In Articles

By:  Emily Devan, Esquire         

Bankruptcy courts are sometimes referred to as the wild west. Rather than using the advantages of the open range, remote countryside and badlands for hideouts, filers use complex bankruptcy statutes and inconsistent case law to protect themselves from paying their debts and turn contracts on their head.  Unfortunately for insurers in this landscape, insurance proceeds become even more attractive when the claimant, either the insured or a third party claimant, is bankrupt.  Insurers can become enmeshed in disputes among creditors and pay significant defense costs and claims.

Below are five tips for insurers to help navigate the wild, wild west of bankruptcy.

1) Litigation will be stayed.  Unless the debtor has filed several bankruptcy cases close together, all litigation against the debtor will be stayed by the automatic stay, codified at 11 U.S.C. § 362.  Any actions taken in violation of the automatic stay will be void and could subject the party who takes them to penalties.  Even actions brought by the debtor are frequently stayed as the opposing party cannot effectively litigate within the strictures of the automatic stay.

However, the automatic stay is not absolute.  Frequently, parties litigating against a debtor will petition the bankruptcy court to lift the automatic stay.  As the bankruptcy court does not have jurisdiction over personal injury cases, it will almost always allow a personal injury plaintiff relief from the automatic stay to pursue his or her case to judgment and collect against insurance proceeds.  In addition, the court will frequently allow complex cases centered on state law issues to proceed to judgment (and sometimes collection against insurance proceeds).  An insurer may wish to monitor a bankruptcy case to see if a party is trying to lift the stay on a matter where the insurer is a party or paying defense costs.

In large cases, especially cases where there is a pending or expected class action lawsuit and a wasting policy, an insurer may want to consider opposing the lifting of the stay.  The bankruptcy court is frequently a better forum to apportion limited insurance proceeds with lower defense costs.  In such cases, the debtor will generally be seeking a similar, efficient result and will also oppose the lifting of the stay.

2) You cannot terminate or modify an insurance contract merely due to a bankruptcy filing.  While an insurance policy and/or local law may allow for termination due to insolvency or a bankruptcy filing, 11 U.S.C. § 365(e)(1) prohibits any termination or modification of an existing contract due to the bankruptcy filing or the debtor’s financial condition.  However, if a policy is up for renewal, the insurer has more options and is likely able to decline to renew of the policy.

3) Your insured and/or the person entitled to payment of proceeds may change.  Upon the filing of a bankruptcy, the policy and/or a claim to insurance proceeds become property of the bankruptcy estate.  The practical implications of this vary based on the type of bankruptcy filing.

In a chapter 7 bankruptcy, a trustee is appointed by the court to liquidate the estate and steps into the debtor’s shoes.  If the debtor was your insured, the chapter 7 trustee now holds the rights of the insured.  The chapter 7 trustee also has a claim to receive any payments that the debtor would have received (whether the debtor was your insured or a third party claimant), although the debtor may be able to exempt certain portions of the proceeds.  If your insured or a third party claimant has filed chapter 7 bankruptcy, be sure to work with the chapter 7 trustee, the debtor and other potential claimants, in adjusting and paying the claim.  If you issue payments to the debtor that should have gone to the chapter 7 trustee, you can be liable to the chapter 7 trustee for those amounts.  If a claimant has filed chapter 7 bankruptcy, you are well-advised to consult with bankruptcy counsel before making any payments.

If the debtor has filed a chapter 13 bankruptcy, the debtor retains his or her pre-petition rights either as the insured or a third party payee.  However, the debtor may be required to pay insurance proceeds to creditors under the bankruptcy plan, and secured creditors (such as mortgagees) retain rights they may have under the policy to receive payment.  The chapter 13 trustee and any alternate payees should be notified before a payment is made to a debtor in a chapter 13 bankruptcy.

In a chapter 11 bankruptcy, it is most common for the debtor to retain control of the bankruptcy estate.  However, occasionally a trustee is appointed or there is a significant change in management.  You should inquire as to who maintains control of the company, especially if there is litigation involved.

Finally, courts are divided on how this change in the identity of the insured impacts insured vs. insured exceptions.  If you want to exercise an insured vs. insured exception after an insured has filed bankruptcy, you should have bankruptcy counsel review the matter.

4) Debt that arises from events prior to the petition date will be paid through the bankruptcy case, even if unliquidated at filing.  Any debt that arises from pre-petition events is considered a pre-petition claim.  This includes unliquidated claims.  For example, if an insured’s premium is subject to a true-up based on claims made through the policy period, any additional premium attributable to pre-bankruptcy insurance claims would be a pre-petition claim to be paid through the bankruptcy case.  If there was a claim made pre-petition that includes a deductible or a self-insured retention portion, that amount would also be a prepetition claim.  In order to preserve your right to receive payment for these amounts, you will likely be required to file a proof of claim.

5) Non-payment of deductibles or premiums may not excuse your responsibility to cover a claim.  As noted above, amounts that are due based on pre-petition events, whether premiums, deductibles or self-insured retentions, are considered pre-petition debt.  As a result, they are paid through the bankruptcy plan or by the chapter 7 trustee following liquidation of assets.  Non-payment of these pre-petition debts is generally not a basis to deny a debtor its rights under the policy such as defense costs or claim payments.  In addition, even when a claim is made post-petition, an insured debtor’s inability to pay a deductible and/or self-insured retention may not excuse an insurer’s performance.  As court decisions on this issue are inconsistent, you should consult with bankruptcy counsel if you find yourself in this situation.

These are just a small number of the complexities that can arise for insurers in a bankruptcy case, especially where large claims or expensive commercial policies are at issue.  In house legal departments are well-advised to be aware of some of the potential pitfalls and contact counsel with bankruptcy experience with questions.  If your company is interested in further educational opportunities or advice on this issue, please reach out to PK Law.

Emily Devan is an Associate in the firm’s General Litigation and Insurance Group. Her practice includes commercial litigation in state and federal courts throughout the country. She has significant experience with litigation arising from or related to insolvency proceedings including bankruptcy cases, receiverships, and assignments for the benefit of creditors.  Emily can be reached at 410-339-6772 or