Liability Coverage Policies: Property of the Estate to Which the Automatic Stay Applies

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When a chapter 7, 11, 12 or 13 case is filed, two key items spring into life. The first is a new entity called the bankruptcy estate which is comprised of all of the debtor’s non-exempt legal or equitable interests in property as of the time of the bankruptcy filing, wherever located and by whomever held, plus certain property that the debtor acquires (or becomes entitled to acquire) within 180 days after the case is filed. The idea is that “property of the estate” is broadly defined so as to maximize payment to creditors of the debtor; in exchange, the “honest but unfortunate debtor” will receive a fresh start.
 
The second item that arises is the automatic stay, which “freezes” the status quo in order to offer the debtor a “breathing spell” from its creditors. Moreover, the auto­matic stay continues during the pendency of the case (until either relief from the stay is granted or the stay is otherwise discontinued) so that the debtor’s property as well as credi­tor claims against the debtor and/or the debtor’s property may be administered in an orderly and equitable process. Similarly to how property of the estate is broadly defined, the scope of the automatic stay is also broadly defined to stay any actions against the debtor that could have been commenced prior to the bankruptcy filing, any actions to enforce a judgment against the debtor or property of the estate, and any actions to possess or control property of the estate. Moreover, the Ninth Circuit has held that any actions taken in violation of the automatic stay are null and void.
 
These two items come to light in the context of a debt­or’s rights under an insurance policy. In The Minoco Group of Cos., Ltd. v. First State Underwriters Agency of New Eng. Reins. Corp. (In re The Minoco Group of Cos., Ltd)., 799 F.2d 517 (Ninth Cir. 1986), First State had issued prepaid excess officers and directors liability policies to the debtor Minoco. The policies provided coverage for claims made from November 1982 through July 1984 and permitted cancellation by either party at any time on 30 days’ notice. In November 1983, two months after Minoco filed for chap­ter 11 bankruptcy, First State gave notice of cancellation. Minoco then sued for declaratory relief that cancellation of the policies was automatically stayed and for injunctive relief to enjoin First State from cancelling the policies.
 
Under the policies, First State provided coverage with respect to two categories of claims: (1) claims made against officers and directors, which First State would pay on their behalves, except for those claims indemnified by Minoco; and (2) those claims indemnified by Minoco, which First State would pay on Minoco’s behalf.
 
A three-judge panel of the Ninth Circuit affirmed the bankruptcy court’s finding that cancellation of the policies was automatically stayed. It rejected First State’s argument that the policies were not property of the estate. Instead, the panel found that unlike First State’s characterization that the policies benefited only the officers and directors of Minoco, the policies also benefited Minoco itself in that they insured Minoco against indemnity claims made by officers and directors. Under the simple reasoning that Minoco’s estate is worth more with the policies than without them, the panel found the policies constituted property of the estate and therefore the automatic stay applied to protect them from cancellation by First State.
 
The Ninth Circuit panel also rejected First State’s argu­ment that the policies were not really property of the estate. First State asserted that Minoco only held the policies in constructive trust for the potential benefit of claimants who make claims against Minoco’s officers and directors. While the panel could see a situation whereby Minoco received insurance proceeds from First State for payment to officers and directors in satisfaction of indemnification claims, such that those proceeds would be held in constructive trust by Minoco, that particular situation was not before the panel. Regardless, the panel noted that coverage policies are not independent contractual obligations running directly to potential claimants; rather, they are direct obligations to the insured. Accordingly, conversely, they carry direct ben­efits to the insured, here, Minoco as well as its officers and directors.
 
In finding for Minoco, the Ninth Circuit panel rein­forced what bankruptcy proceedings are all about – which is to provide a uniform forum for the orderly and equi­table administration of a debtor’s assets and liabilities in exchange for a debtor’s fresh start. The broadly defined scopes of property of the estate and the automatic stay are essential to achieving this overall bankruptcy goal. In that light, it is imperative that they are not only broadly defined, but also arise immediately upon the commencement of a bankruptcy case.
 
This article originally appeared in the May 2017 edition of Riverside Lawyer magazine, a publication of the Riverside County Bar Association. Reprinted with permission.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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