When Defendants File For Bankruptcy

Recently we were defending as New Jersey counsel a class action brought against our client, the maker of a nutritional and dietary supplement. Similar lawsuits had been brought in other states. An insurer’s policies arguably covered some portion of the claims at issue.

Given the widening number of claims and the client’s products which came to be at issue, compounded by national attention from the press, legislature and federal regulatory authorities such as the FDA, our client exercised its option to file a petition for Chapter 11 Bankruptcy.

An automatic stay of all actions affecting our client immediately came into effect pursuant 11 U.S.C. Section 362(a). The act of filing the petition triggered the stay. We advised our state court, adversary and co-counsel by letter, enclosing a copy of the bankruptcy filing petition indicating the docket number, date and venue of filing. We followed up by filing a Suggestion of Bankruptcy in our state court action.

While a trustee can be appointed by the bankruptcy court to take control of the affairs of the debtor-company, no trustee was sought or appointed, leaving those previously in control still in control of the company - a debtor in possession. An official Creditors’ Committee was soon formed.

All action in the state court action involving our client stopped. The defense and indemnity one party was seeking from us through contractual and common law cross-claims would soon be thrown into the bankruptcy as a claim against the estate of the bankrupt debtor.

Insurance policies such as the one involved in our case, where the defense was being handled under a reservation of rights, are typically treated as assets of the debtor’s estate. Plaintiff’s counsel has the option to apply for relief from the stay to the extent of the available insurance proceeds by filing an application for relief in the bankruptcy court. That application will probably be granted. A resolution of outstanding claims arguably covered by the policy may be worked out by counsel in advance. In that way the application to lift the stay to the extent of the insurance proceeds can be accompanied by a proposed settlement of those cases, taking into account available insurance and the debtor’s financial condition.

Any such settlement is subject to the approval of the bankruptcy court. Creditors must be given notice of the proposed settlement and an opportunity to object. The bankruptcy court will approve the settlement if it concludes that it is fair and equitable and in the best interests of the creditors. In bankruptcy our client is finding a forum hospitable to its desire to work out the claims against it, much more so than in the courts.

We used the automatic stay to fend off any activity adverse to our client. All proceedings in state court were frozen. Ultimately the New Jersey state court administratively dismissed the action against us.

As any payment from the client company ceases until further order of the court, the issue of the payment of attorney’s fees for these state court filings can become an issue. In our case, the insurer continued to pay defense costs for our client as the company filed for bankruptcy.

This initial Chapter 11 filing may result in a Plan of Reorganization of the company and a continued business emerging from bankruptcy. Ultimately the company may seek conversion to Chapter 7 liquidation, the end of the corporation. Either way, the company is better served than by an onslaught of uncoordinated litigation – and so is the insurer.

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