On August 26, Indiana Bankruptcy Court Judge Jeffrey J. Graham issued an order in the bankruptcy cases of Aearo Technologies (“Aearo” and, together with its affiliate debtors, the “Debtors”), denying the Debtors’ motion for a preliminary injunction protecting non-debtor parent 3M Company (“3M”) against a slew of litigation related to hearing-protection devices that were allegedly defective and resulted in hearing loss and related injuries. The ruling highlights the risks inherent to the “Texas two-step” or “divisive merger” approach that has become a hot button issue for a few years, playing out in numerous scenarios involving mass tort cases, often in the asbestos context. The most notable prior case to date has been the Chapter 11 filing of LTL Management (Johnson & Johnson), but there have been several others, including Aldrich Pump (Trane Technologies and Ingersoll-Rand), Bestwall (Georgia-Pacific), DBMP (CertainTeed and Saint Gobain), HONX (Hess) and Paddock Enterprises (O-I Glass).
Aearo and 3M face over 200,000 claims on the basis of defective ear protection products (the “Combat Arms Claims”), with judgments in certain “bellwether” trials entered against 3M and Aearo ranging from $1.7 million to $77.5 million. There are two insurance programs, both managed by 3M, that could cover the tort claims: the 3M Tower program providing $1.05 billion in coverage and the Aearo Legacy program providing $550 million in coverage. In advance of Aearo’s bankruptcy filing, 3M and the Debtors entered into a funding agreement, which was executed on July 25, 2022 (the “Funding Agreement”). The Aearo Chapter 11 petitions were filed the next day.
Under the Funding Agreement, 3M agreed to provide $1.24 billion to fund Aearo’s Chapter 11 cases and a claims trust, among other things, and the Debtors, in turn, would indemnify 3M. The purpose of the Funding Agreement was to shift the initial liability for Combat Arms Claims to Aearo, while leaving the ultimate financial responsibility for the claims with 3M. Notably, despite the indemnity in favor of 3M, under the Funding Agreement, 3M agreed to fund all amounts necessary to fund any 3M indemnity claims. It also is notable that 3M’s obligations under the Funding Agreement were not dependent upon an injunction being issued by the bankruptcy court.
In Aearo’s Chapter 11 cases, the Debtors sought an injunction protecting 3M from the Combat Arms multidistrict litigation (“MDL”) to preserve the Debtors’ estates and ultimately consummate a reorganization plan that would include the establishment of a claims trust. The court denied the injunction. Subsequently, on August 29, Aearo filed a motion seeking Seventh Circuit direct review of their appeal of Judge Graham’s denial, and, the next day, Judge M. Casey Rodgers entered an order setting mediation in the MDL.
Some key takeaways from the bankruptcy court’s decision:
- Although there has been a focus on inefficiencies in the MDL process, the bankruptcy court, however, declined to take a position on the relative merits of MDL and bankruptcy litigation processes, with the court making clear that the bankruptcy process is not “the only avenue” to resolve large amounts of claims, as both the MDL and the Bankruptcy Code were both approaches that were approved by federal statute.
- Venue matters – the 7th Circuit’s lack of explicit guidance for extending the automatic stay to non-debtors under § 362(a)(1) of the Bankruptcy Code led to the court declining to do so for 3M. In contrast, the New Jersey bankruptcy court overseeing LTL Management’s Chapter 11 extended such protection to Johnson & Johnson.
- The court found that § 362(a)(3) of the Bankruptcy Code—applying the stay to obtaining property of the estate—did not apply here because of the lack of a “pecuniary effect on the estate” due to 3M, and not Aearo, ultimately being responsible to fund Aearo’s liabilities related to the MDL and state court lawsuits. The Court emphasized that there was no threat of inequitable distribution of insurance proceeds and it would not impact the amount of money Aearo could pay creditors.
- With the bankruptcy court having reached the conclusion that the automatic stay did not directly apply, the focus then turned to whether an injunction could be issued under § 105 of the Bankruptcy Code to protect 3M. At the outset of that analysis, the court focused on the jurisdictional basis which turned on whether the issuance of the injunction was “related to” or was “arising under” the Aearo bankruptcy.
- The parties agreed that § 105 injunction analysis should be focused on “related to” jurisdiction, which the court accepted, while noting, citing Caesars, that an argument could be made for looking to “arising under” jurisdiction, though it stated that it was disinclined to do so. Although the law on “related to” jurisdiction varies, the bankruptcy court focused on the “constrained approach” employed in the Seventh Circuit, which looks principally to whether there is an economic impact on the debtor’s estate.
- The bankruptcy court analyzed the actual economic effect that a continuation of the litigations would have on Aearo’s bankruptcy estate and found no extraordinary circumstances to issue an injunction under § 105(a) for non-debtor 3M. In doing so, the court noted that the Funding Agreement provides for an uncapped, non-recourse commitment from 3M, and that the agreement is a circular arrangement, such that when Aearo makes a payment there is no financial impact to creditors. This yielded contrary results to the bankruptcy courts overseeing LTL Management, Aldrich Pump and Bestwall.
- The court also reasoned the Funding Agreement and Aearo’s reorganization are not contingent upon the Court enjoining the litigations, noting that Aearo must have believed reorganization was possible without the promise of a stay in favor of 3M, as Aearo negotiated the removal of such a condition in the Funding Agreement.
- Aearo seeks an appeal because, without the injunction, 3M could face $100 billion in claims, an amount that far exceeds 3M’s cash reserves and would disastrously effect 3M’s ability to honor the Funding Agreement. The ruling notes that this “is very much the elephant in the room.”