Rochelle's Daily Wire

Reversing the Fourth Circuit, the Supreme Court held that an “insurance neutral” chapter 11 does not deprive the insurer of standing to raise objections to the plan. For a unanimous Court, Justice Sonia Sotomayor said, “Courts must determine on a case-by-case basis whether a prospective party has a sufficient stake in reorganization proceedings to be a ‘party in interest’” under Section 1109(b).

Justice Sotomayor said that the Fourth Circuit had “conflate[d] the merits of an insurer’s ob­jection with the threshold §1109(b) question of who quali­fies as a ‘party in interest.’”

The Court’s June 6 opinion is far from the last word on standing in bankruptcy court or on appeal. In the first place, the case directly deals only with standing in chapter 11. Even in chapter 11 cases, Justice Sotomayor said that “the Court today does not opine on the outer bounds of §1109,” the statutory standard governing standing in chapter 11.

The opinion could be read to mean that a creditor can object to a plan and presumably mount an appeal with regard to a provision that does not directly affect that creditor. The opinion does not tell us when a creditor loses standing because the effect is too indirect.

The opinion might also be read to mean that the contemporary notion of “insurance neutrality” is too narrow.

The ‘Insurance Neutral’ Plan

Facing 14,000 pending lawsuits, the corporate debtor proposed a chapter 11 plan under Section 524(g) to create a trust wiping away present and future asbestos claims. All asbestos claims were to be channeled to a trust.

The principal asset for the trust was the debtor’s primary insurance policy, with a coverage limit of $500,000 per claim. The insurer was obliged by the policy to defend and indemnify the debtor, even if the claim were false or fraudulent. Defense costs were not counted against the policy limit for each claim, meaning that the policy was non-eroding. More to the consternation of the insurer, policy had no maximum aggregate limit.

The plan divided asbestos claims into two classes: (1) insured claims covered by the policy; and (2) uninsured claims not covered by the policy. Uninsured claims, of which there were few, were to be paid entirely by the trust.

Claims covered by insurance were to be litigated nominally against the debtor in the tort system, but subject to the coverage limit for each claim. The trust would pay the $5,000 deductible for each insured claim.

The claims covered by insurance remained subject to the insurer’s prepetition coverage defenses. In short, the insurer was on the hook for any claim that fell under the policy under the unmodified terms of the policy.

The uninsured claims were subject to antifraud provisions under the plan to protect the trust by requiring the claimants to provide disclosures designed to avoid fraud and duplicate claims. The case came to the Supreme Court because the plan had no antifraud provisions for insured claims.

Unsecured creditors were to be paid in full.

The only class impaired by the plan, asbestos claimants, voted unanimously in favor of the plan. The only confirmation objection came from the insurer, which was not entitled to vote because its unsecured claim would be paid in full and it retained all its rights under the insurance policy.

For lack of antifraud provisions applicable to insured claims, the insurer contended that the plan was not proposed in good faith and was not insurance neutral. The bankruptcy court wrote an opinion recommending that the district court approve the plan, finding that it was insurance neutral and filed in good faith. Because the plan was insurance neutral, the bankruptcy court concluded that the insurer was not a party in interest under Section 1109(b) and thus lacked standing to challenge the plan.

The district court confirmed the plan, adopting the bankruptcy court’s findings in toto after de novo review.

On appeal, the Fourth Circuit affirmed. Truck Insurance Exchange v. Kaiser Gypsum Co. (In re Kaiser Gypsum Co.), 60 F.4th 73 (4th Cir. Feb. 14, 2023). cert. granted sub nom. Truck Ins. Exch. v. Kaiser Gypsum Co., No. 22-1079, 2023 WL 6780372 (Oct. 13, 2023). To read ABI’s report on the Fourth Circuit affirmance, click here.

The Fourth Circuit found the plan to have been “insurance neutral,” giving the insurance company no standing in the bankruptcy court or on appeal to object to the merits of the plan pertaining to any aspects of the plan other than insurance neutrality. In a footnote, the appeals court said that the insurer had Article III, or constitutional, standing to challenge the finding of insurance neutrality.

The insurer filed a petition for certiorari, urging the Court to resolve a split of circuits. The Court granted certiorari in October. Argument took place on March 19. It was the last of three bankruptcy cases to be argued this term but the first to be decided.

Section 1109(b) Is ‘Capacious’

Without directly mentioning the constitutional restraint on standing imposed by the case or controversy requirement under Article III of the Constitution, Justice Sotomayor stated the question as “whether an insurer with financial responsibility for a bank­ruptcy claim is a ‘party in interest’ under” Section 1109(b).

The section provides that “[a] party in interest . . . may appear and be heard on any issue in a case under this chapter.” The section goes on to say that parties in interest include “the debtor, the trustee, a creditors’ committee, an equity security holders’ committee, a creditor, an equity security holder, or any indenture trustee.”

