3M (MMM -0.53%) has been making its way through a legal saga for several years now regarding earplugs it sold to the U.S. military. The saga may have taken a definitive turn for the worse this summer as evidence from a separate lawsuit regarding patent infringement is now being used to enhance soldiers' liability cases against 3M and cripple its defense.

The liabilities for 3M if it loses all these cases could easily exceed $1 billion.

3M's courtroom drama heats up

3M has been fighting multiple cases involving military veterans who say they used 3M's specialized combat earplugs and now suffer varying levels of hearing loss. 3M says they aren't liable and that the earplugs are safe and effective when used properly. There are already 115,000 claims filed by veterans against 3M and another 120,000 cases will likely be added to the docket. This massive influx of claims is related to a separate courtroom battle between 3M and an earplug competitor called Moldex.

Statue of a blindfolded person holding a scale of justice.

Image source: Getty Images.

How did 3M get here?

This all started when 3M bought Aearo Technology back in 2008 for $1.2 billion. Aearo made two-sided earplugs that allowed wearers to hear conversations when one side was inserted into the ear and nothing when the other side was inserted. Competition between 3M's Aearo subsidiary and Moldex started intensifying in 2012 when 3M filed a patent-infringement case against Moldex related to the earplugs. 3M ended up withdrawing its patent suit in 2013.

Then, later in 2013, Moldex filed a lawsuit against 3M, claiming it had used the patent-infringement case to dominate the earplug market and push Moldex out. In the discovery phase of that lawsuit, Moldex obtained evidence that Aearo Technologies knew its military-grade earplugs had problems as early as 2000. Despite the known issues, Aearo apparently continued selling the earplugs to the military through 2015, corresponding to roughly when the evidence was presented in court.

The evidence was so compelling that 3M settled with the military and Moldex in 2018. The military veterans who sustained hearing damage learned of these settlements and started filing their own claims against 3M. So far, 16 cases have been tried with 10 veterans winning their suits and 3M winning six. Another eight more cases have been dismissed for various reasons.

Where is 3M now?

Along with the release of 3M's second-quarter earnings report earlier this week, the company issued a press release stating that it was taking action to resolve litigation related to its Combat Arms Earplugs and that its Aearo subsidiary had voluntarily entered Chapter 11 bankruptcy. As part of the bankruptcy proceedings, Aearo will establish a trust and set aside $1 billion to fund it in order to resolve these potential claims. 3M also committed another $240 million for legal fees. In its earnings report, the company took a $1.2 billion pretax charge in connection to the lawsuits.

At first blush, the cash set aside for lawsuits seems manageable, given 3M overall earnings. For instance, 3M still reported $0.14 in GAAP earnings per share for the quarter even after accounting for the $1.2 billion it set aside. In addition, the company has about $3 billion in cash and marketable securities on its balance sheet.

The investor concern here is whether 3M's liabilities may have been underestimated. In 3M's losing earplug cases so far, veterans were awarded damages as low as $1.7 million and as high as $77.5 million. With as many as 230,000 pending and docketed claims, some are wondering if 3M's total liability is more likely to be in the multibillion-dollar range.

What should investors do with this 3M information?

3M stock is down 20% year to date, which is worse than the 13.9% drop in the S&P 500 or the 10.1% drop of the Dow Jones Industrial Average overall, but not terrible given the 3M news of late. The stock price is actually up about 6% since the bankruptcy news was announced. That could mean investors are not concerned with the company's potential earplug liability or that the stock price has already factored in the potential liabilities.

These cases will likely take years to play out and it's far from clear what the final tally on liability will be or how long it will take 3M stock to recover. But if it ends up being worse than expected, shareholders should know now what they are getting into with this stock.