Source: https://www.textrial.com/litigating-financial-collapse-cases/
Timestamp: 2019-04-23 10:12:13+00:00

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Litigating Financial Collapse Cases - Sommerman, McCaffity, Quesada & Geisler L.L.P.
This first sections of this paper discusses methods for obtaining insurance payments during bankruptcy. Specifically, it addresses obtaining insurance payments in bankruptcy under property insurance, director and officer liability insurance, business interruption policies, and key man policies. It also discusses obtaining insurance payments during bankruptcy on personal injury claims and life insurance.
The latter sections of the paper focus on Trustee representation and litigation. It is meant to give an overview of both logistical and substantive considerations.
A majority of courts have determined liability insurance policies are property of the bankruptcy estate. MacArthur Co. v. Johns-Manville Corp., 837 F.2d 89 (2d Cir. 1998); Tringali v. Hathaway Mach. Co., 796 F.2d 553 (4th Cir. 1986); In re Davis, 730 F.2d 176 (5th Cir. 1984); In re Minoco Group of Cos., Ltd., 799 F.2d 517 (9th Cir. 1986). An insurance policy and proceeds deemed part of the bankruptcy estate are subject to the protection of the automatic stay.
In Lexington Ins. Co. v. Buckingham Gate, Ltd., Inc., 993 S.W.2d 185 (Tex.App.—Corpus Christi 1999, pet. denied), the insured brought an action against their property insurer and broker claiming misrepresentation of coverage on docks under an all-risk policy. The insurer claimed the statute of limitations barred the DTPA action because the insured served the insurer nine months after limitations expired. The insured’s counsel explained the delay was in part due to the insured’s creditors putting it into involuntary bankruptcy, and that he moved diligently as soon as the trustee gave him permission to proceed. The court of appeals held because the suit was filed prior to the statute of limitations, 11 U.S.C. § 108(a) tolled the limitations period and the insurer was timely served.
In any suit to recover under a contract of insurance, the insurer has the burden of proof as to any avoidance or affirmative defense that must be affirmatively pleaded under the Texas Rules of Civil Procedure. Any language of exclusion in the policy and any exception to coverage claimed by the insurer constitutes an avoidance or an affirmative defense. Tex. Ins. Code § 554.002. Thus, defendant insurers bear a separate, statutorily-imposed burden of proving the applicability of any claimed exclusion that permits it to deny coverage under Texas law. Venture Encoding Service, Inc. v. Atlantic Mut. Ins. Co., 107 S.W.3d 729 (Tex.App.—Fort Worth 2003 pet. denied); Sentry Ins. v. R.J. Weber Co., Inc., 2 F.3d 554 (5th Cir. 1993).
Entrustment in an exclusionary provision has been defined as “the idea of the delivery or surrender of possession of property by one to another with certain confidence regarding the others care, use or disposal of the property.” Imperial Insurance Co. v. Ellington, 498 S.W.2d 368, 372 (Tex.Civ.App—San Antonio, 1973, no writ). Entrustment “clearly suggests the existence of a consensual bailment situation where the person to whom possession is delivered to use the property for the purpose intended by the owner and stated by the recipient.” Id. The controlling element is the intent of the owner of the property. Balogh v. Pennsylvania Millers Mutual Fire Ins. Co., 307 F.2d 894 (5th Cir. 1962).
In Lone Star Heat Treating Co., Ltd. v. Liberty Mut. Fire Ins. Co., 233 S.W.3d 524 (Tex.App.‑Houston [14th Dist.] 2007, no pet.), a company in the business of heat treating metal was ripped off by a man who claimed to be picking up steel for a customer. The employee on duty at the time gave the man the steel, and as a result steel belonging to two customers was lost. The company’s insurance policy covered the property of others in the insured’s possession or control. The insurer denied the company’s claim based on a dishonesty exclusion which provided the insurer would not cover dishonest or criminal acts by the insured, its agents/employees, or those it entrusted with property. The trial court granted summary judgment and the court of appeals reversed and rendered in favor of the insured. It reasoned the employee’s entrustment to the thief could only be imputed to the company if the employee had actual authority, which he did not have.
In Nat’l Am. Ins. Co. v. Columbia Packing Co., Inc., No. 3-02-CV-0909-BD, 2003 WL 21516586 (N.D. Tex. 2003) (mem. opinion), National American argued that a security guard who had stolen over $200,000 worth of meat from a warehouse that he was supposed to be guarding at night had been “entrusted” with the stolen meat, and thus coverage under the insurance policy for the theft was excluded. The court, considering the plain meaning of the word “entrusted” and several other Texas cases that have defined that word, found that it could not grant National American summary judgment on the submitted entrustment issue because it was unclear as to how much control the guard actually exercised over the meat. Whether or not the guard had permission to (1) enter the locked warehouse; (2) handle any of the meat inventory; and/or (3) remove meat from the premises were all fact questions that had to be considered, precluding the granting of summary judgment.
