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Insurance Law

Impact Of Bankruptcy On Insurance Matters – New Appleman on Insurance Law Library Edition, Chapter 109



Having considered the bankruptcy process generally in Chapter 107 and undertaken an inquiry into how insurance functions as an asset of the bankruptcy estate in Chapter 108 above, this chapter turns to the impact of bankruptcy on insurance-related matters and addresses issues that may arise between insurers, the debtor-insured, and claimants seeking recourse from the debtor’s insurance policies.

Section 109.01 discusses the Bankruptcy Code’s “automatic stay” – the statutory provision that stops all collection activity and preserves the assets of the bankruptcy estate so that they can be equitably distributed to creditors.  By terminating the race to the courthouse that occurs outside of bankruptcy, the automatic stay benefits both creditors and the debtor.  Similarly situated creditors are assured that they will be treated equitably, and the debtor receives a reprieve or “breathing spell” from collection activity.

The automatic stay prevents both judicial and non-judicial attempts to collect debts owed by the debtor.  Since an insurer’s liability is derivative of the debtor-insured’s liability, the automatic stay also halts all activity on third-party claims that may implicate the debtor’s insurance policies.  Even corresponding about the merits of a claim while the stay is in effect is proscribed, since such communications are attempts to liquidate and collect a debt owed by the debtor-insured (notwithstanding the fact that the claimant seeks to have the insurer pay that debt).  Parties seeking a recovery against the debtor’s insurance policies must either file a motion seeking relief from the automatic stay (also referred to as “lifting” or “modifying” the stay), or they must stipulate with the debtor for the stay to be lifted.

Section 109.01 also explains the consequences of violating the automatic stay.  The majority of Courts of Appeal have determined that actions taken in violation of the stay are void (as opposed to merely voidable), meaning that they are a nullity and without legal effect.  In all Circuits, violations of the stay can subject the offending party to serious sanctions.  In additional to actual damages, attorneys’ fees and even punitive damages can be awarded for violations of the automatic stay.

The automatic stay can be modified, or even retroactively annulled, for cause.  Termination or annulment of the stay requires consideration of multiple factors, including the relative burdens on the debtor and the requesting creditor of granting or denying relief from stay, and the impact on the bankruptcy process, generally.  With respect to claims that implicate the debtor’s insurance policies, in those instances where the claimant waives any right to recovery from the bankruptcy estate itself and the liquidation of the claim will not impact the reorganization process, relief from stay is often granted.

Discrete stay-related issues are also addressed in Section 109.01, including the implications of the stay on claims arising in “direct action” states, the special provisions applicable to debtors that have filed multiple bankruptcies, and how the stay functions with respect to non-debtor parties that may be co-liable with the debtor, such as landlords, employees, and joint-tortfeasors.  Although the stay applies only to the debtor by its terms, under certain circumstances, a bankruptcy court may enter an injunction that provides the protections of the automatic stay to third-parties that have a identity of interest with the debtor.

Section 109.02 explains how insurance-related matters can be treated by a debtor-insured’s Chapter 11 plan of reorganization.  A Chapter 11 plan, and the bankruptcy process, generally, must be “insurance neutral.”  This means that the insurer’s obligations cannot be increased or modified by any aspect of the reorganization, and its rights must not be impaired by the bankruptcy of the debtor-insured. The pre-bankruptcy status quo must be maintained.  If the plan or any action taken by the debtor has a substantial economic impact on an insurer, that plan provision or debtor activity is impermissible.

Section 109.02 also discusses that various ways that claims implicating applicable insurance can be treated under a Chapter 11 plan.  In many cases, insurance-related claims are not singled out. Instead, they are grouped with other claims against the debtor, usually as “general unsecured claims.”  This is typically unobjectionable, as it is tantamount to providing for “coverage in place;” the insurance policies and the rights and obligations of the insurer, the debtor-insured, and the claimants simply “ride-through” the bankruptcy.  Claimants are still able to pursue a recovery from insurance, which is appropriate because the plan that governs the parties’ rights must  be insurance-neutral, and the insurer, as a non-debtor, is not released from liability under the policies it issued as a result of the bankruptcy of its insured.

Some bankruptcy plans separately provide for the treatment of insurance-related claims.  This is commonly done to achieve administrative benefits.  Through Chapter 11, claims resolution procedures can be imposed to funnel claims into a uniform, non-judicial resolution process.  Although claims resolution procedures have  no substantive effect on the claims, in situations where there are hundreds or even thousands of pre-bankruptcy claims that implicate the debtor’s insurance policies, the administrative savings can be substantial.  These procedures, sometimes referred to as “CRPs,” usually provide for claimants to submit answers to a questionnaire, along with a variety of documentation in support of their claims.  In response to the information provided, an offer-exchange procedure is commenced.  If no agreement is reached, the parties usually proceed to non-binding mediation, or arbitration (upon consent).  Only if the matter remains unresolved after these steps is the claimant permitted to return to the tort system to litigate the claim.  Debtors imposing CRPs have frequently realized significant cost-savings and success in resolving the claims, as evidenced by the small number of claimants that ultimately file pleadings seeking authority to return to the tort system to litigate their claims in those bankruptcies where CRPs are implemented.

