By John Bae, Eric Daniel, Will Henry, and Heather Richardson, partners with Thompson Hine LLP. Mr. Bae’s practice focus is business restructuring; Mr. Daniel’s is product liability litigation; Mr. Henry’s is corporate transactions and securities; and Ms. Richardson’s is environmental.
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Asbestos was once prevalent in U.S. manufacturing and construction due to its heat-resistant and flexible properties. Despite its advantages for certain manufacturing applications, however, the inhalation of asbestos fibers became associated with workers developing various latent medical conditions, such as mesothelioma (a cancer of the mesothelial lining of the lungs or the peritoneum that is nearly always fatal), lung cancer, and other lung-related impairments.
While the use of asbestos was largely banned in the late 1980s and the manufacturing industry took steps to remove the material from its products over the years, litigation arising from historic asbestos usage has run rampant for decades and continues to this day. Moreover, due to the vast use of asbestos in thousands of different applications, it has become difficult, if not impossible, to eliminate all vestiges of its use. Although most companies have worked to ensure that their employees and customers will not be exposed to asbestos, they still may be faced with challenges associated with such past use, including ongoing litigation, which is becoming more complex and resulting in ever-increasing jury verdicts.
These challenges can come into play when a company considers the acquisition of another entity that historically used asbestos in its products or worksites, raising the possibility that the transaction could inadvertently include the purchase of future asbestos liability as well. It is prudent for companies to be aware of the risk of asbestos liability in such acquisitions and, where possible, pursue creative transactional approaches to ensure that the acquiring company does not inherit the target company’s asbestos exposure and face the burden of being a defendant in the asbestos tort system for decades to come.
Even if the acquiring company is careful to isolate the acquired company by retaining corporate separateness, the differing state laws on successor and alter-ego liabilities provide no assurance that abiding by this and other corporate formalities will shield the acquiring company from exposure to asbestos litigation.
This Legal Backgrounder provides a snapshot of current asbestos litigation trends, considerations in the acquisition of entities with potential asbestos claims, and a path for companies to separate their assets from existing asbestos liabilities.
Litigation Trends
Take Home Exposure Claims
The number of asbestos-related lawsuits was predicted to decline over time as the population of workers who had been exposed to asbestos also decreased. That prediction, however, did not anticipate a noteworthy trend in asbestos litigation involving allegations that individuals who worked directly with asbestos in their jobs decades ago brought home asbestos on their clothing after their shifts, known as “take home exposure” claims. These claims allege that workers’ shaking out and laundering of clothes increased levels of airborne asbestos. As a result, spouses, children, and even grandchildren of those workers have claimed that they developed asbestos-related diseases through secondary exposure. Despite studies showing asbestos is not the sole cause of mesothelioma, a significant number of courts have accepted the notion that asbestos is the cause of these lung-related injuries if the claimant was exposed to asbestos.
Plaintiffs face several challenges when advancing take home exposure claims, including the need to establish: (1) they were in fact exposed to asbestos through a relative’s work clothing in the first place (because there is rarely proof that asbestos fibers actually attached to worker clothing, were released in the home, and were inhaled by the household resident); (2) if the plaintiff did inhale asbestos from work clothing, that the fibers came from a particular defendant’s products; and (3) the exposure to a particular defendant’s asbestos product was a substantial factor in the development of the underlying asbestos-related disease. Further, such claims raise issues as to whether a legal duty exists to protect family members of the individuals who purportedly were exposed to asbestos in the first place. Plaintiffs’ inability to overcome these challenges have led some courts to limit take home exposure claims, though such limits have not reduced take home exposure filings in the last several years.
The rise in take home exposure cases has expanded the pool of theoretical plaintiffs who could file future claims. With this greater number of potential new plaintiffs comes decreased predictability for companies regarding their asbestos litigation risks. While the number of former employees who may have worked in the vicinity of asbestos-containing products, for example, may be calculable, determining how many people lived with those workers during the time frames of alleged exposures is less certain. Moreover, to the extent a take home exposure family member could have been an infant at the time of alleged exposures, the time frame for filing a lawsuit—which would typically only be triggered after the disease (which has a multi-decade latency period) is diagnosed and determined to be asbestos-related—could arise several decades after the dates of alleged exposures. Thus, the increase in permissible take home exposure cases has increased the number of potential future plaintiffs while extending the timeline for foreseeable continued asbestos litigation filings.
