In a significant development that could force Owens Corning's bankruptcy lawyers back to the drawing board, a federal appeals court yesterday overturned a key provision of the firm's plan for exiting Chapter 11.
The effect of the ruling, if left standing, would be to greatly improve banks' position in the debate over how to divide the cash, bonds, and new stock the company will distribute to creditors as part of its emergence from bankruptcy.
In the short term, however, the ruling by a three-judge panel of the Third Circuit Court of Appeals in Philadelphia could further delay a multibillion-dollar Chapter 11 case that soon will enter its sixth year, a creditor lawyer said.
The appeals panel said that U.S. District Judge John Fullam erred last October when he sided with OC and other proponents of the firm's plan of reorganization in the debate over whether assets of company subsidiaries should be combined with those of the parent firm or treated separately.
Plan proponents said they should be combined. But the banks, which before Chapter 11 made nearly $2 billion in loans to OC and demanded that the subsidiaries sign contracts guaranteeing repayment, convinced the appeals judges that they should be treated separately.
"The banks did the 'deal world' equivalent of Lending 101," the appeals judges said. "They loaned $2 billion to OC and enhanced the credit of that unsecured loan indirectly by subsidiary guarantees.
"Playing by these rules means that obtaining the guarantees of separate entities entitles a lender, in bankruptcy or out, to look to any [or all] guarantors for repayment when the time comes."
Subsidiaries involved hold title to OC's European operations and own the rights to company patents and technology used to make insulation and other products sold by the Fortune 500 firm.
Lawyers for asbestos claimants, who are co-sponsors with OC of the bankruptcy exit proposal, couldn't be reached for comment on the ruling.
Stephen Krull, company legal chief, said it is too soon to say if plan sponsors will ask the full court to reconsider the ruling or appeal to the U.S. Supreme Court.
The company arrived at its position on the issue after consulting with top legal experts and believed the advice reflected prevailing law, Mr. Krull said.
Now, however, the appeals panel has established a new test that could have an impact on other bankruptcies, he added.
Attempting to put the best face on the decision, Mr. Krull said the ruling brings clarity to a major point of disagreement among the firm's feuding creditor groups.
The ruling, if it stands, won't affect how much OC will distribute, just how it is divided, Mr. Krull explained.
"I view it as a positive decision," he said.
"We simply are happy to have this issue decided. The certainty, we believe, will pave the way for us to have productive discussions with our creditors and move our case forward."
But a creditor lawyer, who spoke on the condition he wasn't identified, said that just the opposite is possible.
The ruling clears the way for asbestos liability lawyers, who are the primary foes of the banks, to pursue a lawsuit contending that the repayment guarantees made by the subsidiaries are invalid because the subsidiaries were technically insolvent when the promises were made in 1997.
Martin Bienenstock, a New York attorney who represents the banks, didn't return a call seeking comment.
Under the current bankruptcy-exit proposal, creditors would receive less than 40 cents on each $1 owed them.
OC, which filed for Chapter 11 protection in October, 2000, is seeking to discharge $12 billion in debt, nearly 60 percent of which is owed to construction workers and others made ill by exposure to asbestos-containing insulation once made by the firm.
That amount does not include the yet-to-be determined asbestos liability of OC's fibreboard subsidiary.
The ruling was made in Philadelphia because appeals judges there have jurisdiction over Delaware, where OC filed the case.
The appeals court classified the ruling as precedent-setting. The case attracted wide attention.
Briefs were filed by Loan Syndications and Trading Association Inc., Clearing House Association LLC, Commercial Financial Association, and the Commercial Law League.
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