The other common reason that claims may be provided for separately is that the universe of claims is reasonably expected to exceed the limits of available insurance.  As explained in Section 109.02[3][c], although the asbestos mass tort bankruptcies were the impetus for the creation and use of bankruptcy trusts to administer and pay mass tort claims, the use of trusts has expanded in recent years, both to other types of personal injury claims, and to non-tort cases, such as construction defect claims.

Trust use has been invaluable in resolving bankruptcy cases involving large numbers of claims, especially in instances where those claims arise in multiple jurisdictions, or where the claims trigger insurance policies spanning multiple years (as many asbestos claims do).  In the typical case, the debtor has several insurance policies issued by a number of different insurers for each year in which claims are alleged to have arisen.  Frequently, the primary insurers and certain lower-tier excess insurers will have determined, based a pre-bankruptcy evaluation, that under almost any set of facts, their policies will be exhausted.  In this situation, these parties’ main interest is in using the bankruptcy process to insulate them from having to deal with the claims after paying the limits of their policies.  Other excess carriers, especially those in the highest tiers, often are not in a position to simply tender their policy limits (either for lack of information, or because they believe the exposure of the asserted claims is not certain to reach and/or exhaust their policies).  There may also be issues with other parties claiming a right to coverage under the policies, such as vendors or joint-tortfeasors.  The use of bankruptcy trusts provides a resolution mechanism for the complex issues that arise in such a situation.

The Bankruptcy Code permits the debtor to create a trust that constitutes the sole source of recovery for claimants seeking recourse from the debtor’s insurance policies.  The equitable powers of bankruptcy courts have been interpreted to permit the confirmation of a plan that contains injunctive provisions that bar claimants from pursuing their claims against either the debtor’s insurers (as they might otherwise be able to in a “direct action” state like Louisiana or Rhode Island), or other parties that are insured under the debtor’s policies (vendors, joint-tortfeasors, or other additional insureds).

Funding of bankruptcy trusts generally occurs in two ways.  For those insurers that have determined that exposure exceeds their policy limits, a cash payment is often made (denoted as a settlement payment) into the bankruptcy trust.  These “settling insurers,” as they are sometimes denoted, will have no further responsibility or liability with respect to the policies issued to the debtor, and they receive the right to return to the bankruptcy court for relief if any such responsibility or liability is alleged.

The other insurers—the non-settling insurers—have the debtor-insured’s rights under their policies assigned to the bankruptcy trust.  These insurers will work collaboratively with the trust to resolve the asserted claims, and will make payments in accordance with the obligations under the policies they issued.  As long as the process is insurance-neutral, the assignment of the policies and/or rights under the policies is unobjectionable, and the non-settling insurers’ rights and obligations remain the same as they were prior to the bankruptcy (courts have determined that the Bankruptcy Code overrides the non-assignability provisions in insurance policies in situations where the assignment is to a trust and the  purpose of the assignment is to facilitate the administration of existing claims).

Section 109.03 of this chapter addresses the more common litigation issues that arise in bankruptcy cases with respect to insurers, their insureds, and claimants seeking redress from available insurance.  The implications of bankruptcy on the rights of third-parties, like additional insureds, that seek coverage under the debtor’s insurance policies is addressed.  The bankruptcy has no affect in instances where coverage is sought by a party that is an additional insured under the debtor’s insurance policies.  Additional insureds have direct rights under a debtor’s policies, and thus neither the automatic stay nor any other provision of the Bankruptcy Code impacts those rights.

In contrast to the treatment of additional insureds, parties seeking coverage under a debtor’s insurance policies on account of a contractual indemnification agreement from the debtor are affected by the bankruptcy process.  Insurance that extends to “insured contracts” of the debtor does not provide direct rights to the party seeking indemnification.  Instead, the insurer’s obligation is to the debtor, to pay the assumed tort liability of the party that is owed indemnification by the debtor.  That party’s right to coverage is derivative with respect to the debtor-insured.  The indemnified party must seek relief from stay before coverage can be provided, since the essence of the indemnification claim is a monetary claim against the debtor.

