3M (MMM 0.46%) is currently embroiled in a courtroom saga against U.S. military veterans who claim they suffered hearing impairment stemming from the use of earplugs made by its subsidiary Aearo Technologies. While 3M is currently involved in other lawsuits, its earplug case has the potential to balloon into a liability of historic proportions. Here's what it could mean for the stock.
How did we get here?
The case originated from 3M's acquisition of military earplug maker Aearo Technology in 2008. The company made two-sided earplugs that soldiers could use to completely block out sound on one side and allow them to hear close conversation when using the other. Aearo faced competition for its military earplug business from a private company named Moldex.
To protect its turf, 3M launched a patent-infringement case against Moldex in 2012, which it eventually withdrew. In response, Moldex launched its own lawsuit against 3M in 2014, alleging that its patent-infringement case was an attempt to put Moldex out of business and eliminate the competitive nature of the earplug market. During the case, Moldex presented evidence that Aearo's earplugs were defective and that 3M continued to sell the faulty earplugs despite knowing of the defects. The evidence also showed that 3M ordered employees to discontinue selling the earplugs only after the evidence was presented in court.
Image source: Getty Images.
3M later settled the case with Moldex and the U.S. Justice Department in 2018. Upon hearing about the settlement, U.S. military veterans began filing suit against 3M for hearing impairment caused by the defective earplugs. The company is now facing the largest single multi-district litigation in U.S. history.
Aearo files for bankruptcy
Along with the company's third-quarter 2022 earnings report, 3M told investors that its Aearo subsidiary had filed for Chapter 11 bankruptcy protection. By putting the subsidiary into bankruptcy, 3M may absolve itself from exposure to the case against Aearo. It also spelled out that 3M had established a trust to pay potential claims against the Aearo subsidiary and funded it with $1 billion.
Lawyers representing the veterans claim that because 3M had not tried to separate the two businesses in prior litigation, it should not be allowed to separate the two now, and the case should not be moved to bankruptcy court. A bankruptcy judge denied Aearo's attempt to extend its stay on ongoing litigation to 3M. Now, the cases will resume being tried one by one, proceedings that could cost 3M $3.8 million a week, according to The Wall Street Journal. The stock fell 9.65 % on the day of the announcement.
What should investors do?
Aearo and 3M said they would appeal the denial. Meanwhile, service members won 13 out of the 19 cases that went to court before Aearo's bankruptcy filing. In the losing cases, claimants were awarded personal injury damages totaling $265 million, and there are still 230,000 military veterans on the docket. If those cases indicate awards to the remaining claimants, 3M's $1 billion trust may be considerably underfunded.
At the end of last quarter, 3M had $7.9 billion in cash and marketable securities. So, the company can withstand a blow. But with hundreds of thousands of potential claims remaining and an average award of over $26 million in previous cases, its cash position could evaporate as the case wears on. In a worst-case scenario, 3M may have to dedicate earnings to fund the awards, cut its dividend, or even raise debt or equity.
3M stock is down 30% this year and 15% over the last month. So, some bad news is already reflected in the stock price. But the courtroom drama is far from over, and there will likely be many twists and turns in the case embedding significant uncertainty in the stock. As the stock market continues to recede, there are many other opportunities for long-term investors to buy great companies' stocks at a discount without the legal risk. You might want to focus on those instead of 3M.
Corrections: This report has been updated to clarify bankruptcy court proceedings and the potential status of ongoing cases.
