Welcome to the New Asbestos Scandal

For a quarter-century, companies have struggled with asbestos liability. Now, thanks to the very lawyers who are suing them, they've found a new tool--one that sticks it to their insurance companies and the genuinely sick.

Joe Rice is smokestack industry's new best friend. That's an unaccustomed role for Rice, since he is the co-leader of Motley Rice (formerly Ness Motley), the most feared asbestos/tobacco/mass-torts plaintiffs law firm in the country.

Over the years his firm has represented more than 96,000 asbestos plaintiffs against hundreds of corporations. Rice and his more famous partner, trial lawyer Ron Motley--actor Bruce McGill played Motley in the 1999 film The Insider--are also the ones who helped engineer the great tobacco industry takedown of 1998, which will ultimately divert about $246 billion in tobacco revenues into state treasuries and another $2 billion to $3 billion (yes, billion) to Motley Rice.

That resume notwithstanding, Rice is now the guy corporate executives want to see when their company needs to get out from under asbestos liabilities. He can get them something they need very badly, something Congress still hasn't seen fit to give them, and something even the courts can't secure for them--at least not without Rice's consent: total and final asbestos absolution. Rice can exorcise from a corporation, once and for all, the ghosts of asbestos liability past, present, and future. He can save its employees from layoffs and turn its stock back into the investment-grade security it once was. And if a company is good and follows his instructions to the letter, he might even let its shareholders keep their stock. That way they'll get rich when it skyrockets in value after Rice lifts the asbestos "overhang."

Rice's panacea is called a prepackaged asbestos bankruptcy--or "prepack." The executive summary goes like this: Your company (or a subsidiary) will have to dip into Chapter 11 bankruptcy, but just briefly. Rice will make the experience as painless as possible. Instead of languishing in Chapter 11 for years, you might be able to blaze through it in months--theoretically in as little as 30 to 45 days. You'll go in, wash off all your asbestos liability for surprisingly little money, and then re-emerge clean and healthy. Your company does fine, the plaintiffs lawyers do great, and most of the asbestos claimants do well enough. The only ones who may get hurt are the usual big losers in asbestos litigation: the insurance companies--some of which may go belly-up paying for the liabilities you and Rice are going to agree that they owe--and the tiny minority of asbestos claimants who are severely sick and may get paid less than they need and deserve. Nobody said life would be fair.

Rice's fee for putting together a prepack varies. The giant Swiss power conglomerate ABB--which used to be known as the General Electric of Europe but was teetering on the brink of insolvency because of the asbestos liabilities of its Combustion Engineering unit in the U.S.--agreed to pay Rice $20 million in October 2002. (That, of course, is over and above the millions of dollars in contingency fees Rice will receive from his thousands of asbestos clients when they get paid under the terms of the prepack itself.) For the small Alabama contractor Shook & Fletcher, on the other hand, Rice charged just $3 million. Perry Weitz of New York's Weitz & Luxenberg initially asked for $30 million for himself and Rice to put together another prepack, that of flooring manufacturer Congoleum, according to the deposition testimony of a Congoleum attorney. Though Congoleum refused, it did agree to pay Rice and Weitz $2 million cash as an advance toward reimbursing their professional fees on the deal. (They don't have to submit documentation or return unspent portions.)

That $2 million expense allowance is eight times greater than the total sum of cash--just $250,000--that Congoleum will pay its hundreds of thousands of present and future asbestos claimants under the deal Rice and Weitz negotiated. Beyond that modest cash outlay, Congoleum will toss in a $2.7 million note, due in ten years, to round out its obligations. Congoleum's shareholders will keep all their stock. Congoleum's insurers, on the other hand, will owe their entire policy limit--close to $1 billion. And instead of paying it in dribs and drabs over the next 50 years, the way their actuaries had anticipated, they will owe it all in cash on the day the prepack is confirmed by the bankruptcy court--possibly before year-end.

When this magazine last addressed the asbestos litigation crisis, in March 2002 (see "The $200 Billion Miscarriage of Justice" on fortune.com), we described the 25-year evolution of a national scandal. That article chronicled the transformation of asbestos litigation from a means of enabling injured and dying asbestos workers to gain compensation from corporations that had grievously wronged them into a means of transferring the shareholder wealth of thousands of companies--whose blame is so marginal as to be a legal construct--to a handful of plaintiffs law firms and hundreds of thousands of people who aren't sick. The situation had become so disgraceful that plaintiffs firms specializing in representing the truly sick had broken ranks with the rest of the plaintiffs bar and aligned themselves with the defendant corporations and insurance companies in seeking reform.

At that time we hailed a Senate bill that would have imposed stiff, nationwide medical criteria for asbestos suits. But that bill, like every other effort to address the asbestos crisis through congressional legislation over the past quarter-century, failed.