Increased Lung Cancer Case Filings
Although mesothelioma is considered the hallmark diagnosis associated with asbestos exposures, individuals with a high level of asbestos exposures also are at risk of developing lung cancer. While there is dispute among medical experts as to the level of exposure that is needed before one can conclude that a lung cancer was caused by asbestos exposure, courts have permitted some experts to testify that asbestos and cigarette smoke have a synergistic relationship such that an individual’s past history of smoking may increase their chances of developing lung cancer, but the alleged asbestos exposure is still causative in the disease process. Simply speaking, courts have permitted the introduction of evidence that asbestos exposure caused lung cancer even if that person has only minimal evidence of asbestos exposure, while simultaneously having decades of extensive smoking history.
This trend is important because it broadens the pool of potential plaintiffs in asbestos litigation. Only approximately 3,000 people in the United States are diagnosed with mesothelioma annually (Key Statistics About Malignant Mesothelioma | American Cancer Society) while more than 230,000 are diagnosed with lung cancer (Lung Cancer Statistics | How Common is Lung Cancer? | American Cancer Society). Thus, to the extent an individual develops lung cancer, even if that person had a multi-decade smoking history, a good faith belief that the person also had asbestos exposures likely will be sufficient for that person to maintain an asbestos lawsuit related to the lung cancer diagnosis.
Importantly, juries appear to have become more receptive to the theory that a person’s lung cancer can be caused by asbestos exposure even if the subject plaintiff had an extensive smoking history. In recent years, multiple juries have awarded significant verdicts to former smokers who claim that asbestos exposures were causative in their development of lung cancer. Thus, asbestos litigation involving plaintiffs with lung cancer must be taken seriously.
Increased Verdicts and Settlement Demands
While the pool of potential asbestos plaintiffs is increasing through take home exposure claims and an increase in lung cancer filings, there has been a noticeable increase in jury verdicts in asbestos cases regardless of the underlying diagnosis at issue. Although verdicts in asbestos litigation have been significant for many years, recent trends show an increase in jury verdicts in excess of $10 million. With increased verdict trends come increased monetary demands for case settlements. Companies have therefore faced the stress of defending cases in which the cost of resolution, whether through settlement or trial, is growing ever higher. This comes at a time when companies defending long-term legacy asbestos cases must also deal with the exhaustion of insurance policies. Without insurance, companies must absorb the financial blow of funding the defense and settlement of asbestos cases with cash.
Genetic Testing
Although asbestos litigation trends have grown more troubling for defendants, recent scientific literature suggests the possibility of a new defense to asbestos lawsuits. While an estimated 27 million workers in the United States were exposed to asbestos between 1940 and 1979, mesothelioma remains a rare disease with approximately 3,000 cases diagnosed in the United States each year. For years, scientists have searched for explanations to account for the discrepancy between the number of people exposed to asbestos versus the number of people diagnosed with mesothelioma. Recently published scientific studies suggest that certain gene mutations significantly increase one’s chances of developing mesothelioma. Moreover, some experts opine that the presence of such gene mutations could be solely causative in the development of mesothelioma even if the plaintiff claims to have been exposed to asbestos in the past. In cases where an individual has a relevant gene mutation and the evidence of asbestos exposure is weak, or no radiographic evidence showing hallmark signs of asbestos exposure exists, a jury could conclude that the gene mutation, rather than asbestos exposure, was the sole cause of a person’s mesothelioma. Such a defense could provide a firm alternative causation argument that has been missing for decades of asbestos litigation.
As with other defenses, a battle of the experts will occur over whether an individual with a relevant gene mutation was merely more susceptible to developing mesothelioma due to the gene mutation or whether the mutation was the sole cause of the disease process. Nonetheless, the evidence of a link between these gene mutations and the development of mesothelioma appears to provide an explanation for the numerous mesothelioma cases that are filed each year with only tenuous evidence of any asbestos exposures.
