Handling and Resolving First-Party Claims With an Insured in Bankruptcy
March, 2009
Insurance Policy: Property of the Estate
An insurance policy is considered property of the debtor's bankruptcy estate. The proceeds of a first-party policy are also considered property of the bankruptcy estate. The proceeds paid to the insured for any covered claims will be considered property of the debtor's bankruptcy estate.
Automatic Stay
When an insured-debtor files for bankruptcy, Section 362 of the Bankruptcy Code stays all claims, actions or proceedings against the debtor. 11 U.S.C. § 362(a). However, the automatic stay does not apply when it is the insured-debtor pursuing a claim. A first-party insurance claim involves pursuit of insurance coverage by the insured, thus the automatic stay would not apply. An insurer can adjust the insured-debtor's claim without violating the automatic stay. Additionally, an insured-debtor may hire an attorney for pursuing such a claim, but only after obtaining the bankruptcy court's approval.
11 U.S.C. § 327(e). An attorney of the insured-debtor must disclose compensation paid by the insured-debtor to the trustee. FED. R. BANKR. P. 2016.
Dealing with the Claimant
It is important for the claim adjuster to know with whom they are dealing. A Chapter 7 bankruptcy is used for liquidation purposes. In Chapter 7, a trustee is appointed to collect, liquidate, and distribute nonexempt property of the debtor.
11 U.S.C. § 701-703. Thus, an insurer will be dealing with a trustee when the insured-debtor files under Chapter 7.
Conversely, if the insured-debtor files under Chapter 11, the insurer will usually be dealing with the individuals from the company that filed bankruptcy, referred to as the "debtor-in-possession." 11 U.S.C. § 1107. A Chapter 11 bankruptcy is generally used by businesses to reorganize. A debtor-in-possession will file a plan of reorganization which sets forth the details of the debtor's reorganization and the repayments to be made to creditors. A debtor-in-possession can only be removed for "cause" in which case a trustee will be appointed in his stead. 11 U.S.C. § 1104.
In a Chapter 13 bankruptcy, the insurer deals with the individual debtor. A Chapter 13 enables an individual debtor with a regular income, as opposed to a business, to propose a plan to repay various creditors. 11 U.S.C. § 1321. The debtor operates under the supervision of a trustee. 11 U.S.C. § 1302. The Trustee investigates and supervises the debtor, and distributes payments to creditors pursuant to the debtor's plan. 11 U.S.C. § 1302.
Negotiations and Settlement
If a settlement is reached with the insured, the insurance company should have the debtor seek bankruptcy court approval. FED. R. BANKR. P. 9019. A settlement agreement that is not approved by the bankruptcy court may not be enforceable. For a settlement to be approved, interested parties must receive notice and have an opportunity to object. FED. R. BANKR. P. 9019(a); 2002(a).
Settlements are routinely granted if no objection is filed. A creditor is unlikely to object to the settlement as the settlement with the insurer will provide additional funds to the debtor. Nevertheless, creditors seek to maximize the value of the estate to increase their ultimate recovery. A creditor may object to the settlement if the creditor perceives the settlement to be insufficient. A settlement must be fair and reasonable, made in "good faith" and for an "adequate price." The payment of the trustee's fees as well as counsel retained for the litigation must be paid out of the bankruptcy estate. Thus, needlessly objecting to a settlement on the grounds of insufficient funds may, in fact, serve to deplete assets of the estate. This would ultimately not be in the best interest of the bankruptcy estate and the creditors.
A creditor's objection, however, is not controlling and it alone does not preclude a bankruptcy court's approval. Whether a settlement is approved is within the discretion of the bankruptcy court. Generally, the bankruptcy court will approve the settlement if it is in the best interest of the estate. Courts consider four factors: 1) the probability of the success of the litigation; 2) likely difficulties in litigation; 3) complexities, expenses, and inconvenience of litigation involved; and 4) the interests of creditors.
While the various parties to the settlement may have diverse motives, the bankruptcy court evaluates the best interest of the bankruptcy estate. Absent an objection, the bankruptcy court will defer to the business judgment of the debtor or the trustee.
QUESTIONS TO ASK WHEN THE INSURED FILES BANKRUPTCY
First-Party Property Claims
1) Q. Who filed bankruptcy? (Parent, subsidiary, additional insured)
A. This is the starting point for determining if any rights of the insured are affected. Determine the relationship of the insured to the entity that filed bankruptcy.
2) Q. In what court was the bankruptcy filed? (Bankruptcy courts are federal.)
A. The bankruptcy system is governed by federal law. The insured should be able to provide you with the state and federal district in which the bankruptcy case has been filed. In some instances a company will dissolve pursuant to state law, in which case there is a court appointed receiver.
3) Q. What is the bankruptcy case number?
A. The bankruptcy case number will allow us to look up the case and search the bankruptcy docket for relevant pleadings.
4) Q. When was the bankruptcy petition filed? (Get a copy of Petition.)