With the bill's failure, asbestos defendants turned to a new solution offered not by Congress but by the plaintiffs lawyers themselves: the prepack. Shook & Fletcher's was announced in February 2002, insulation contractor AC&S followed suit two months later, and Houston contractor J.T. Thorpe came next, in June. Combustion Engineering unveiled its own version in November 2002, as did Congoleum in January 2003.

Prepacks were not invented by the plaintiffs bar. Outside the asbestos context, they are a common, respected means whereby debtors and creditors settle most of their differences prior to a bankruptcy filing--thus minimizing the costs of bankruptcy. But asbestos prepacks are nearly always characterized by a unique feature: They call for the debtor company, a few months before the filing, to turn over a huge chunk of its assets to a subgroup of privileged asbestos claimants, to be divvied up outside the scrutiny of a bankruptcy judge. One veteran bankruptcy lawyer refers to this distinctive feature of prepacks as their "great train robbery" aspect.

The perils posed by these unusual agreements are further complicated by the lawyers involved, who often play multiple roles--roles that critics claim constitute conflicts of interest. In the ABB/Combustion Engineering matter, for instance, Rice simultaneously represented asbestos claimants and the parent of the company that they were suing. ("I had ethical consultants all along," says Rice. "I get paid a fee for a business transaction, and the claimants get paid because I was able to put together that transaction. My interests are 100% aligned with my clients'.")

This article, then, is about the new asbestos scandal--the scandal within the scandal. Because asbestos prepacks are such a recent phenomenon, few of them have wended their way through the courts, and some, like Congoleum's, have not yet even cleared the first hurdle--approval by a bankruptcy judge. Accordingly, no one knows precisely what is and isn't legal in this context. We will begin getting guidance when the federal appeals court in Philadelphia rules on the legality of the ABB/Combustion Engineering prepack--a ruling expected any day.

As we write, Congress is once again debating asbestos reform legislation. This time it's the Fairness in Asbestos Injury Resolution Act (FAIR), which would set up a $140 billion industry-funded national trust fund to pay off all asbestos claims. Once again the bill's fate seems doubtful, since it is opposed by the plaintiffs bar and labor. If FAIR fails to pass this congressional session, many companies will have no choice but to begin (or resume) talking to Rice or other prominent asbestos plaintiffs lawyers about prepacks. It'll be a seller's market, because more than 8,400 companies have been named as asbestos defendants at this point, including some names that might surprise the reader. Ford Motor, for instance, had 41,500 asbestos cases outstanding as of February--a 66% increase over the previous February--while Pfizer faced 169,900 cases as of March.

The underlying asbestos scandal has not abated since we last visited it. The Manville Trust, which pays the claims that are still being filed against the old Johns-Manville company, once the biggest manufacturer of asbestos products, received a record 101,172 new claims last year. (The Manville Trust's data are thought to provide the best barometer for what is happening nationally in asbestos litigation. In its 15-year existence it has had 670,000 claims brought against it.) Last year only 9.5% of the claimants against the Manville Trust suffered from cancers. The rest were "nonmalignants." According to estimates accepted by the most experienced federal judges in this area, two-thirds to 90% of the nonmalignants are "unimpaireds"--that is, they have slight or no physical symptoms. Indeed, many nonmalignants actually have ailments that have nothing to do with asbestos--or have nothing wrong with them at all. Several painstaking audits over the years have reached that conclusion, the latest being a peer-reviewed study of the X-rays of 492 asbestos claimants published in the August issue of Academic Radiology. Though doctors working with the plaintiffs lawyers had interpreted 96% of those films as being consistent with asbestosis, a debilitating disease involving scarring of the lungs, the study's panel of dispassionate experts found that only 4.5% merited such a reading. (That does not mean, by the way, that 4.5% really had asbestosis. It means that 4.5% really had lung scarring. The next question that a doctor would grapple with, were he treating a patient rather than recruiting clients for a plaintiffs lawyer, would be: Was the scarring brought on by asbestos or by one of more than 100 other possible causes?)

Without legislation, asbestos defendants will resume their inexorable march toward the bankruptcy cliff, over which 73 have now toppled, according to the Tillinghast unit of Towers Perrin--36 since 2000. No company, once targeted in earnest, has yet been able to fend off the thousands of court cases that, like crows in the Hitchcock movie, suddenly appear out of nowhere to darken its future. Indeed, once a company has been placed in the cross hairs of the asbestos lawyers, it is inevitable that either it or a subsidiary is going to have to go into Chapter 11. And after a targeted company comes to that realization--and sooner or later, they all do--then the idea of a prepack, scandalous though it may be, becomes not just palatable but downright appealing.

The Holy Grail for an asbestos defendant is something called a channeling injunction. It's a court order that channels all of a company's current and future asbestos liabilities away from the company and into a trust, which is a fund that's set up for the sole purpose of paying off the company's asbestos liabilities from that point forward. (Future liabilities are an enormous concern for asbestos defendants because of the long latency periods of asbestos-related diseases.) A company can get a channeling injunction only by going into bankruptcy.

Part 1 - Part 2 - Part 3