Such scientific studies, however, could provide only limited protection for asbestos defendants, who must continue to contend with the long-held belief that asbestos is the sole cause of mesothelioma.
Mergers and Acquisitions
In M&A and real estate acquisition transactions, the possibility of asbestos associated with the seller—either as historical liability or the potential presence of asbestos on properties sought to be acquired—can be a deal-stopper. Even with thorough environmental testing, prospective buyers that are well-aware of the heyday of asbestos litigation in the 2000s often view the potentially unlimited risk as simply not worth the potential valuation associated with the acquisition. Particularly when there is a historic risk of asbestos litigation, prospective buyers are therefore less likely to reduce the price to attempt to account for the risk and are more likely to instead walk away from the deal entirely. For example, in deals that closed despite the existence (or likelihood) of asbestos litigation, even where complete indemnities were negotiated in favor of buyers, buyers would have to administratively ensure that all suits filed after the closing were passed along to the sellers, and further verify that the sellers would assume and continue to defend such litigation. And even if the seller’s indemnity obligation is ironclad, the seller’s future financial capability to make good on the indemnity would add another layer of uncertainty. In some extreme cases of this kind, multiple lawsuits were filed each week (at least two or three) for years after the closing. As such, hesitation in doing deals involving even the mere possibility of asbestos is highly warranted, especially for private equity buyers that would face the challenge of eventually selling assets with potential asbestos liability three to seven years down the line.
First, buyers must, from the start of any M&A or real estate transaction, include asbestos or asbestos-containing materials as part of the environmental diligence process. Buyers in M&A or real estate deals assess if there are any asbestos-containing materials in building materials, while M&A transactions also require the assessment of historic use of asbestos-containing materials in products and exposure issues.
For asbestos in building materials, the initial step for a buyer making this assessment is a visual inspection for asbestos and possible invasive sampling, in each case likely engaging an industry-standard environmental consultant. Particular to M&A transactions, the buyer must also discern if there are potential exposure liabilities either relating to historic manufacturing processes or exposure to asbestos-containing materials. Certain buyers, especially strategic buyers, often elect to proceed with the acquisition of a property with either known or plausible asbestos or asbestos-related risks if diligence does not deem them to be material. The theory behind such an approach is that the risk, like most other acquisition risks, tends to decline over time and/or can be subsumed as a liability carried on the balance sheets of a much larger organization—and perhaps more basically, the acquirer need not worry about selling the assets at a later date as would a private equity buyer. The latter piece involves both appreciating clean-up of prior asbestos issues as well as how any litigation, fines or fees have been dealt with (and, in each case, how frequently). A seller that is not upfront on diligence in this area is highly likely to cause the deal to stall or to cause the buyer to lose trust and therefore walk away.
Second, in connection with known legacy asbestos liabilities, a buyer most often utilizes a line-item indemnity, usually with few (or no) dollar or time caps, and likewise regularly with a separate asbestos-specific indemnity escrow. In certain occasions where the seller is subject to pending (or imminent) litigation involving asbestos, the line-item indemnity will usually be insufficient, and a buyer may look to restructure a stock purchase as an asset purchase to reduce the risk of inheriting the seller’s potential liabilities, though the transaction would have to be structured to minimize a potential claim for successor liability.
At a minimum, buyers would likely require that the seller’s (or the seller’s insurer’s) counsel is responsible for dealing with all litigation. Pending litigation in asbestos matters means the possibility of many more suits following the closing against the buyer, and in those cases an asset purchase structure with asbestos liability treated as (vis-à-vis the seller) an excluded liability is critical if the deal is to move forward.
In addition to legacy asbestos-liability concerns, in deals that involve representation and warranty insurance, insurers have become risk-averse on providing such coverage. If known legacy asbestos liabilities are uncovered—whether or not a buyer seeks or obtains a line-item indemnity or treats the liabilities as excluded liabilities in an asset structure—insurers will exclude these liabilities from the representation and warranty insurance. Risk aversion in a buyer’s diligence does not help either: if a buyer indicates to an insurer that it did not take the above steps in diligence to confirm that asbestos or asbestos-containing materials were present (or that such presence was likely), then the insurer will nonetheless exclude anything relating to the subject. In the last few years, irrespective of the buyer’s due diligence, carriers have increasingly included a blanket exclusion for anything involving asbestos, declining to get involved in the buyer’s diligence process and simply noting that the representation and warranty policy will not cover asbestos risk.