A. The Petition is evidence of the filing, as well as providing general information about the case, including under what chapter the case has been filed.
5) Q. Under what Chapter is the insured proceeding? (Chap. 7, 11 or 13.)
A. A Chapter 7 is a liquidation proceeding, a Chapter 11 is a reorganization typically used by companies, and Chapter 13 is a reorganization filed by an individual with a regular income.
6) Q. Is the insured going to reorganize or liquidate?
A. A reorganization will likely mean that the company and its existing officers and employees will remain, and the company will try to stay in business. If it is a liquidation, a trustee will be appointed. An insurer should make certain that the trustee signs off on any relevant documents, including a proof of loss.
7) Q. Has a trustee been appointed?
A. The insurer should be dealing with the entity and its representatives authorized by the bankruptcy court or the individual authorized by the trustee. If a trustee has been appointed, then the insurer should be dealing with the trustee. There is likely a court order identifying the responsible entity.
8) Q. Has a creditor's committee been formed?
A. When a company has assets and is reorganizing, a committee may be formed comprised of representatives of the unsecured creditors. The committee has general oversight responsibility and can object to any motions filed by the debtor, including proposed insurance settlements.
9) Q. Has a deadline been set for the filing of a "proof of claim" in the bankruptcy proceeding?
A. If an insurer has a claim against the debtor/insured, it must file a "proof of claim." This is to be distinguished from a "proof of loss" required under a property policy. Anyone who has a "claim" against the bankruptcy estate must file a "proof of claim" in the bankruptcy proceeding. Whereas, an insured is responsible for preparing a "proof of loss" to be submitted to the insurer for any claim the insured may have.
10) Q. Has a deadline been set by the bankruptcy court for objecting to discharge/dischargeability of debt? (Generally relates to acts of fraud by the debtor.)
A. Any debt related to fraudulent conduct may be non-dischargeable, which means that the debtor would remain legally obligated to pay the non-discharged debt. There are deadlines within which these claims must be asserted. If the property policy required the insured to present a "proof of loss" to the insurer then the insurer's claim representative can control the due date by extending additional time for filing a proof of loss.
11) Q. Are there any other parties claiming an interest in the insured property? (eg. Secured creditor.)
A. Some creditors may have general liens acquired by written agreement on inventory, receivables, etc. and therefore may assert a right to any proceeds related to collateral. There can be creditors of the insured who are not listed on the policy as loss payees or mortgagees.
12) Q. f there is a loss payee, are those rights impacted by any act of the debtor?
A. A loss payee may be entitled to payment pursuant to the policy provisions. As the policy is property of the bankruptcy estate, the insured should obtain authorization from the bankruptcy court for disbursements or settlements.
13) Q. Has the stay been extended to cover any of the debtor's insured property?
A. While the automatic stay does not prevent claims and litigation from being asserted by the debtor, a debtor may seek to have the stay extended to cover estate property if a third party also claims a right in the property.
14) Q. Has the debtor or trustee removed, repaired or replaced any of the property loss?
A. This will impact whether the insurer is responsible for actual cash value or replacement cost recovery.
15) Q. Who has control or possession of the property?
A. As you know, the insured must protect property from further damage following a loss. The insurer should consider what should be done to preserve evidence particularly where the insured is without funds.
16) Q. Has the filing of bankruptcy impacted the day to day operations of the insured?
A. Business interruption may be impacted by the cessation of operations by a debtor insured. Whether the interruption was caused by an insured event or the mere election of the insurer to cease operation may be an issue.
17) Q. Does the debtor intend to sell the insured property?
A. If the insured property is sold while a claim is pending, there may be issues related to the claim and any attempt to assign the claim to a purchaser. It is possible for the insured to extinguish an insurance claim by the sale of the property if no reservation of claim rights is secured. The insurer should identify whether there is increased exposure to loss.
18) Q. Is the insurance policy listed on the debtor's schedules as an asset?
A. Typically a property policy will be listed as an asset of the estate, which means the bankruptcy court has jurisdiction over any claim made under the policy.
19) Q. Does the debtor provide for any treatment of the policy or for payment from the policy proceeds in its plan of reorganization?
A. It is important to understand whether the bankruptcy trustee or bankruptcy court are considering receipt of any claim payment by the insurer as an asset of the bankruptcy estate.
20) Q. Is there a third party such as a company doing claim preparation work that has a contract with the insured?
A. It is important to ascertain whether there is any contractual agreement with a public adjuster, or an accounting firm, to prepare the claim. Such agreements will likely have to be approved by the bankruptcy court. If the insurer pays such expenses without proper approval it may be subject to liability.
Please contact Susan N.K. Gummow at (312) 606-7802 or via email at sgummow@clausen.com with any questions related to insurance and bankruptcy matters.
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