Restructuring

Contributed by Andrea Saavedra
In our previous entries in the Slice of the Pie series, we explored the art of valuation and the role of the artist, or valuation expert, in assisting a court’s determination of a debtor’s solvency and/or capitalization at a particular point in the past or as of the petition date.  Questions of future value also can come into play in bankruptcy.  Perhaps one of the more challenging valuation exercises arises in the context of a mass tort bankruptcy, where the claims estimation process can be highly litigious and is often shaped by a debtor’s prepetition experience in a less than perfect tort system.  Mass tort claims estimations often involve numerous experts testifying about the estimated liability of the debtor not only for cognizable personal injury or wrongful death claims, but also for the future claims of individuals whose injuries are not yet manifest despite their alleged prepetition exposure to the debtor’s products.
Likely the classic example of such cases stems from the asbestos-related filings of the early 1990s.  As the W.R. Grace Company marks its exit this month from a more than decade-long chapter 11 case, we take a look at the recent asbestos-related claims estimation decision of the United States Bankruptcy Court for the Western District of North Carolina in the chapter 11 case of In re Garlock Sealing Technologies, LLC.
What Is Claims Estimation?
Claims estimation, in simplest terms, is just that — a debtor’s estimation of the value of those claims filed against it that may be contingent, unliquidated, or otherwise contested.  Specifically, section 502(c) of the Bankruptcy Code authorizes the estimation of any contingent or unliquidated claim if fixing or liquidating the claim otherwise would cause undue delay.  Notably, although the estimation of personal injury or wrongful death claims “for purposes of distribution” in a chapter 11 case are not “core proceedings,” courts have concluded that bankruptcy courts may conduct such estimations for large groups of claims where no single claim is capped for distribution purposes, and such estimation is being done in connection with a chapter 11 plan.  As the Garlock court observed, though, the Bankruptcy Code does not explain how a court is supposed to estimate such claims when their value — or even existence — is contested.
How Have Courts Estimated Mass Tort Liabilities in Chapter 11 Cases?
Despite this lack of explicit statutory guidance, the Garlock court found useful precedent in the various estimation decisions of other large chapter 11 cases involving asbestos liabilities, specifically those of Eagle-Picher Industries, USG Corporation, G-1 Holdings, Owens Corning, Federal-Mogul, W.R. Grace, Armstrong Industries, and Specialty Products.  In fact, the court boiled these asbestos-related claims estimation proceedings down to four general principles.
First, the court observed that each court endeavored to reach a fair estimate based on the particular facts and circumstances of the case before it, recognizing the validity of the competing concerns of the various litigants in attempting to reach a proper resolution.  Indeed, even when valuation is not in dispute, the Garlock court recognized the general prudence of reaching its “own estimates of liability.”
Second, the court noted that the debtor’s role in estimation can vary from case to case.  At times, litigants reach a consensual resolution in order to propose a plan of reorganization.  At other times, the debtor is agnostic to the value of the claims because it has no financial exposure.  In other cases, the debtor, like Garlock, hotly contested claimants’ liability estimates.  The level of a debtor’s participation can also inform the court as to its acknowledgement of — or challenge to — liability.
Third, the court observed that the type of asbestos product at issue can be relevant in determining the extent of a particular debtor’s liability.  Garlock argued that its products produced a small dose of a less potent form of asbestos in contrast to the products of comparable debtors, and the claimants failed to produce persuasive evidence to the contrary.  Accordingly, the court concluded that historical asbestos estimations from those other cases were inapplicable to Garlock.
Fourth, the court recognized that a debtor’s claims resolution history (i.e., its prepetition litigation settlements) could be a useful — if not even the best — data point in estimating a debtor’s acknowledged liability.  However, it is neither the exclusive nor controlling means to estimate liability, particularly where a bankruptcy court has discretion to determine the appropriate method of estimation in light of the particular facts and circumstances of the case before it.
The Garlock Conclusion
Noting that it had conducted a seventeen-day plus trial, with 29 witnesses and hundreds of exhibits, the Garlock court reached its estimation of present and future mesothelioma claims with these principles in mind.  The present and future claimants’ representatives argued for a “settlement” based approach to estimation by way of statistical extrapolation from Garlock’s history of resolution of mesothelioma claims, a methodology employed in other asbestos-related bankruptcy cases.  In contrast, the debtors argued for a “legal liability” approach that focused on the merits of the claims, reduced further by claimants’ prospects for recovery from other sources, to develop a projected estimate of value.
Recognizing that the settlement approach was generally useful in an estimation analysis because a defendant’s “own history of valuing claims in the tort system” may serve as a reliable benchmark of acknowledged liability, the court concluded that its application to Garlock was of limited use where (1) there was evidence of substantial malfeasance by plaintiffs’ attorneys in the underlying litigations (including, among other things, withholding exposure evidence and purporting to not have filed claims in other debtors’ chapter 11 cases so they could inflate their clients’ claims against Garlock), and (2) significant evidence suggested that Garlock’s settlement data represented a strategy of “cost avoidance” rather than actual liability.  Accordingly, the court rejected the entirety of the claimants’ experts’ estimation data and relied entirely on the “reasonable and reliable estimate” of Garlock and the work of its experts.
Garlock’s estimate was “based on econometric analysis of current data produced in discovery by the representatives of a sizeable sample of the current claimants,” with “applied parameters based on observation and accepted measures.”  Specifically, Garlock had created an analytical database from questionnaires that it had sent to the current claimants’ law firms as part of its discovery efforts.  The data produced included job histories, asbestos exposure information relating to Garlock’s and third-parties’ products, claims and recoveries made in the tort system, and claims made to other asbestos plaintiffs’ trusts.  The court observed that Garlock’s efforts resulted in the “most extensive database about asbestos claims and claimants” that had been “produced to date” and, unlike historical information, was the “only data” that accurately reflected the pool of claims against Garlock.
From this “reasonable and representative” sample, Garlock’s experts extrapolated estimates of Garlock’s liability for current claimants ($25 million) and for future claimants ($100 million).  Although the estimate was a “‘projection,’” the court concluded that it was accurate and reliable.  As a result, the court held that Garlock’s aggregate liability for present and future mesothelioma claims was $125 million — in contrast to the claimants’ estimation of $1-1.3 billion.
The Takeaway
Claims estimation can be important for many reasons when it arises in the context of plan confirmation, particularly as a court examines feasibility and fairness.  Accordingly, practitioners and experts alike should be aware of its potential impact on total enterprise value at exit and ensure that their presentation is both reasonable and reliable in order to win claims estimation litigation.