Third, to the extent that the buyer identifies asbestos-containing building materials during the environmental diligence process, the buyer should assess whether such materials require remediation. Oftentimes, asbestos-containing materials can remain in place if they are in good condition and not susceptible to releasing asbestos dust that can be inhaled. Any future demolition or disturbance of asbestos-containing materials will trigger various regulatory obligations and permitting requirements. Federal, state, and local regulations must be considered when determining how to manage asbestos-containing materials in a compliant manner. As such, a buyer should consider any future likely required asbestos-remediation costs as part of its overall diligence assessment. To the extent a compliance issue is identified, a buyer should address this as promptly as possible following the closing to avoid any direct (operator) liability in connection with the affected site(s). Additionally, lessees should ensure that landlords retain liability for asbestos-containing building materials under the lease.
The above solutions do not necessarily address successor liability concerns—for instance, whether the seller either goes bankrupt following the closing or is, due to a sale of substantially all assets, a shell company with few assets remaining. The buyer, however, can take steps to mitigate against potential plaintiffs and government agency claims by making it harder for plaintiffs or governmental authorities to hold the buyer responsible for the predecessor’s liabilities. One possible solution may be to assess whether old insurance policies could cover any successor asbestos exposure claims, noting that it will be necessary to review policies that were in place during the dates of alleged exposures—not just the date of illness diagnosis.
Moreover, buyers should be cognizant of the “product line exception” applicable to certain successor-liability challenges. Although the minority position, a handful of courts have held that buyers who purchase a company’s product line as part of an asset agreement can be held liable for pre-transaction liabilities arising out of the product line regardless of any contractual language that was used to prevent the transfer of such liability. The notion is that, where the predecessor is no longer able to compensate the consumer who has been injured from the use of the product in question, the buyer that is benefiting from the predecessor’s products should be required to compensate the plaintiff who otherwise would be left without a remedy. In the context of asbestos litigation, a jurisdiction that has adopted the product line exception could hold that a purchasing company that otherwise disclaimed pre-sale liability is responsible for asbestos claims that arise years after the transaction, due to purported asbestos exposures that occurred prior to the transaction. Because asbestos-related conditions typically have a latency period of 20-50 years (or more), the time frame for potential liability could be significant if the product line exception were to apply. Because of this and other similar exceptions, it is important to understand whether a transaction involves the purchase of a product line that once included the manufacture of asbestos-containing products.
Restructuring
A company that acquires another company with unanticipated asbestos liabilities have solutions available to protect the acquiring company without having to resort to chapter 11 bankruptcy. The traditional avenue of addressing asbestos liabilities through the chapter 11 bankruptcy process comes with significant costs and uncertain outcomes. This section of the paper provides a summary of how asbestos bankruptcies work and explains the costs and challenges that come with the bankruptcy process. It then discusses an alternative approach to addressing asbestos liabilities that more companies are successfully utilizing to avoid many of the challenges presented in the bankruptcy process.
In broad strokes, a chapter 11 asbestos bankruptcy involves the debtor utilizing section 524(g) of the Bankruptcy Code to confirm a plan of reorganization that establishes a trust to which all present and future asbestos claims are channeled. As such, the amount of money and insurance that will be deposited into the “asbestos trust” is the focal point of any plan of reorganization in an asbestos bankruptcy. The players in an asbestos bankruptcy are the debtor, a creditors committee consisting of asbestos claimants (“Asbestos Committee”) and a representative for future asbestos demand holders (“Futures Representative”). Each of these parties participates in the negotiations over how much money must be deposited into the asbestos trust. Each constituency is advised by bankruptcy lawyers and economic consultants in negotiating the amount that would be needed to fund the asbestos trust before the debtor is able to emerge from chapter 11 with the protection of the channeling injunction.
