’s ruling on Monday. I suspect the company will ask to bypass federal district court and take its appeal directly to the 7th U.S. Circuit Court of Appeals. 3M and its subsidiary co-defendants also have pending appeals at the 11th Circuit of major rulings from the MDL judge. The 11th Circuit stayed those appeals in light of the subsidiaries’ bankruptcy, but if the MDL steams ahead with claims against 3M, I would not be surprised if the company asks the 11th Circuit to proceed. Much uncertainty, in other words, remains in the earplug case.

And before drawing any sweeping conclusion from Graham’s ruling on Friday, said Georgia law professor Simon and Melissa Jacoby of the University of North Carolina School of Law, it’s important to remember that the decision is rooted in not just the particular facts of 3M’s funding agreement with its bankrupt subsidiaries but also in precedent from the 7th U.S. Circuit Court of Appeals. The 7th Circuit, as Graham repeatedly noted, has a narrower view than other federal circuits of the bankruptcy code provision that allows bankruptcy judges to exercise their jurisdiction to enjoin related proceedings.

Nevertheless, Graham’s ruling is at the very least “an important wake-up call,” said Jacoby via email. “Lawyers have to be ready to prove their case under applicable law. They need to show the impact on the bankruptcy estate specifically, and they cannot make a distraction argument without more details.”

Graham was careful, Simon noted, to cabin his decision within bankruptcy law. As you surely recall, 3M used the bankruptcy filing by its Aearo subsidiaries as an opportunity to rail against an MDL process it portrayed as hopelessly broken. Lawyers for the veterans who have litigated the MDL against 3M for more than three years accused the company, in turn, of abusing the bankruptcy process in a naked attempt to wrest control from a judge whose rulings it doesn’t like. The MDL judge, Rodgers, has made no secret of her take on 3M’s bankruptcy strategy, but has left it up to Graham in bankruptcy court to decide whether MDL claims against 3M could continue.

The bankruptcy judge explicitly said he was not passing judgment on Rodgers’ handling of the earplug MDL – nor on the relative merits of bankruptcy court as an alternative to the MDL process for purposes of global mass tort settlements. “Both are merely tools, engineered by Congress, for the adjudication and resolution of claims,” Graham wrote, with notable diplomacy. “Neither is perfect and each present both risk and reward for all of the various constituencies.” (Graham also did not opine on whether the Aearo subsidiaries had acted in bad faith when they filed for bankruptcy protection because that issue was not squarely before him.)

For Graham, the critical fact in the case was 3M’s uncapped commitment to cover the Aearo entities’ liability for earplug claims. 3M initially sought to condition Aearo’s funding on a stay of the MDL litigation against the parent company. But the independent directors who joined Aearo’s board, both longtime bankruptcy professionals, negotiated to remove that provision from the ultimate funding agreement with 3M.

Effectively, Graham concluded, that agreement left 3M – the profitable parent company – entirely on the hook for Aearo’s earplug liability. So, to make a long decision short, the judge said that ongoing litigation against 3M would not impact Aearo’s ability to reorganize and pay its creditors. (Technically, Graham ruled both that he would not extend the automatic stay on litigation to 3M because Aearo would not be irreparably harmed and that an injunction was not warranted because claims against 3M are not related, under 7th Circuit precedent, to the Aearo bankruptcy.)

The takeaway for future MDL defendants hoping to use a subsidiary’s bankruptcy to exit consolidated litigation, said Georgia professor Simon, might be to condition funding for bankrupt subsidiaries on an injunction to halt litigation against the parent company. Such a condition would inextricably connect the fate of the subsidiaries’ bankruptcy with the cessation of litigation against the parent company, even under the 7th Circuit’s narrow view of relatedness.

But such a condition, Simon said, might raise bankruptcy court concerns about whether a funding agreement was negotiated in good faith. Independent board members, she said, might also balk at a condition that seems to favor the parent company when their fiduciary duty is to the subsidiaries.

As I said, we haven’t heard the last word on 3M’s injunction. But Friday’s decision undoubtedly adds new steps to what had been a predictable dance for mass tort defendants.

Read more:

3M combat earplug lawsuits to proceed, judge rules, despite bankruptcy case

3M earplug MDL judge adds to bankruptcy’s tangles with injunction order

How a bankruptcy ‘innovation’ halted thousands of lawsuits from sick plaintiffs

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