Exit from a downward spiral

By Mitchell Vininsky
Illustration: Blair Kelly

Is it possible for a viable business to recover from the US phenomenon of mass tort litigation?

Deadlines of yet another US bankruptcy caused by mass tort litigation are all too familiar. Manufacturers of silicone breast implants, asbestos, intrauterine devices, pharmaceutical products, diet products and lead paint have been subjected to multiple tort lawsuits. And Canadian companies that sell into the US are not immune from these risks. But can an otherwise viable business recover from mass tort litigation using restructuring legislation?

Mass tort has become a US phenomenon for a number of reasons, including:

• jury trials regularly resulting in substantial damage awards, particularly large in the Southern US. The first trial in Vioxx cases resulted in a US$253-million award against Merck by a Texas jury. Merck is appealing.
• the lack of cost awards against plaintiffs (i.e., loser pay system). This limits the risk of initiating claims and, arguably, promotes litigation.
• contingency fee arrangements of 33% or more in favour of plaintiffs’ counsel. It should be noted that counsel representing a complicated tort claim will invest substantial time and incur expenses that may never be recovered.
• A perceived home-field advantage to plaintiffs who file litigation in state courts. State judges, who are elected officials, can hear cases against out-of-state defendants.

In response to this industry of litigation, a virtual restructuring model has been developed in the US to navigate the mass tort jungle.

As in any restructuring, there must be a sustainable core business worth saving. Assuming this is the case, if a business is faced with mass tort litigation, it has a number of issues to consider, including: the nature and merits of claims; available resources, including management time and insurance to defend and/or settle those claims; and the impact of the claims and of expected future claims on the ability of the business to survive.

Merck, for example, is sorting through these issues with its 14,000 Vioxx tort claims. The same holds true for Wyeth, another pharmaceutical company that has been hit with 4,000 tort claims related to Prempro. For the time being each has stated it will defend each case individually — a daunting task.

Differentiating factors
A mass tort insolvency proceeding has three features that differentiate it from standard insolvency proceedings.

1. The underlying business is viable The purpose of mass tort restructurings is not to fix the operations; the filing is a balance-sheet fix. A mass tort restructuring’s sole purpose is to dispose of discovery, depositions, trials and other elements of litigation and permit the unencumbered business to move forward.

2. Claim characteristics Claims in these proceedings relate to alleged or proven injuries that are difficult to quantify, as opposed to simple unpaid goods or services. A large mass tort proceeding may involve thousands of claims, potentially all unliquidated, with more surfacing as a result of the publicity. The claims are rarely centralized within a particular locality. Instead, they are likely filed at the state and federal court levels, crosscountry, crossborder or worldwide.

3. The number of implicated parties Suppliers, distributors and retailers of products often get tangled in the web as defendants in the litigation. In many cases they hold indemnities from the main defendant. They are usually willing to contribute to a settlement and thus get certainty rather than look to the indemnity of the main defendant.

CCAA/Chapter 11 pros and cons
Most mass tort claims are unliquidated or contingent. A contingent claim is one of undefined quantum that may become a debt, depending on the outcome of a future event. Absent a filing, in a mass tort claim context, the claim is only likely to become a provable claim pursuant to some form of court judgement. This raises an interesting question for insolvency practitioners — can an other-­­wise solvent company apply for creditor protection solely as a result of contingent claims? Though discretionary to a court, there are strong arguments in favour of this relief.

Assuming the business is entitled to protection, there are a number of benefits to pursuing a filing.
The most obvious advantage is that a stay of proceedings is imposed to allow for planning to attempt to resolve the claims globally. As mass tort claims often name multiple parties, an expanded stay covering solvent third parties (or nonapplicants) has become more common. This is unusual but very important to the global settlement process overall. Courts have extended the stay to nonapplicant defendants (customers, suppliers) including related parties (officers, directors, shareholders, insurers) when their liability is inextricably linked to the debtor.

This stay is even beneficial to the mass tort claimants as it may act as an incentive for potential contributors to step up and fund a restructuring plan (rather than the debtor alone) and therefore provide a greater distribution to creditors. Canadian courts have recently tuned into the benefit of such a broader stay.

Another advantage is instead of addressing each claim as a one-off, a formal proceeding can consolidate all the claims into one jurisdiction and process. This is another key benefit that is not a factor in a standard insolvency proceeding. In the US, for example, state and federal cases can be consolidated at the federal level, with one judge as case manager. This provides a consistent result. It also reduces the costs of retaining multiple counsel and experts.

