Like Dorothy In Oz: Insurers in Banruptcy Court

by Julia Molander, Lillian Stenfeldt

“The insured has filed for bankruptcy.” These words can strike terror in the hearts of insurers and their counsel. Bankruptcy court is not always a friendly forum for insurers. Insurance policies, even liability policies, may be regarded as assets of the bankrupt estate, and therefore a way of resolving the debts owed by the bankruptcy estate. (Hornsby v. Floyd (In Re Vitek), 51 F.3d 550, 553 (5th Cir. 1995); In Re Minoco Group Cos., 799 F.2d 517, 519 (9th Cir. 1986); A.H. Robins v. Piccinin, 788 F.2d 994, 1001 (4th Cir. 1986); but see In re Pintlar Corp., 124 F.3d 1310 (9th Cir. 1997) (liability insurance policy is not estate property subject to automatic stay).) The focus of the parties involved in a bankruptcy proceeding, therefore, may be to find coverage rather than to observe policy defenses.

There are numerous other reasons why bankruptcy court can be an alien environment for the insurance practitioner. The bankruptcy court has far-reaching equitable powers. (11 U.S.C. § 105.) The bankruptcy court must balance the various interests in the bankruptcy estate, which include the debtor, the secured creditors and the unsecured creditors. Although the Federal Rules of Civil Procedure generally apply in bankruptcy court litigation, these rules may be bent to achieve an equitable result. The Bankruptcy Rules add another layer of complexity to the process, but they too can be softened to achieve an equitable result in a particular case. In fact, parties may make a “Section 105” motion to invoke the bankruptcy court’s broad powers even though there is no other statutory authorization for the motion.

Additionally, the goal of Chapter 11 proceeding, the more common form of commercial bankruptcy, is to achieve a confirmed plan of reorganization. This goal sometimes is at odds with vigorous litigation, particularly since such litigation can deplete the bankruptcy estate through the payment of attorneys fees and other costs. For the active trial attorney, the proceedings in bankruptcy court may seem to be overly genteel. Even the terms can give an air of ritualized cordiality: filing the petition can be called “a suggestion of bankruptcy”; the statutes talk about giving the debtor a “breathing spell”; the court may refer to a “fresh start” for the debtor.

The roles of the parties can be confusing. A Chapter 11 bankruptcy typically involves a debtor-in-possession, various secured creditors (usually banks) and various unsecured creditors, who are represented by a creditors’ committee. Each of these has counsel in the proceedings. Occasionally, a trustee of the bankruptcy estate is appointed in a Chapter 11 proceeding because of fraud or malfeasance on the part of the debtor. (11 U.S.C. § 1104.) The trustee is usually a non-lawyer, appointed by the bankruptcy judge from a panel of pre-approved trustees. appointed to oversee the orderly reorganization or distribution of the debtor’s estate. (11 U.S.C. § 321.) He or she also is paid from the debtor’s estate and is represented by counsel, of the trustee’s own choosing. (11 U.S.C. § 330.) A Chapter 7 bankruptcy, though, has a trustee appointed in every case, because there is no debtor-in-possession. The bankruptcy judge, although a federal court judge, is not a “Article III” judge under the Constitution. Bankruptcy judges are not appointed by the President but instead are appointed by a majority of the judges sitting in the Circuit in which the bankruptcy court is located. (28 U.S.C. § 152.)

Most, if not all, of the bankruptcy counsel for these parties know each other well because the bankruptcy bar is relatively small, the counsel regularly see each other in bankruptcy court, and the bar is well-organized with a number of fraternal associations. The bankruptcy judges nearly always are members of good standing in the bankruptcy bar, so they share the collegiality with the attorneys. Some of the interactions among counsel and the judge can be highly informal. As a result, the non-bankruptcy lawyer can feel “hometowned” whenever he or she appears in bankruptcy court.

The journey of a case through the bankruptcy system can be bewilderingly complicated. First there is the question of whether the matter comes within the jurisdiction of the bankruptcy court. The case must be related in some way to the bankruptcy estate in order for the court to have jurisdiction. Then there are questions of whether the matter is a “core” or “non-core” proceeding. Core matters are statutorily defined to include matters concerning the administration of the bankruptcy estate, allowance or disallowance of claims, motions to terminate or modify the automatic stay, determinations of the dischargeability of certain debts, and confirmation of a reorganization plan. (28 U.S.C. § 157.) Non-core matters are those that are only tangentially related to the estate, or involve a tort claim. The bankruptcy court can hear both core and non-core matters. When adjudicating core matters, the bankruptcy court may issue final orders and judgments and may conduct jury trials, although these are very rare. (In re Ben Cooper, Inc.. 896 F.2d 1394, 1402 (2d Cir. 1990), vacated and remanded, 498 U.S. 964 (1990), reinstated on remand, 924 F.2d 36 (2d Cir. 1991).) In non-core but related matters, the bankruptcy court has more limited powers. It may not issue final orders and judgments without the consent of the parties. Instead, it must submit proposed findings of fact and conclusions of law to the District Court. Also, it may not hold a jury trial in a non-core-proceeding. (In re Orion Pictures Corp., 4 F.3d 1095, 1101 (2d Cir. 1993).)

However, the distinction between core and non-core matters can be blurry at times, a circumstance which can be used strategically by skillful counsel in determining whether to remove a case from state court, withdraw the reference to bankruptcy court, have the case heard in federal District Court or remand the case back to state court. Appeals from bankruptcy decisions can be equally convoluted. The bankruptcy judge’s decision, in some Circuits, can be appealed to either a panel of three judges from the bankruptcy court (called the Bankruptcy Appeals Panel or “BAP”) or to the District Court, at the litigant’s option. Then that decision can be appealed to the Circuit Court.

Research into issues in bankruptcy can be difficult at times. The precedents are surprisingly few. This perhaps reflects the fact that the bankruptcy court is an equitable forum, where the parties may be more often concerned with achieving a deal than adjudicating the rights of the litigants. However, despite their scarcity, the cases are spread throughout a number of official reports, including the Federal Supplement, the Federal Reporter, the Bankruptcy Reporter, and the Federal Rules Decisions. The cases are not collected in any one compendium or service, although Collier’s on Bankruptcy is the most widely used reference work.