Herlihy v. DBMP LLC, No. 24-2109 (4th Cir. 2026)
The Fourth Circuit confirmed that balance-sheet solvency does not disqualify a company from invoking § 524(g) and that early-stage dismissal requires proof of both subjective bad faith and objective futility.
In Herlihy v. DBMP LLC, the court rejected an early-stage effort to lift the automatic stay and imposed a disciplined evidentiary standard for such challenges. For public company boards, private equity sponsors, lenders, and parent entities managing long-tail mass tort exposure, the decision recalibrates early litigation risk analysis and sharpens what challengers must demonstrate to prevail.
THE RULING
The opinion’s most consequential holding was its treatment of bad faith. The court confirmed that good faith is an implied limitation under §§ 1112(b) and 362(d) and imposed a demanding evidentiary threshold: challengers must establish both subjective bad faith and objective futility. The inquiry is not whether the enterprise could pay claims outside bankruptcy, but whether the filing served a purpose inconsistent with reorganization or lacked a reasonable relationship to addressing financial distress. On a record containing tens of thousands of claims, multi-decade exposure projections, and an uncapped funding agreement preserving enterprise-wide value, neither showing was satisfied.
The court also rejected the premise that balance-sheet solvency forecloses access to § 524(g). Long-tail liabilities that impair capital allocation, insurance recovery, and enterprise planning can constitute sufficient financial distress. Congress enacted the asbestos trust mechanism to address latency-driven, structurally destabilizing liabilities, not only those that have ripened into present insolvency. That clarification will likely reverberate beyond the asbestos industry.
Equally significant was the court’s focus on economic substance. The uncapped funding agreement, which was enforceable and not subject to unilateral termination, undercut the narrative that assets had been walled off from liability. The majority emphasized that no enterprise value was immunized; it was instead channeled into a centralized process designed to treat all claimants uniformly. Future courts will likely scrutinize structural integrity, including enforceability, termination rights, and economic substance, as a predicate to stay protection. A funding commitment that can be unwound on demand is not a funding commitment; it is a business option.
THE DISSENT: A ROADMAP FOR CHALLENGERS
The dissent is a roadmap for challengers. It is a litigation roadmap that opposing counsel will cite in future Texas Two-Step proceedings, and sponsors, boards, and restructuring counsel should understand its arguments with the same precision that they apply to the majority.
The dissent advances three arguments that will resurface in other circuits and, perhaps, ultimately, at the Supreme Court. First, it urges that the burden of proving good faith should rest with the debtor, not the challenger. A burden shift of this magnitude would materially alter the cost-benefit calculus of early-stage stay litigation by requiring debtors to affirmatively justify every structural choice before a motion to dismiss can be defeated. Second, the dissent calls for a granular, temporal analysis, scrutinizing the speed and deliberateness with which the divisional merger was executed as independent evidence of bad faith. The fact that the legacy entity and its NewCo counterpart existed simultaneously for less than four hours was, in the dissent’s view, telling. Third, it argues that courts should deploy their equitable powers under § 105 more aggressively to police structures perceived as engineering financial distress.
None of these arguments prevailed in the Fourth Circuit. But the dissent’s framing (i.e., solvent enterprise, engineered liability, civil-justice displacement) is consistent with the skepticism expressed in other circuits and tracks the Supreme Court’s emphasis on textualism. Going forward confirmation records should be built with the dissent’s theory in mind. Every governance decision, every funding agreement term, every timeline, and every board communication is a potential exhibit in a bad-faith challenge.
NATIONAL IMPLICATIONS AND CIRCUIT-LEVEL RISK
Venue selection is no longer procedural housekeeping; it materially affects dismissal risk, stay protection, and the evidentiary burden challengers must carry. The stabilizing effect of Herlihy is presently confined to the Fourth Circuit, and that jurisdiction must be evaluated at inception, not after a filing is made.
The principal inter-circuit divergence concerns what qualifies as sufficient financial distress. The Fourth Circuit accepted long-tail, enterprise-destabilizing liabilities without requiring present insolvency. Courts in other circuits have required a more immediate and quantifiable impairment of the debtor’s viability. That distinction affects filing timing, funding design, and the actuarial showing necessary to support a legitimate restructuring objective. Where a company files in a circuit that applies the more demanding standard, the same structure that survives early challenge in the Fourth Circuit may not survive a motion to dismiss elsewhere.
