Welcome to the New Asbestos Scandal - Continued [Part 3]

A likable, thoughtful, and seemingly guileless man, Gilbert recounts the course of asbestos-coverage litigation of the past quarter-century with clarity, distance, and civility. Few appreciate, as Gilbert does, the degree to which that history has been shaped by a few subtle clauses in the standard corporate insurance contract. After the bankruptcy of manufacturer Johns-Manville in 1982, for instance, asbestos litigation entered a long period in which the predominant strategy of the next tier of defendants--mainly producers and distributors of asbestos-containing products--became quick surrender and settlement. With the enthusiastic support of their insurers, many companies banded together to form two successive "settlement facilities"--Gilbert helped organize and run each--that would pay valid claims as they arose, holding wasteful litigation costs to a minimum. That strategy was driven largely by the fact that most primary insurance carriers were required not only to indemnify the policyholders' legal judgments--which are capped by an aggregate limit--but also to pay the costs of defending those suits. Crucially, the defense costs do not count toward the aggregate limit. Since aggressive litigation is much more expensive than settlement, primary insurers often preferred that its policyholder settle. Otherwise, Gilbert explains, "an insurer could have a $1 million policy and spend $10 million on it. It's not a good economic proposition."

Unfortunately, the settlement strategy made claims so easy for plaintiffs lawyers to collect that it spurred the filing of ever more claims. X-ray screening firms sprouted up to supply the plaintiffs lawyers with an inexhaustible supply of unimpaireds, whose numbers were thickly padded--unwittingly, let us assume--by healthy people with misinterpreted X-rays.

Over time, as the settling defendants exhausted their aggregate policy limits, many dropped away into bankruptcy. Others, however--the ones who had retained lawyers as sharp as Gilbert--learned that maybe they were actually entitled to still more insurance coverage. It turns out that under the standard policy, the "aggregate limit" applied only to a company's products-liability exposure. While insurers tended to treat all asbestos cases as products-liability cases, there were actually strong legal arguments to be made that many of those suits properly fell into different categories of coverage, known collectively as "nonproducts." The beauty of nonproducts coverage is that there is no aggregate cap on it! Incredible as it may sound, if a company had a contracting subsidiary--a unit that installed asbestos products, say, as opposed to just selling them--then that company might have a potentially infinite amount of insurance coverage. Once plaintiffs lawyers found out about nonproducts coverage, they had an incentive to go after lots of small, free-standing contracting companies because of their potentially inexhaustible insurance policies. "There's a lot of mom-and-pop companies out there that did almost nothing but asbestos installation," Gilbert explains.

Now it should be dawning on readers why bigtime plaintiffs lawyers are bothering to sue all these little contracting companies you've never heard of--Shook & Fletcher, J.T. Thorpe, AC&S. Though these companies have virtually no assets except their insurance policies, those policies may be bottomless.

Those tiny companies created the paradigm for the first asbestos prepacks, Gilbert continues. "Say you're the management of a company worth $5 million," Gilbert explains, "and you're told by your lawyers that you have insurance coverage that's potentially unlimited. The insurers are giving you the finger because you don't have the wherewithal to fight them. What do you do? You could go into bankruptcy, liquidate, and lose everything you have. Or you can go out to the people suing you--the plaintiffs lawyers--and say, 'Look, I don't have the money. My insurers are breaching their obligations. I believe my insurance should pay all my liability. Tell you what. I'll settle all your claims for a reasonable sum, and when I recover insurance money, you'll be the first people to get it.'" (Under the terms of the prepack, the defendant will sign over all its insurance rights to the bankruptcy trust that is supposed to pay future claimants. The trust will then sue the insurers seeking the nonproducts coverage.)

It sounds innocuous and sensible when Gilbert describes it, and at first it might have been. Rice's first prepack, Shook & Fletcher, sailed through the courts with little opposition, while the small deal for regional contractor J.T. Thorpe attracted only slightly more. But when AC&S, a more prominent asbestos defendant, announced its intentions in April 2002, the phenomenon finally registered on Elizabeth Magner's radar screen.