Other litigation issues addressed in Section 109.03 include the handling of settlements that implicate insurance, and the rights and duties of the debtor-insured.  Settlements whereby a third-party claimant is receiving a payment from the debtor’s insurer do not require bankruptcy court approval, but first-party settlements and third-party settlements where the debtor is making a payment may require approval or at least notice to creditors.  Issues that arise with respect to claim estimation and statutes of limitation are also discussed.

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Susan N.K. Gummow is a partner in the Chicago office of Foran Glennon Palandech Ponzi & Rudloff P.C., where she handles business-related matters including bankruptcy, business litigation, and insurance law.  She has extensive experience representing insurance companies confronted with a full array of bankruptcy issues and is the author of several publications, including the BANKRUPTCY AND INSURANCE  LAW MANUAL, currently in its third edition.

John Eggum is an attorney in the Chicago office of Foran Glennon Palandech Ponzi & Rudloff P.C.  He concentrates his practice on representing insurance companies in restructuring and insolvency proceedings throughout the country. 

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Table of Contents

§ 109.01 Impact of the Automatic Stay

[1] The Filing of Bankruptcy Creates an “Automatic Stay” That Prevents Any Attempts to Collect Debts Owed by the Debtor-Insured

[2] Actions Taken in Violation of the Automatic Stay

[a] Courts Are Split on Whether Violations of the Stay Are Void or Merely Voidable

[b] “Void” Actions Taken in Violation of the Stay Can Be Ratified By Retroactive Annulment of the Stay

[c] Violating the Stay May Subject a Party to Damages and Sanctions

[3] The Automatic Stay Can Be Modified on Request of a Party in Interest

[a] Claimants Must Get an Order or Stipulation Modifying the Automatic Stay in Order to Pursue a Claim

[b] The Movant Must Demonstrate “Cause” for Modification of the Stay

[4] The Protections of the Automatic Stay Are Not Provided to Certain “Repeat-Filers”

[5] Application of the Automatic Stay to Third-Parties

[a] The Automatic Stay Applies Only to the Debtor-Insured; It Has No Affect on Third Parties

[b] The Automatic Stay Can Be “Extended” to Protect Third Parties

[c] In Individual Chapter 13 Cases, the Automatic Stay Is Accompanied by a Co Debtor Stay

[6] Automatic Stay in Direct Action States

[7] The Automatic Stay Does Not Apply to Claims That Arise Post-Petition

[8] The Automatic Stay Does Not Apply When It Is the Debtor Who Is Pursuing a Claim

§ 109.02 The Plan of Reorganization and the Treatment of Insurance-Related Matters

[1] Overview

[2] Insurance Neutrality Is Mandated by the Bankruptcy Code

[3] Treatment of Claims When Insurance May Be Available

[a] The Failure to Specify the Treatment of Insurance-Related Claims Is Tantamount to Providing for “Coverage In Place”

[b] Claim Administration Is Frequently Facilitated by Claims Resolution Procedures

[c] Trusts

[i] The Asbestos Cases and the Use of Trusts to Administer and Pay Claims

[ii] Funding of Bankruptcy Trusts May Be Accomplished With Cash Settlements or the Assignment of Insurance Policies

[iii] The Use of Injunctions as Part of a Plan That Includes a Trust

[4] The Provisions of the Plan Relating to “Discharge” Have Little Impact on the Obligations of Insurers

[5] The Post-Confirmation Injunction Is Inapplicable to Claims for Which Insurance Is Available

§ 109.03 Litigation Issues

[1] Handling Claims of Additional Insureds and Those Claiming Coverage Through Insured Contract Provisions

[a] Additional Insureds Have Direct Rights Under the Debtor-Insured’s Policy

[b] Parties Seeking Indemnification Under an Insured Contract Provision Do Not Have Direct Rights Under the Debtor-Insured’s Policy

[2] Negotiating a Settlement of a Claim Against a Debtor-Insured

[a] The Debtor-Insured Must Comply With Policy Provisions Relating to Settlement of Claims

[b] Approval of Settlements Under Federal Rule of Bankruptcy Procedure 9019 May Be Appropriate in Some Situations

[c] Settlement of First-Party Property Claims Can Frequently Be Accomplished by Stipulation

[3] The Debtor-Insured Must Comply With the Duty to Cooperate

[4] The Effect of Estimation of Claims Is Confined to the Bankruptcy Process and Is Not Determinative of Liability Issues Between Claimants and Insurers

[a] Estimation of Claims That Implicate Insurance Is Rare and Not Usually Appropriate or Constructive

[b] The Minority Position: The UNR Decision

[5] Statutes of Limitation

[a] No Provision of the Bankruptcy Code Tolls Statutes of Limitation

[6] Venue for Personal Injury Claims

[7] Issues Specific to Chapter 7

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