The domains of bankruptcy and insurance frequently intersect, making this an area that is quickly developing and where competing interests collide.
Insurers frequently occupy a dual role in bankruptcy:
- Creditor of the debtor, in consideration of premiums unpaid, or different amounts that are due to be paid by the debtor-insured. As a creditor, the insurer's rights are the same as any other creditors' rights. If the insurer is a secured creditor, it will collect complete payment to the extent of the value of the property which secures the debt. If the insurer is an unsecured creditor, it will probably receive little or nothing on account of its claim.
- Counterparty to a contract with the debtor. Contracts, including insurance policies, cannot be modified by the debtor-insured, even though it has filed bankruptcy. In this role, the insurer's rights are significantly more robust.
Rights of secured creditors
What are the rights of the secured creditors when the insured files for bankruptcy? Courts have held that secured creditors are only entitled to adequate protection and nothing more. Courts presented with the question of whether the debtor, whose vehicle was destroyed or the lien holder of the car was entitled to the insurance proceeds noted that a creditor is only entitled to adequate protection, and is not entitled to possession of the collateral nor the insurance proceeds. The motivation for this rule starts with the proposition that property is nevertheless considered part of the bankruptcy estate in spite of the fact that it is subject to a lien or other encumbrances. Accordingly, it will not be disturbed so long as it can be shown that the creditors' interests are otherwise protected.
Bankruptcy preference demand letters
In a bankruptcy proceeding, the bankruptcy trustee initiates a preference claim "dunning" letter. The trustee has the power to demand the return of certain payments on any and all unsecured debts during the 90-day pre-bankruptcy preferential payment period.
Insurance companies should never ignore the preference demand issued by the trustee; they are not immune to a bankruptcy preference letter.
Preference letters are received by all unsecured creditors to provide them each impartial and equal treatment. Reclamation of such payments is designed to redistribute and disperse the bankruptcy estate's assets justly amid all of the unsecured creditors.
After a party files for bankruptcy and the insurance company files its proof of claim with the proper court, the insurance company is thereafter confronted by a demand letter from the bankruptcy trustee seeking repayment of all the money received from the customer within the 90 days before the filing of the bankruptcy petition.
This period is usually known as the preference period. A debtor is assumed insolvent by The Bankruptcy Code during the 90-day period before the bankruptcy petition is filed. Accordingly, all payments and transfers made by the debtor to creditors during that period are suspect.
Within 90 days before the filing of the bankruptcy petition, any action taken by the insurer may be deemed ineffective and subject to the automatic stay set by the bankruptcy filing. Also, the insurance company may get a preference demand letter for premiums it already earned.
Accordingly, it is essential to be vigilant as to whether an insured is in unable to pay and raises the possibility of filing for bankruptcy, because, once the 90-day pre-petition period begins, the earned premium faces possible preferential claim treatment.
Chapter 11 plans of reorganization
Concerning insured claims, a plan of reorganization can be structured to resolve numerous claims fairly and on a global basis through, for example, the creation of a trust, funded in part by the debtor?s insurance, which will assume liability for all covered claims.
The Bankruptcy Code provides certain procedural and substantive requirements and protections for plan confirmation. For example:
- Plan voting can only occur after solicitation with a court-approved disclosure statement containing adequate information sufficient to advise a hypothetical investor.
- A plan must be authorized by at least one non-insider, impaired, class of creditors.
- A plan must be proposed in good faith and be possible in that it is not likely to lead to a future reorganization or liquidation of the debtor.
- With regard to distributions, a plan cannot classify substantially dissimilar creditors in the same class and must treat all creditors in a particular class the same.
- Unless the plan is consensual, distributions must be in accordance with the Bankruptcy Code's waterfall payment structure namely, secured creditors are to be paid before unsecured creditors, and unsecured creditors are to be paid before shareholders. In other words, a subordinate class cannot receive a distribution from the estate on account of its claim or interest unless the senior class either assents to the plan or is satisfied in full by the plan. Assignment of insurance proceeds cannot be used to prefer particular creditors unjustly and can prompt other challenges to plan confirmation. Assignments of coverage proceed properly structured can be used to create and help fund a confirmable Chapter 11 plan.
Bankruptcy can influence insurance-related issues, which can become complex. For this reason, you need a seasoned, experienced bankruptcy attorney to handle the case. At the Law Offices of Kevin S. Neiman, we will guide you every step of the way and ensure you receive the best possible outcome.