A bankruptcy specialist from New Orleans, Magner represents a committee of 17 boutiques that specialize in representing the severely ill. The committee was formed by plaintiffs lawyer Steven Kazan in early 2000 when he decided that the official asbestos claimants committees in bankruptcy proceedings around the country were not adequately representing cancer claimants' interests because they were dominated by the mass filers who served the unimpaireds.

Magner wanted her committee to oppose the AC&S prepack on principle. The prebankruptcy agreement in that deal had given away all of AC&S's cash to certain claimants, gave others first crack at the company's insurance proceeds, and left future claimants with only a glimmer of hope of ever recovering a dime. Nevertheless, her committee's members did not have a large enough stake in the AC&S case to want to challenge it.

Then, in November 2002, ABB/Combustion Engineering announced its planned prepack. In many ways Combustion Engineering was a different animal from the deals that had preceded it. Though insurers were outraged by it, it was not fundamentally an insurance play in the way its predecessors had been. In addition, the problem in ABB's case was not so much that Combustion Engineering was facing bankruptcy--the former boilermaker, ravaged by asbestos litigation, had actually been an empty shell for several years--but rather that the parent, the vast ABB conglomerate itself, was on the ropes. ABB's lenders were refusing to provide critical refinancing unless ABB came up with a resolution of Combustion Engineering's asbestos liabilities. ABB's lawyer was David Bernick of Kirkland & Ellis. He was given a deadline of Dec. 15, 2002, to come up with a solution; otherwise ABB would default on its bank loans.

This magazine has repeatedly celebrated Bernick for his aggressive, creative efforts to use the bankruptcy courts to rationalize mass-tort litigation, both in asbestos and breast implants. He continues those efforts today in the W.R. Grace bankruptcy. Nevertheless, Bernick recognized that protracted litigation was out of the question for ABB. "In ABB, I had a client that had a very different perspective," he explains. "It couldn't wait that long." Accordingly it was Bernick who, over dinner in Zurich on Oct. 22, 2002, offered Rice $20 million to put together ABB's prepack.

From both Bernick's and Rice's perspective, the ABB/Combustion Engineering deal seemed best for asbestos claimants too, since Combustion Engineering relied entirely on infusions from ABB to pay its asbestos debts. If ABB failed, Combustion Engineering's asbestos claimants would have gotten nothing.

Magner, however, didn't see it that way. What she saw was Combustion Engineering sending $417 million in cash and notes to privileged, mostly unimpaired claimants, on the eve of bankruptcy, in a deal that was being blessed after the fact by means of a vote-buying scheme. "This case was so patently unfair," she says, that she decided that "this was the place to take it through the court system and determine once and for all what could and could not be done with 524(g)."

In July 2003, Judge Wolin approved the prepack--but not without reservations. "The court was between a rock and a hard place," he says. "If I did not affirm, then the sick people would've gotten zero and ABB more than likely would've gone bankrupt.... Whatever occurred in Combustion Engineering should not be the formula for future prepacks.... Sometimes judges have to bite a bullet that they don't particularly like."

Meanwhile, new prepacks keep coming down the pike, adapting and evolving, precluding easy generalization. The prepack for Halliburton's KBR and former Dresser units, for instance--just confirmed by a bankruptcy judge in late July--currently has no opposition from either insurers or Magner's committee. That's largely because Halliburton is committing $4.6 billion of its own money to pull the deal off and establishing a bankruptcy trust that is currently projected to pay future claimants 100 cents on the dollar.

But with many of the deals we see new evidence of the quiet change sweeping across the asbestos landscape. Defendants are increasingly making common cause with the plaintiffs lawyers in their quest to empty out that great Platonic ATM machine, the insurance industry. Scott Gilbert's unusual law practice epitomizes the transformation. Though Gilbert once represented only defendant companies, he now also represents asbestos plaintiffs lawyers when they need independent advice on their target companies' insurance prospects. He even acts as co-counsel with some of them in their efforts to recover insurance for their clients on policies held by defunct companies. Gilbert is also a major player in the world of prepacks. He has represented Shook & Fletcher, AC&S, J.T. Thorpe, and Congoleum, and he says he has others in the works that he can't yet talk about.

