Misery Loves Another Company

Federal-Mogul, burdened with asbestos claims, tests the limits of bankruptcy law.

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.

Costly Claims

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.

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