The broader judicial climate reinforces the need for structural discipline. Recent Supreme Court decisions, most notably in the non-debtor release context, reflect increased textual rigor and skepticism toward expansive uses of the bankruptcy courts’ equitable powers. Courts assessing divisional-merger structures may scrutinize whether they align with congressional intent for resolving mass-tort liabilities or instead stretch the statute’s design through corporate engineering. If circuit divergence sharpens, Supreme Court review becomes a realistic possibility. Enterprises should evaluate not only current circuit precedent but its defensibility under a more textualist interpretive framework.
Abstention presents a related tactical front. Under 28 U.S.C. §1334(c), claimants may attempt to carve out discrete state-law disputes, particularly on liability and causation, and pursue parallel proceedings designed to influence valuation arguments ahead of estimation. Mandatory abstention is unlikely in core proceedings, and permissive abstention is rarely granted where centralized control is essential. But the threat of parallel proceedings, even where unsuccessful, can complicate a debtor’s ability to present a unified liability profile and should be anticipated in pre-filing planning.
Governmental posture remains an independent variable. The U.S. Trustee Program and other institutional stakeholders have shown heightened sensitivity to filings perceived as strategic rather than necessity driven. Even where dismissal risk is controlled, regulatory objections can affect discovery, confirmation timing, and reputational exposure. Structural defensibility requires governance discipline and a contemporaneous record.
EXECUTION VARIABLES FOR SPONSORS AND BOARDS
- Funding Integrity. Confirm enforceability, scope, and durability of any funding commitment. The Fourth Circuit’s emphasis on the uncapped and non-terminable nature of the funding agreement makes clear that economic substance controls: a commitment subject to unilateral modification or cap will not anchor stay protection and will likely be the first target of any bad-faith challenge.
- Financial Distress Record. Develop actuarial and financial support demonstrating enterprise-level destabilization, not generalized exposure. The record should show that contingent liabilities impair capital allocation, insurance recovery, and enterprise planning in a way that a centralized bankruptcy process is uniquely suited to address.
- Venue Discipline. Evaluate circuit standards at the inception of any pre-filing planning. Jurisdiction materially affects dismissal risk, stay durability, and the evidentiary threshold challengers must clear. With the current circuit splits, venue is a substantive legal decision, not an administrative one.
- Governance Alignment. Ensure board materials, resolutions, and internal communications reflect restructuring purpose and equalized claimant treatment from the earliest stages of planning. The dissent’s temporal framing means that compressed timelines and sparse board records will be characterized as evidence of bad faith. In this context, the governance record is a key litigation asset.
- Confirmation Posture. Build a record capable of withstanding confirmation-stage scrutiny on feasibility, funding stability, and injunction scope from day one. Stay litigation is increasingly a preliminary skirmish; the dispositive contest is confirmation, where challengers will press the arguments that the dissent presented.
STRATEGIC IMPLICATIONS
For sponsors, lenders, and boards evaluating legacy-liability strategies, Herlihy is both validation and instruction. The decision confirms that § 524(g) divisional-merger structures remain viable when executed with economic substance and evidentiary rigor, but their risk profile is meaningfully influenced by jurisdiction, timing, and structural design. Where those elements are present, early-stage dismissal risk recedes and the focus shifts to confirmation.
At the same time, the ruling makes clear that venue selection and adversarial posture are variables that shape structural defensibility from inception. Circuit divergence, evolving Supreme Court jurisprudence, heightened regulatory scrutiny, and the tactical threat of parallel abstention proceedings mean that corporate structure and litigation positioning must be designed together. A structure that is technically sound but strategically exposed (e.g., wrong circuit, compressed timeline, thin governance record) will face challenges that a well-designed structure would not.
We are closely monitoring circuit-level developments and are available to discuss litigation risk, venue considerations, and confirmation-stage exposure as this jurisprudence continues to evolve.
This Client Alert is provided by Bradford Edwards LLP for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered to be advertising under applicable state laws.