The multiple roles Gilbert plays can get perplexingly dense. In the Congoleum case, for instance, it was plaintiffs lawyer Weitz--who has thousands of cases pending against Congoleum--who first recommended to Congoleum that it hire Gilbert to help with its insurance coverage disputes. Congoleum then retained Gilbert (for a $2 million flat fee) to represent it on its prepack--negotiating across the table from, of course, Weitz. At the same time the two lawyers were negotiating against each other in that case, Weitz and Gilbert were also co-counsels on behalf of about 15,000 asbestos plaintiffs who were suing three defunct companies whose only sizable assets were their insurance proceeds. In these matters Gilbert's and Weitz's firms are to share a 10% contingency fee on any moneys Gilbert can ultimately recover for Weitz's plaintiffs from the insurers--a fee worth potentially tens of millions of dollars. Gilbert also acknowledges that it is quite possible--he says he's never checked--that some of the asbestos plaintiffs Gilbert represents against those three defunct companies are, in fact, the same individuals that Weitz is now representing against Gilbert's client Congoleum. But Gilbert maintains that none of these potential conflicts matter as long as he discloses them all to Congoleum, as he has. Both the bankruptcy judge and district judge have ruled for Gilbert on the issue.

To have the full picture, the reader should be apprised that Gilbert's law firm also owned a 70% interest in the consulting firm that was selected to do the claims-processing work in Rice's AC&S prepack--the same one that subcontracted that work to the Clearing House, the outfit run by Rice's paralegal. Gilbert still claims not to see anything amiss there. It was "ministerial" work that could be audited by the insurers, Gilbert says. That Rice's paralegal made close to $1 million doesn't bother him either. "She wasn't a paralegal--she was running a business," he says. "In this country there's nothing illegal or inappropriate about somebody improving their quality of life." (Nevertheless, Gilbert's firm severed all ties to its former consulting firm as of June 1.)

"Insurers are getting set up in these deals," claims the general counsel of one insurance company, who requests anonymity. "Insurers have an obligation to pay claims," she acknowledges, "but we also get to decide how to defend and whether to settle, which is only fair, since it is our money that's at risk. The prepack situation turns this ordinary relationship on its head. Instead of working together to resist and defend claims, in a prepack the insured and the plaintiffs attorney work together to force the insurer to pay as much as possible."

It's not hard to see why she feels that way. Once a defendant reaches an agreement with the plaintiffs lawyers about what its own lump-sum contributions will be, it has no further incentive to fight spurious claims. In the two decades prior to September 2002, for instance, Congoleum incurred just $13.5 million in asbestos judgments in the course of resolving 33,000 cases. Because so many of the cases filed against it were meritless, Congoleum disposed of 99% of them at an average price of just $102 each. Yet in 2003, during the asset transfer preceding its prepack, Congoleum settled 79,630 claims for $466 million--all of which it hopes to pass along to its insurers. Similarly, over the 20 years that preceded AC&S's decision to do a prepack, it had paid a total of $600 million in asbestos settlements. Yet in the four-month run-up to its September 2002 bankruptcy filing, AC&S liquidated $2 billion worth of claims--all but $24 million of which it hopes to force its insurers to pay for.

Then there's the tragicomic kicker. When an insurer goes to bankruptcy court to challenge the legality of a prepack, the judge often rules that it has no legal standing to object! While it might seem odd that the party footing the bill for the whole thing should have no say in the matter, those rulings may be technically sound. In theory, at least, by approving a bankruptcy plan judges are not making any binding decision about insurance coverage. Insurers can still bring separate litigation in state court later and argue that their policies don't require them to fund the plan that's been approved. But it's a little like asking Congress not to appropriate funds for troops after the President has already sent them into combat.