Parsing the statute, Justice Sotomayor said that the “text is capacious.” She found a “common thread [that] the seven listed par­ties . . . may be directly affected by a reorganization plan.” She cited the Court’s own precedent for saying “that Congress uses the phrase ‘party in interest’ in bankruptcy provi­sions when it intends the provision to apply ‘broadly.’ ” Hartford Underwriters Ins. Co. v. Union Planters Bank, N. A., 530 U. S. 1, 7 (2000). Consulting a dictionary, she concluded that “parties in interest” refers “to entities that are potentially concerned with or affected by a proceeding.”

Justice Sotomayor girded her broad reading of “party in interest” by reference to “historical context and purpose.” Historically, she noted how adoption of the Bankruptcy Code in 1978 “moved from an exclusive list to the general and capacious term ‘party in interest,’ accompanied by a nonexhaustive list of parties in interest.”

In terms of purpose, the justice said, “Broad participa­tion promotes a fair and equitable reorganization process.”

Alleged Collusion Gave Rise to Standing

Applying general principles to the facts of the case, Justice Sotomayor noted how the insurer had alleged collusion between the debtor and asbestos claimants by including no antifraud provisions in the plan to protect the insurer. The allusion to alleged collusion led immediately to a finding of standing, when she said,

An insurer with financial responsibility for bankruptcy claims can be directly and adversely affected by the reorganization pro­ceedings in these and many other ways, making it a “party in interest” in those proceedings.

Note the reference to “directly and adversely,” terms that are used in defining standing under Article III of the Constitution. The reference means that Justice Sotomayor was anchoring the notion of standing under Section 1109(b) to traditional concepts of constitutional standing.

Critique of ‘Insurance Neutral’

Justice Sotomayor devoted the remainder of her 15-page opinion to a refutation of the Fourth Circuit’s analysis finding no standing to challenge the plan. “Conceptually,” she said,

[T]he insurance neutrality doctrine conflates the merits of an objection with the threshold party in inter­est inquiry. The §1109(b) inquiry asks whether the reor­ganization proceedings might affect a prospective party, not how a particular reorganization plan actually affects that party.

Justice Sotomayor explained that insurance neutrality is “too limited in scope” and “zooms in on the insurer’s prepetition obligations and policy rights. That wrongly ignores all the other ways in which bank­ruptcy proceedings and reorganization plans can alter and impose obligations on insurers.”

Observing that insurance neutrality does not coincide with lack of standing, Justice Sotomayor might be understood as not telling the Fourth Circuit to reverse on the merits following remand, when she said,

Whether and how the particular proposed Plan here affects [the insurer’s] prepetition and postpetition obligations and exposure is not the question. The fact that [the insurer’s] fi­nancial exposure may be directly and adversely affected by a plan is sufficient to give [the insurer] . . . a right to voice its objections in reorganization proceedings.

The Narrow Opinion

Section 1109 applies only in chapter 11. The section does not generally confer standing on shareholders or debtors in chapter 7, for example. Justice Sotomayor concluded her opinion by saying that “the Court today does not opine on the outer bounds of §1109.” However, she quoted the Collier treatise, saying that “a party in interest is ‘not intended to include literally every conceivable entity that may be in­volved in or affected by the chapter 11 proceedings.’”

Despite the paucity of dicta prescribing rules for other cases, the opinion is not silent. Just before reversing and remanding, Justice Sotomayor dropped a quote with the words “truly peripheral” that will be used in the future to define when a party’s interest is insufficient to confer standing.

Justice Sotomayor said, “There may be difficult cases that require courts to evaluate whether truly peripheral parties have a sufficiently direct interest. This case is not one of them.”

Judges in the future will tell us what “truly peripheral” means. Some courts might question whether there is standing in a case where the interest is more than “peripheral.” Nonetheless, dicta from the Supreme Court is highly persuasive, to say the least.

Observations

The opinion is narrow. It does not define the outer limits of standing; it does not deal with chapters 7, 12 and 13, and it does not explicitly say whether the more exacting “person aggrieved” standard for appellate standing in some circuits survived adoption of the Bankruptcy Code.

A “person aggrieved” is typically defined as a party who is directly and adversely affected pecuniarily. Without saying so directly, the opinion seems to replace “person aggrieved” for appellate standing with a less exacting standard.

Perhaps Section 1109(b) can be seen as presumptively bestowing standing on the enumerated parties, because Congress cannot grant standing broader than Article III permits.

The opinion does not tell us whether stockholders, for instance, will always have standing in chapter 11. Can the presumption be overcome if the bankruptcy court conducts a hearing and decides that the debtor is hopelessly insolvent and that shareholders lack standing?

By saying that “truly peripheral parties” can lack standing, is Justice Sotomayor telling us that Section 1109(b) would be unconstitutional as applied if a peripheral party was granted standing?

The opinion does seem to open the door to conferring standing for more wide-ranging appellate attacks on confirmation and other orders of the bankruptcy court. The opinion may enable more appeals to survive motions to dismiss. Often, though, appellate courts will have an easier time ruling on the merits than deciding nettlesome issues about standing.

Because standing is jurisdictional, appellate courts must address the question before tackling the merits. The opinion provides appellate courts with more leeway to find standing and reach the merits.