In Glick v. Excess Ins. Co., 198 N.E.2d 595 (N.Y. 1964), there was a fact issue as to whether a jewelry store operator had entrusted jewelry to a thieving employee. The employee had reentered the store at night to steal the jewelry from the safe. But, although the employee had a key to the store and the combination of the safe, he did not have authorization to open the store or the safe outside the operator’s presence. Thus, whether or not entrustment had occurred was a question for the jury, which had evidence to support its finding that the wholesale jewelry dealer could recover against the insurance company for refusal to cover the theft.
What Qualifies as Property Damage?
In re ML & Assoc., 302 B.R. 857 (Bkrtcy. N.D. Tex. 2003), involved a general contractor which filed for bankruptcy after being sued by a city for damages in connection with its construction of a municipal complex. The debtor’s insurer brought an adversary proceeding to declare its obligations, if any, to defend and indemnify the debtor. The insurer contended the city’s complaint did not assert property damage covered by its policy. The policy stated it would cover “damages because of bodily injury or property damage.” It defined “property damage” as “physical injury to tangible property, including all resulting loss of use . . . or [l]oss of use of tangible property that is not physically injured.” The city alleged that it lost the use of the building at issue because of the damage to the building. Consequently, the court found the property damage asserted was covered.
In In re ML & Assoc., 302 B.R. 857 (Bkrtcy. N.D. Tex. 2003), the debtor’s insurer also tried to escape the duty to defend by claiming an impaired property exclusion which excluded coverage for property damages to impaired property arising out of a defect, deficiency, inadequacy or dangers condition in the insured’s product or insured’s work. The city’s petition stated damages to the municipal complex building were caused by MLA or its subcontractors. The court found that the policy’s definition of impaired property did not include the insured’s work, and therefore, the exclusion did not apply.
In Betco Scaffolds Co., Inc. v. Houston United Cas. Ins. Co., 29 S.W.3d 341 (Tex.App.—Houston 2000, no pet.), Betco brought suit against its property insurer for breach of contract after the insurer refused to cover losses from burglaries. Prior to bringing the claim, Betco was burglarized twice. It reported both burglaries to the police, but failed to notify the insurer until discovering an additional shortage in its annual inventory. The insurer denied the claim under the inventory exclusion provision and for failure to provide a sworn proof-of-loss statement within ninety-one days of the original burglaries. The inventory exclusion at issue provided the policy did not cover losses or shortages disclosed upon taking inventory. The trial court granted the insurer’s motion for summary judgment. On appeal Betco argued the exclusion only meant a loss reflected on the insured’s books instead of an actual shortage of goods based on the Fourth Circuit case of Betty v. Liverpool & London & Globe Ins. Co., 310 F.2d 308 (4th Cir. 1962). It contended that the “paper loss” interpretation was a reasonable interpretation to be construed in its favor as the insured because another court had accepted the interpretation. The court of appeals disagreed with this approach, but stated: “[w]e recognize that a regularly scheduled inventory could coincide with the investigation of a casualty in such a way that the inventory is intended by the insured as a means to quantify the loss. In that event, the inventory exclusion provision would not” apply. Betco Scaffolds Co., Inc., 29 S.W.3d. at 347.
Am. Stone Diamond, Inc. v. Lloyd’s of London, 934 F.Supp. 839 (S.D. Tex. 1996), involved a loss sustained when the rental car of a wholesale jewelry salesman was robbed. Several pieces of jewelry were stolen from the trunk of an unattended rental car while the salesman went into pay for gas at a service station. The property insurer denied the claim because the man was not actually in the car when the theft occurred. It argued on summary judgment that the language excluding losses from vehicles when there is not “actually in or upon such vehicle, the Assured, or a permanent employee of the Assured, or a person whose sole duty it is to attend the vehicle” was unambiguous. The court agreed, and also rejected the plaintiff’s argument that the policy exclusion was unconscionable on the facts of the case.
Words matter. It is possible to plead your case into a policy exclusion. Careful pleading can also keep your case alive.