It should come as no surprise that the Asbestos Committee and the Futures Representative will advocate that the monetary value of present and future liabilities will be a higher figure, while the debtor will advocate for a lower number. While these parties will negotiate the amount of funds that must be deposited into the asbestos trust, the debtor simply cannot confirm a plan with a section 524(g) asbestos trust without the consent of the Futures Representative and the vote in favor of the plan by the supermajority (75% or more) of the present asbestos claimants. This dynamic provides significant leverage to the plaintiffs because the debtor cannot emerge from bankruptcy until the Futures Representative and the asbestos claimants are satisfied with the amount of funds that will be deposited into the asbestos trust. In asbestos bankruptcy cases, it is common for asbestos trusts to be funded with cash and insurance that well exceeds a billion dollars.
In addition to funding the asbestos trust, the debtor must bear the cost of the lawyers and experts for each of the three constituencies. These costs routinely exceed several millions of dollars monthly until the plan is confirmed.
The bankruptcy solution for asbestos litigation is extremely uncertain and expensive. Many companies facing asbestos liabilities that otherwise have valuable operating businesses have thus looked for an alternative solution that does not involve a bankruptcy filing. Our law firm has advised a number of clients (including private equity funds wishing to free their portfolio companies of asbestos liabilities) in effectuating an out of court restructuring that protects the company’s operating business from asbestos liabilities.
This solution involves: (1) forming a new affiliate (“NewCo”) and transferring all of the company’s operating business to NewCo; (2) capitalizing the company possessing the asbestos liabilities (“OldCo”) with sufficient assets to fund the costs of defense and settlement of present and future asbestos claims; and (3) selling OldCo to a company that is in the business of managing asbestos defense. Each of these steps is briefly discussed in turn.
Protecting OldCo’s operating business from asbestos liabilities requires the transfer of the business to NewCo. Depending on the complexity of OldCo’s business operations, this process can be extremely complicated and difficult to effectuate. Advisors would have to review all of OldCo’s operations to ensure there are no obstacles to transferring the operations to NewCo, including contracts, loan agreements and indentures, leases, collective bargaining agreements, etc. Some companies have tried to simplify the restructuring by having OldCo retain the operating business and transferring the liabilities to NewCo, with NewCo indemnifying OldCo for asbestos-related liabilities. This approach is not recommended because OldCo will retain the asbestos liabilities, and asbestos claimants are not precluded from suing OldCo if NewCo fails to meet its indemnity obligations for whatever reason. In addition, insurance policies are not assignable to another company without the insurer’s consent. This precludes NewCo from utilizing the insurance to fund asbestos defense and settlement costs, and all such costs would have to be funded with cash.
Thus, though difficult, transferring the operating business to NewCo is the preferred and recommended approach.
Capitalizing OldCo is the most critical component of the restructuring. If OldCo is not sufficiently capitalized, NewCo risks fraudulent transfer claims by asbestos claimants if OldCo is unable to fund the defense and settlement of claims. An economic consultant would be retained to review OldCo’s historic business when asbestos-containing products were made, as well as settlement and dismissal history, to calculate OldCo’s projected future asbestos liabilities. The consultant would review the available insurance and calculate the amount of additional cash needed to fund the projected liabilities. OldCo would then be capitalized with insurance and cash in accordance with the consultant’s estimates.
Once OldCo is capitalized, OldCo would retain an expert to prepare a solvency opinion that OldCo remains solvent both before and after the operating business is transferred to NewCo. The solvency expert will largely rely on the projections of the economic consultant in issuing the solvency opinion.
Once OldCo is sufficiently capitalized and the solvency opinion is in place, the equity interests of OldCo would be sold to a company that specializes in asbestos litigation management. These companies earn a profit by investing the cash portion of the capitalization, and reducing the costs of asbestos defense and settlements based on their ability to efficiently manage the litigation. The sale documents would have to be carefully structured to protect NewCo from OldCo’s asbestos liabilities, including by limiting the buyer’s ability to make risky investments and take excessive dividends.
The sale of OldCo is an important part of the restructuring to avoid claims of successor liability against NewCo.
The above discussion is an extremely simplified description of the out-of-court restructuring to explain the fundamentals of how these transactions are structured. There are important details and nuances to this type of restructuring.