3M unit's bankruptcy could put U.S. mass tort system on trial

Why it matters: Aearo's rationale for the bankruptcy involves questioning whether the U.S. mass tort and MDL system is even functional, calling its own experience "a cautionary tale of a MDL that is broken beyond repair."

• And large companies regularly exposed to mass torts — think pharma and medical device makers — are closely watching what happens with both Aearo and last year’s bankruptcy of a Johnson & Johnson subsidiary. The latter was filed to help settle baby powder litigation and is the second largest MDL in history.
• The outcomes could provide a playbook for large, profitable parent companies — which don't appear to be insolvent — to take advantage of certain features of the bankruptcy process without actually filing for bankruptcy themselves.
• In other words: The benefits of bankruptcy, without the drawbacks.

The benefits: Bankruptcy provides an efficient route to settling with a sprawling group of claimants. Instead of plodding through thousands of individual cases, the bankruptcy court estimates the liability via expert testimony and bellwether verdicts so far and facilitates settlement negotiations if the company doesn't have the money.

• Often, bankrupt entities get an "automatic stay" (or pause) of litigation against them, which prevents additional unfavorable trial verdicts from rolling in — and can thus give them more leverage in settlement talks.

The drawbacks: Bankrupt entities come under court control for day-to-day financial decisions like paying vendors and their use of cash. They typically wouldn’t be able to transfer value to shareholders in the form of dividends or spinoffs (3M is currently planning to spin off its health care business).

What they're saying: After the J&J case last year, "the flood gates are open," wrote Georgetown Law professor Adam Levitin on the Credit Slips blog.

• In Levitin’s view, "like J&J, 3M appears solvent and capable of paying all of the hearing claims in full. So instead, it is hoping to use bankruptcy to be the forum for forcing a deal on plaintiffs."

State of play: So far, the Indiana bankruptcy judge isn't totally going along with it — he refused to stay the litigation against 3M. The company's appealing.

• Meanwhile, critics cite 3M's planned health care spinoff in particular as a way to potentially move assets out of reach of the litigation claimants — and a group of earplug plaintiffs has sued to block the spinoff. (3M chief legal officer Kevin Rhodes says the two transactions have completely separate rationales; 3M maintains the earplugs were effective when used properly.)

By the numbers: Whether the spinoff plans are a bad look or not might depend on how much you think the earplug plaintiffs will ultimately be owed.

• 3M estimates it’ll likely be about $1 billion — and it funded a trust with that amount in conjunction with Aearo’s bankruptcy filing. Rhodes says the estimate is based on valuation analysis by consulting firm Bates White.
• But the plaintiffs allege it could be more than $80 billion, based on extrapolating the bellwether cases so far (plaintiffs prevailed in 10 of 16 jury trials). Meanwhile, a 3M sell-side research note published by Wells Fargo listed a settlement expectation in the $15-$20 billion range.
• For comparison, 3M’s market cap is about $66 billion, and analysts estimate the health care business it plans to spin could be worth as much as $45 billion.

The bottom line: The MDL process "is going to be the foremost issue in Aearo’s bankruptcy. It’s not an understatement to say this case will help decide whether mass tort MDLs remain viable, or whether defendants like Aearo will routinely use bankruptcy to avoid them," wrote Reuters' Alison Frankel.