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Federal-Mogul, burdened with asbestos claims, tests the limits of bankruptcy law.
Kris Frieswick, CFO Magazine
May 1, 2003
Federal-Mogul Corp. had already recognized a $1.6 billion liability for asbestos-litigation costs when it filed for bankruptcy. But that expenditure got it no closer to ending these liabilities. The nature of asbestos claims is such that companies rarely solve their problem, no matter how much they pay out. But after a bankruptcy, says Todd R. Snyder, managing director of reorganization and restructuring for Rothschild Inc., the American arm of the global investment bank, it becomes easier to craft a lasting solution.
And Rothschild, which is working with auto-parts maker Federal-Mogul in its case, is all about helping clients in bankruptcy find a solution. Rothschild has made a practice of finding innovative, even aggressive, interpretations of bankruptcy law for its clients.
In 2000 it extended the bounds of asset sales typically completed under Section 363 of the bankruptcy code when it helped TWA complete the sale of 100 percent of its assets out of Chapter 11 protection. Rothschild also negotiated a $1.5 billion debtor-in-possession financing for United Airlines, a large portion of which, says Snyder, was predicated on such unconventional assets as the airline's Bank One credit-card relationship and its frequent-flier program.
Rothschild is now helping break more new ground with Federal-Mogul. In January it announced a deal that may lead to settling not only Federal-Mogul's present and future asbestos liabilities, but also those of Honeywell, whose Bendix friction-parts division — like Federal-Mogul's own — has been plagued with lawsuits related to its use of asbestos, a material that causes serious respiratory diseases. (Honeywell took a $1.5 billion restructuring charge in its 2002 fourth quarter related to the settlements.)
In a move that could suggest how future asbestos cases may be resolved, Honeywell has agreed to transfer its Bendix unit to Federal-Mogul, along with the value of Honeywell's $2 billion insurance policy. If the arrangement is approved by U.S. Bankruptcy Court in Delaware, the U.S. and U.K. liabilities of both companies, and the value of the insurance, will be placed in a special trust. The trust, authorized under the bankruptcy law's Section 524(g), is designed to insulate companies from ongoing asbestos lawsuits while providing mechanisms for paying current and future claims.
The transfer of Bendix assets is contingent on court approval of the deal and on Federal-Mogul's emergence from Chapter 11. With those two objectives achieved, as presently structured, Honeywell will give Federal-Mogul Honeywell's foreign Bendix assets and transfer the capacity of its domestic Bendix assets, making Federal-Mogul one of the nation's largest friction-parts makers. (Honeywell will also phase out the last vestiges of its asbestos use in Asia.)
Federal-Mogul CFO Mike Lynch sees nothing in that structure that should be a problem, although the specifics of the reorganization plan and the trust distribution plan haven't been hammered out.
The Icahn Factor
The genesis of the deal, says Snyder, was an early agreement in the bankruptcy proceedings. Coming to terms were lawyers for asbestos complainants, who automatically became unsecured creditors when Federal-Mogul filed, and the company's bondholders, who also became unsecured creditors.
Most notable among the bondholders was billionaire financier Carl Icahn. The two unsecured groups decided on the creation of a 524(g) trust, holding 50.1 percent of the stock of the postbankruptcy firm. Bondholders would receive the remaining 49.9 percent.
The unusual nature of the deal — with plaintiffs' attorneys negotiating with other unsecured creditors rather than with secured lenders, who have legal first dibs on the company's assets — apparently resulted from the influence of Icahn, who asserts that he holds a blocking position in the Federal-Mogul bonds. Icahn, says Snyder, was able to convince plaintiffs' attorneys that he, not the banks, could most efficiently help manage the company "for value that would reward the plaintiffs as well as the bondholders."
Because a provision of Section 524(g) inhibits "cramdown," in which reorganization plans are confirmed over the objections of an impaired class, the only deal plaintiffs would accept was probably the one they'd negotiated already with Icahn. So Rothschild, Federal-Mogul CEO Frank Macher, CFO Lynch, and other executives were left to design a plan permitting the reorganized Federal-Mogul to successfully continue to service upward of $2.5 billion in debt.