As part of the process, a claims bar date will be set to ensure the proceeding encompasses all claims. Defining the claim pool is important for a number of reasons. It hopefully will result in a single voice at the negotiating table and it defines the parties that will provide releases upon plan acceptance and share in plan distributions. Instances where injuries only manifest in the future can be dealt with by establishing an estimated fixed reserve (channelling injunction), perhaps funded from future earnings.

Cost may also be reduced. While a filing will result in the debtor incurring significant costs within a relatively short period of time, all other litigation expenses stop. The added layer of professionals includes the debtor’s counsel, a monitor or trustee, and even representative counsel for plaintiff committees, unsecured creditors committees and others.

There are negatives. Few companies welcome the publicity associated with insolvency proceedings. In order to get all the claims out of the woodwork, the court will mandate that advertisements be placed. Customers, suppliers, employees and other stakeholders will require communication. Not only will there be an acceleration of claims but there is a risk of generating new claims that absent the publicity would never have surfaced.

A filing can have an impact in other ways too. A debtor must make public disclosures of sometimes sensitive and confidential information as part of the plan approval process. This will be subject to scrutiny by creditors and could involve sales data, management salaries and profitability.

Take the recent example of Twinlab Corp., a restructuring of mass tort claim case.

US-based Twinlab manufactured and marketed brand name and private label nutritional supplements, including energy drinks, weight-gain powders and diet pills. Ephedra was included in a number of the Twinlab products as an ingredient to promote weight loss.

In the late ’90s, publicity became increasingly negative with respect to ephedra and its alleged harmful effects. Regulations were proposed by various state and federal governments. This, in part, led to mass tort litigation against Twinlab. The company commenced cases under Chapter 11 of the US Bankruptcy Code on September 4, 2003 citing deteriorating financial condition and a lack of liquidity primarily caused by increasing ephedra-related liabilities. Twinlab was not unique. It was the first of several competitors to seek creditor protection to address ephedra-related tort claims.

As part of a restructuring plan, Twinlab sold substantially all its assets as a going concern (its core business continues today). The proceeds from the sale, approximately US$49 million, were left to fund the restructuring and compromise creditor claims. During the proceeding, Twinlab received more than 440 ephedra-related tort proofs of claim.

The company succeeded in its motion filed at the outset of the Chapter 11 case to extend the stay of proceedings to include a number of its customers, including GNC, Wal-Mart, CVS and other defendants named in the product liability actions. This changed the dynamic common in more standard insolvency proceedings as there were a number of co-defendants with a financial interest in the outcome of the case.

Twinlab had insurance that covered all pre-2002 ephedra tort claims (the claim date was based on the initial ingestion of the product that gave rise to the injury). Its biggest hurdle was effecting a global settlement of ephedra claims from 2002 forward. From the ephedra claimants’ perspective, the distribution had to be sufficient to justify not pursuing the co-defendants named in the litigation. From Twinlab’s perspective it had US$16 million in various secured and priority claims, which could not be compromised, approximately US$65 million in general unsecured claims and a growing number of unliquidated ephedra tort claims.

In order to value the ephedra claims and determine an appropriate settlement, Twinlab pursued a mediation process. The mediation was attended by Twinlab, the co-defendants, Twinlab’s and co-defendants’ insurers, individual plaintiffs, the committee of ephedra claimants and other stakeholders.

After months of negotiations, the parties settled on the formation of a personal injury trust funded by the sale of Twinlab’s assets and the co-defendants. The motivation for the contribution was a global release from any and all claims or causes of action from 2002 onward. The personal injury trust was to be administered by a trustee appointed by the ephedra claimants committee. The trust was to pay the creditors according to claim values.

Approximately 75 claims were subject to the trust, as many were previously settled or insured. In order to quantify the claims the parties developed a claims resolution facility — essentially a scorecard to evaluate the injuries and losses suffered by the claimants. A retired judge was retained to determine the claim values based on the procedures and guidelines under the facility. This claims valuation process was also novel as it provided an agreed upon mechanism to quantify and rank claims based on injury, age, income earning potential, medical requirements and a host of other criteria.

On July 26, 2005 Twinlab’s plan was approved by the District Court in the Southern District of New York.

Conclusion
Although the Twinlab case is dwarfed by the major asbestos and pharmaceutical proceedings both in complexity and number of mass tort claims, the basic structure remains the same. Ultimately a coordinated process is required to bring all parties of interest under one roof, quantify the exposure and contributions and effect a global settlement with releases. Absent a coordinated process, plaintiffs and defendants become subject to years of protracted litigation, endless costs and an uncertain outcome, which inevitably takes its toll on otherwise viable businesses.

Mitchell Vininsky, MBA, CIRP, is a senior manager with RSM Richter Inc. in Toronto

Technical editor: Peter Farkas, CBV, CIP, CA, RSM Richter Inc.