LOS ANGELES—A provision in federal bankruptcy law designed to facilitate the payment of damages to asbestos claimants does not extinguish insurers' contractual rights, a California appellate court has ruled.

The provision, which allows bankrupt companies to establish trusts to pay asbestos liabilities and avoid further liabilities if they emerge from bankruptcy, does not compel insurers to abide by the trusts' settlement plans, the court ruled.

Insurers have a right to challenge the plans on several grounds, including whether the plans are fair or the products of collusion, the court said.

The Jan. 19 decision partially overturns a California trial court's decision that would have required numerous U.S. and London market insurers to immediately pay the Fuller-Austin Asbestos Settlement Trust nearly $189 million to cover a portion of the trust's estimated future asbestos claims (BI, May 19, 2003).

The trust, as allowed by the U.S. Bankruptcy Code, was established in 1998 to handle the thousands of asbestos liability claims filed against Fuller-Austin Insulation Co., which filed for bankruptcy at the same time.

In its 3-0 ruling, the California Court of Appeal stated that even insurers that had passed up ample opportunity to participate in a settlement between their policyholders and claimants still retain the right to review those settlements for fraud and fairness.

Considering that more than 60 major asbestos company defendants have filed for bankruptcy and that asbestos-related litigation has spread to more than half of U.S. industries, the reversal of the Fuller-Austin decision is "a major, major deal," asserted Laura A. Foggan, counsel for the Complex Insurance Claims Litigation Assn., a liability insurer organization.

The Fuller-Austin reversal, in addition to a handful of recent similar rulings in other cases, "reinforces that insurers are going to have an opportunity to be heard" on asbestos coverage issues, said Ms. Foggan, a partner with Wiley, Rein & Fielding L.L.P. in Washington.

"At its most basic level, this ruling confirms that a policyholder's bankruptcy does not expand or contract the terms of an insurance contract. The policyholder, bankrupt or not, is bound by the terms and conditions set forth in the plain language of the insurance contracts it purchased. This concept is fundamental to the insurance contract mechanism and was threatened by the trial court ruling."

Fuller-Austin attorney Robert M. Horkovich noted that the ruling does not relieve the insurers of their coverage obligations and that it upheld a $50 million judgment against one insurer.

"There's a lot they should not be happy with," said Mr. Horkovich, a partner with Anderson Kill & Olick P.C. in New York.

Mr. Horkovich said the court made some errors that should be cleared up in a rehearing that Fuller-Austin will seek. For example, the court asked a lower court to decide whether the settlement with asbestos claimants involved collusion, but the lower court has already resolved that issue, he said.

Ms. Foggan said the lower court did not give insurers adequate opportunity to address the collusion issue or whether the settlement was fair.

Mr. Horkovich also said Fuller-Austin will appeal the ruling to the state Supreme Court.

Fuller-Austin set up its trust in accordance with provision 524(g) of Chapter 11 of the U.S. Bankruptcy Code.

In November 1998, a bankruptcy court ruled that Fuller-Austin's insurers had no standing to review or modify the trust's asbestos liability settlement plan. Court documents state Fuller-Austin did not invite the insurers to participate in creating the plan, but that the insurers knew about the settlement negotiations in advance.

In coverage litigation, a trial court in February and August 2002 ruled the bankruptcy action established Fuller-Austin Insulation's liability and obligated its insurers to immediately pay their policyholder the so-called allowed liquidated value of claims, which is a model of claims payments under the best-case scenario.

In 2003, a jury trial determined, among other things, that: Fuller-Austin's settlement did not arise from collusion; nearly all of the insurers breached their obligations after the bankruptcy plan was confirmed; the value of pending but unresolved claims totaled $108 million; and the value of future claims was $750 million.

The jury ordered the insurers to pay the trust $188.7 million to respond to future claims. The amount was about $5 million less than Fuller-Austin Insulation's total limits, according to Mr. Horkovich.

Last week, the California Court of Appeal ruled that estimations of individual and aggregate value of present and future asbestos claims "served neither to affix nor to accelerate" insurers' indemnification obligations. "Rather, the bankruptcy confirmation constituted a settlement of Fuller-Austin's liability, the effect of which was subject to challenge" by the insurers, the court ruled.

"To hold that a jury's estimation of the value of present and potential future asbestos claims is binding on (insurers) would obligate them to indemnify Fuller-Austin in an amount beyond what their policies provide," the court reasoned.

The appellate court did agree with the trial court finding that the insurers had "a reasonable opportunity to participate in the settlement negotiations." It added that the insurers' policies do not give them the right to refuse to participate and then "resist all responsibility on the basis of lack of consent."

Still, the court said it did not believe that the insurers "waived all rights under the policies where they attempted to participate in the final stages of the section 524(g) proceedings but were directed to raise their objections in this action." On remand, the insurers "will be entitled to litigate the issue of whether, as to them, the bankruptcy Plan is unfair, unreasonable or the product of fraud or collusion."

Fuller-Austin Insulation Co. vs. Highlands Insurance Co. et al., California Court of Appeal, Jan. 19; No. B170079.