Johns-Manville

The Johns-Manville Corporation was a pioneer in the use of Chapter 11 bankruptcy as a strategic defense against exposure to product liability lawsuits. Manville was a major supplier of insulation materials. Unfortunately, asbestos was one of Manville's main insulation products. Exposure to even small quantities of airborne asbestos particles can cause debilitating and often fatal lung disease. There is evidence that Manville knew of the link between its asbestos and lung disease as early as the 1930s. An appeals court judge even held that Manville had engaged in a conspiracy to hide that link. Not surprisingly, the industrial workers who had been exposed to asbestos began to file lawsuits in increasing numbers during the 1970s and 1980s.

In 1982, faced with this burgeoning potential liability, Manville sought protection in the bankruptcy court through a reorganization that created two separate entities: an operating company whose assets would be shielded from asbestos liability and a trust that would handle payouts of asbestos-related claims. The trust was funded by a grant of 50% of Manville's common stock and 20% of the operating company's profits (a payment that continued until the operating company was sold in 2001). Shareholders opposed the arrangement as a dilution of their equity but the bankruptcy court accepted the company's plan in 1986.

The original formula for payouts from the trust was 100% of a claim's settled value on a first-come, firstserved basis. The number of claims against the trust quickly swelled, however, and as of 2004 the trust was paying just 5 cents on the dollar for claims.

The Manville case raises serious ethical questions about how to apportion the assets of a firm between shareholders, creditors, and victims when the firm is faced with liability claims that approach or even exceed the value of the firm itself. Shareholders naturally feel that as owner-investors they are entitled to retain the firm's equity value and profits. Yet creditors believe that they have a binding claim based on prior corporate promises. And, of course, victims of the company's products claim that they are entitled to be made whole for injuries that were not their fault. If the bankruptcy court does not shield firms when they are exposed to such enormous liability, the odds are that those victims who file their lawsuits early may receive full compensation while creditors and other victims will receive little or nothing. However, if the courtaccepts this strategic use of the bankruptcy laws, it is likely that no injured party and no creditor will be fully remunerated. Shareholders, in either case, are likely to lose both equity value and future dividends.