"I'm asking you, How practical is that?" says the insurance carrier's livid general counsel. "The cow's out of the barn at that point! And if I do prevail, what happens to Elizabeth's clients then?" she asks, referring to the cancer victims Magner indirectly represents. "You now have a plan where the insured is released from asbestos liability. They got their 524(g) injunction! That's all they care about. They could care less whether there's money to pay future people who get mesothelioma. If we win, they get nothing."

And if the insurers lose, they'll begin failing. At least one already has. An early asbestos prepack involving the small Houston insulation contractor Fuller-Austin put Highlands Insurance into receivership last year, before the company could complete its appeals. In an October 2003 report, A.M. Best estimated that insurers' reserves for asbestos were underfunded by at least $20 billion, and it opined that the ability of some of them to weather their predicament "seems questionable." Kemper Insurance, for instance, which has significant asbestos liabilities, went into "runoff" mode in March, meaning that it will no longer write new policies. In June, Equitas--the giant reinsurer of Lloyd's of London's pre-1993 liabilities--increased its asbestos reserves for the fourth time in five years. Its chairman, Hugh Stevenson, commented that asbestos is "the greatest single threat to Equitas."

"Insurers cannot just say, 'Okay, fine. Enter these two-and three-and four-billion-dollar settlements, and we'll just come pay it,' " continues the insurer's general counsel. "We don't have enough money to do that. Insurance is all about spreading risk. You can't do that for 8,000 commercial insureds who are currently being sued in asbestos litigation. It will take down the insurance industry."

Gilbert acknowledges that some insurers are probably struggling for their lives. But that's not the fault of the prepacks, he says. It's the fault of those insurers' having written unwise policies. "That liability's there with or without prepacks," he says. "The policies say what they say."

At some level of consciousness, nearly everyone in the asbestos game knows that we, as a society, should have stopped paying the unimpaireds decades ago. In 1993, Joe Rice acknowledged that was the right thing to do, as did most of the other big asbestos plaintiffs lawyers of that era. That year Rice and a group of 20 asbestos defendants entered into a creative, convoluted legal agreement they termed a "settlement class action" in a case called Georgine. Under Georgine, most of the plaintiffs bar agreed in essence that in exchange for one last massive payday for all their existing clients, they would agree to set up a trust to handle all claims from that day forward. Under the terms of Georgine, unimpaireds would have received nothing from that trust--except the peace of mind of knowing that if they ever did come down with a serious illness, there would be money readily available for them.

In 1997, though, the Supreme Court struck down Georgine, finding that it strained class-action concepts past the breaking point. Since then the mass filers have never again offered to relinquish their lucrative franchise representing the unimpaireds and their practically indistinguishable cousins--healthy claimants with misinterpreted X-rays. This magazine mistakenly thought they might be cajoled into doing so in 2002, when Senator Don Nickles (R-Oklahoma) introduced his "medical criteria" bill. The bill had been backed by a remarkable coalition of asbestos defendants, insurers, and the plaintiffs firms that Magner represents. The mass filers refuse to join, however, and in any event the coalition disintegrated. Too many asbestos defendants began to fear that the cancer cases alone could put them into bankruptcy. (The value of mesothelioma claims in the tort system has doubled in the past four years for some defendants, according to Tillinghast.)

The FAIR Act then rose in the Nickles bill's place. Sadly, since it does not incorporate the Nickles medical criteria, it actually represents the "worst of all worlds" from Magner's perspective. "It caps the total dollars that are available to pay claimants," she says, "and then it lets in all the junk at the bottom.... So now we're back to where we are every day, fighting in the tort system for limited dollars with people who aren't hurt."

Still, the FAIR Act is the closest Congress has ever gotten to bringing rationality and finality to the asbestos mess, and we may never get this close again. Though the mass filers evidently have too much political power to let us root out the scandal, they might permit us at least to contain it through the FAIR Act.

Maybe Congress could appropriate a little something for Joe Rice to get his people onboard.

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