In In re ML & Assoc., 302 B.R. 857 (Bkrtcy. N.D. Tex. 2003), a general contractor filed for bankruptcy after being sued by a city for damages in connection with its construction of a municipal complex. The debtor’s insurer brought an adversary proceeding to declare its obligations, if any, to defend and indemnify the debtor. As to the duty to defend, the court explained the duty to defend was “‘triggered if at least one of the several claims in the [city’s] complaint potentially falls within the scope of coverage, even if other claims do not.’” Id. at 862 (citing Federated Mut. Ins. Co. v. Grapevine Excavation, Inc., 197 F.3d 720, 726 (5th Cir. 1999)) (emphasis in original). The court found the duty to defend existed because the city’s pleadings that negligent performance (a covered claim). It further stated: “The complaint does not allege that MLA intended not to perform [under the contract] or MLA intended to cause damage to the building. Rather, the court infers from the complaint that the city alleges that MLA’s negligence in performance caused the damage. . . .” Id.
Director and officer liability insurance (“D&O insurance”) is often used by corporations to induce talented individuals to accept positions of authority by providing them with a shield from personal liability against potential claims arising out of their duties in the corporation. See In re La. World Expo., Inc., 832 F.2d 1391, 1398 (5th Cir. 1987).
There are three basic types of D&O insurance— corporate indemnification coverage, individual liability coverage, and entity coverage. Corporate indemnification coverage provides reimbursement to a corporation for the expenses it incurs as a result of indemnifying officers and directors for wrongful acts. Individual liability coverage is paid to the officers and directors when a corporation does not indemnify them. Finally, entity coverage provides insurance against claims brought against the corporation which are not covered in any other way.
Additionally, while the automatic stay may prevent litigation against a corporate debtor from proceeding, it does not necessarily protect officers and directors from claims asserting their contribution to the corporate debtor’s failure. See Matter of S.I. Acquisition, Inc., 817 F.2d 1142 (5th Cir. 1987). Whether proceeds of a D&O policy are considered property of the bankruptcy estate is a key determination. Executives attempting to draw from the policy for protection are considered creditors, and thus subject to the automatic stay, if the policy and its proceeds are deemed to be part of the estate. 11 U.S.C. §362. However, if proceeds are not considered part of the estate, they are not subject to the bankruptcy priority rules, and will be available for corporate executives to fund their individual defense costs.
In re La. World Expo., Inc., 832 F.2d 1391, 1398 (5th Cir. 1987), involved a corporate debtor which purchased D&O insurance proceeds pre-petition in order to protect its officers and directors against potential liability. The policy had both indemnification and liability coverage subject to a single coverage limit. The corporate-debtor’s creditors filed suit against the officers and directors for mismanagement, and the executives filed a claim with the insurer for legal expenses. The creditors sought to prevent the reimbursement of legal fees by asking the bankruptcy court to deem the proceeds property of the estate subject to the stay. On appeal, the Fifth Circuit held the proceeds of the liability portion were not property of the corporate debtor’s estate. It did not address whether the indemnification proceeds of the policy were part of the estate.
In In re Edgeworth, 993 F.2d 51 (5th Cir. 1993), the Fifth Circuit further expanded its jurisprudence on the subject of insurance proceeds and the bankruptcy estate. It explained, “ whether the debtor would have a right to receive and keep  proceeds when the insurer paid the claim” is the operative question in determining whether insurance proceeds are property of the estate. Id. at 55. Following that reasoning, it would seem indemnification proceeds would not be property of the estate. However, answering the Edgeworth question in regards to indemnification proceeds is often fact-intensive and not as simple as it seems.
In In re Vitek, 51 F.3d 530 (5th Cir. 1995), a prostheses manufacturer filed for bankruptcy after several products liability claims were filed. The trustee gained permission from the bankruptcy court to enter compromises with the corporate-debtor’s liability insurers to protect the carriers from third-party suits. Executives from the corporate debtor objected to the court approved settlements because it left them exposed to litigation and denied them liability coverage under the policy. The Fifth Circuit recognized the analysis presented in Louisiana World Exposition and Edgeworth was incomplete. Namely, it did not address the question of how to treat proceeds when the policy- owning debtor is not the only insured, the rights of the other insured are not derivative of the primary insured, and the potential liability exceeds the aggregate limits of insurance coverage. However, the court declined to address the open question. Instead, it hung its hat on the fact the insurance coverage at issue was entity coverage to protect the corporation itself, and declined to recognize the executive’s property interest in the D&O proceeds.
In In re Zale Corp., 62 F.3d 746 (5th Cir. 1995), parties filed a motion with the bankruptcy court to approve a settlement agreement between the debtor and the debtor’s D&O insurer. The bankruptcy court approved the settlement and entered an order enjoining third-party claims against the insurer. The court of appeals reversed. It held the bankruptcy court did not have jurisdiction to enjoin.

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