Without the ability to convert some amount of pre-petition bank debt to equity, Federal-Mogul had no choice but to restructure its debt load, which would be difficult, says Lynch. "Prior to going into bankruptcy, because of cash-flow problems associated with the asbestos liabilities, we were in danger of defaulting on bank covenants," he says.
This meant the company had to find a way to increase its cash flow. That need, coupled with a 524(g) provision extending a release from future asbestos liabilities to "affiliated parties," gave the Federal-Mogul-Rothschild team an idea.
"We started looking for companies that could contribute to the reorganized Federal-Mogul within the context of the deal," says Snyder. "We came to the conclusion that what we had to offer other asbestos defendants that they potentially lacked was the Section 524(g) release." Because of Federal-Mogul's already-high asbestos liabilities, adding more didn't "alter the calculus of the deal all that much," he adds.
Honeywell seemed a natural choice as an asbestos-liability-plagued company that would play ball. "Brake pads are a core business for us, and they're not for Honeywell," says Lynch, and the business had been on the market "for some time."
Despite the contingencies, many see this deal as offering a structure that could be useful in eventually solving the asbestos-litigation crisis, which has already cost corporations $54 billion and has drawn nearly 60 into bankruptcy, according to a RAND Corp. study.
RAND estimates that future claims could top out at between $200 billion and $265 billion. (Surprisingly, despite the enormous economic and human cost of asbestos, its use has not been banned by the United States.)
Some believe, though, that the deal abuses bankruptcy laws and represents an attempt to skirt responsibility to victims. It's just "a new scheme for off-loading asbestos liabilities," says Laurie Kazan-Allen of the International Ban Asbestos Secretariat in London, who calls the plan "breathtaking in its audacity." She also criticizes efforts by Honeywell and Federal-Mogul to enjoin claims while their deal is still being worked out.
History doesn't bode well for claimants seeking compensation from a trust. The Manville Trust, set up in 1988 to pay current and future asbestos claims against that asbestos-products maker, announced in 2001 that it would pay only 5 percent of the full liquidated value of claims, in order to preserve cash for future claimants, according to RAND. Before, it had paid 10 percent. (Other trusts have encountered similar dwindling asset problems.)
But that's better than nothing, which is what claimants get if a company goes out of business. "There's not a soul involved in this issue that doesn't think this is a tragedy," says Snyder. "Everyone recognizes the real human sadness of the problem. But we're struggling to put together an economic solution that is sustainable."
The sentiment also prevails on Capitol Hill, where bizarre new alliances have formed between plaintiffs' lawyers and corporate lawyers, who were previously warring parties. Both are keenly interested in finding a solution to the asbestos crisis — corporate attorneys to reduce company liabilities and avoid bankruptcies, plaintiffs' attorneys to shorten the time it takes cases to get through clogged court systems.
Two proposals are currently circulating in Washington, D.C. One suggests a nationwide version of the combined trust currently proposed by Federal-Mogul and Honeywell. If it is created, future asbestos plaintiffs would be required to make a claim against this megatrust, although the complex logistics promise to keep this plan on the drawing board for the foreseeable future.
It would also need to overcome the ongoing funding problems that have plagued asbestos trusts in the past. The other proposal would establish medical criteria for claimants, requiring that a certain level of medical harm be demonstrated before they could file their claims.
Despite the remaining obstacles, the Federal-Mogul deal and action in Washington represent the most significant movement yet toward a permanent fix to the nation's asbestos-liability crisis.
The Ballooning Asbestos Crisis
|Number of claimants||21,000||600,000|
|Number of defendants||300||6,000|
|Total costs to date||$1 bill.||$54 bill.|
|Estimated future costs||$38 bill.||$145 - $210 bill.|
Cost estimates do not include the effect of lost wages or productivity.
Source: RAND Corp.