Opinion ID: 2631019
Heading Depth: 4
Heading Rank: 2

Heading: The Earmarking Doctrine

Text: ¶ 26 Anchor Wate also urges us to hold that the reinsurance proceeds did not become part of SAIC's estate because the funds were earmarked for Anchor Wate. Earmarking is a judicially-created doctrine said to apply when a new creditor pays a debtor's existing debt to an old creditor. [24] Funds are earmarked and therefore not part of the debtor's estate where there is (1) the existence of an agreement between the new lender and the debtor that the funds will be used to pay a specified antecedent debt [to a specific creditor], (2) performance of the agreement according to its terms, and (3) the transaction viewed as a whole (including the transfer in of the new funds and the transfer out to the old creditor) does not result in any diminution of the estate. [25] Some courts also examine the amount of control the debtor exercised over the funds or whether the estate was diminished by the transfer. [26] ¶ 27 We decline to apply the earmarking doctrine here because it was never intended to apply to reinsurance cases. And in any event, we conclude that Anchor Wate cannot establish the elements of an earmarking claim. ¶ 28 Application of the earmarking doctrine in recent decisions has generally been restricted to loan cases where a third party lends money to the debtor for the specific purpose of paying a selected creditor. [27] Historically, the doctrine's use was even more limited; courts used it when a new creditor, who was obligated on an existing debt as a guarantor or surety, provided the debtor with funds to pay the creditor. [28] The doctrine is restrictive because it was created for the very limited purpose of protecting the guarantor or codebtor who would be subject to double liability should its transfer to the debtor be considered a voidable preference. [29] ¶ 29 The earmarking doctrine was later expanded to cover situations where the new creditor is not a guarantor but merely loans funds to the debtor for the purpose of enabling the debtor to pay the old creditor. [30] But such an expansion was justified because a third-party loan does not diminish the estateit merely substitutes creditors. [31] This same rationale does not apply in reinsurance situations. Expanding the earmarking doctrine to such situations would not only divorce this doctrine from the historical policies justifying its existence, it would create a situation where the debtor's payment to its original insured would directly diminish the amount of the debtor's estate available for other creditors. [32] At least one court has warned that `[e]xtension of the earmarking doctrine beyond the guarantor situation is both unwise and unwarranted, and would inevitably result in an inequitable treatment of creditors.' [33] ¶ 30 The purpose of the Liquidation Act is to equitably distribute funds among creditors. We conclude that it would be inconsistent with both this statutory purpose and the broad scope of the statutory language to expand the scope of the earmarking doctrine. [34] ¶ 31 Policy arguments aside, we also decline to apply the earmarking doctrine here because Anchor Wate cannot establish the required elements. As has been previously explained, the reinsurers and SAIC did not specifically agree that the reinsurance proceeds would be targeted to pay only the Anchor Wate claim. Rather, the reinsurance agreements provided that third parties, such as Anchor Wate, would have no right under them. And because there was no agreement giving Anchor Wate any claim to the reinsurance proceeds, there could have been no performance of such an agreement. Finally, as discussed below, Anchor Wate cannot establish that the transfer would not result in a diminution of the debtor's estate because the money that SAIC received would have otherwise been available for distribution to all of its creditors. ¶ 32 Anchor Wate similarly cannot establish an earmarking claim under the control test. Under the control test, funds can be earmarked only if the debtor has exercised no control over them. [35] In determining whether a debtor or an insurer has control of funds, courts typically consider whether the new creditor restricted the use of the funds, whether the debtor had physical control over the funds, and whether the debtor had the ability to direct to whom the funds should be paid. [36] Although physical possession alone may not necessarily demonstrate the right to control, [37] at least one court has found that a debtor did control funds where they were deposited into the debtor's general checking account and not put into an identifiable, segregated trust account. [38] ¶ 33 In this case, SAIC deposited the reinsurance funds into its general account where, in the ordinary course of business, they were swept into another account and commingled with other funds. This demonstrates that SAIC had the right to disburse the funds to whomever it wished. [39] And even though there is evidence that the reinsurers expected the funds to be used to pay the Anchor Wate claim, there is no evidence suggesting that the reinsurers advanced these funds only on the condition that Anchor Wate be paid. [40] Rather, Anchor Wate had no rights under the reinsurance contracts because they provided that any funds disbursed thereunder were intended to indemnify SAIC. SAIC therefore had complete control over the funds, preventing application of the earmarking doctrine.