Opinion ID: 2631019
Heading Depth: 2
Heading Rank: 1

Heading: utah code section 31a-27-321

Text: ¶ 11 We begin by considering whether SAIC's payments to Anchor Wate constitute voidable preferences under the Liquidation Act. [5] When interpreting the voidable preference provisions of the Liquidation Act, we previously have stated that Utah courts may look for guidance to federal bankruptcy law and its interpreting precedent. [6] This is so because federal bankruptcy law and the voidable preference provisions of the Liquidation Act share the common purpose of effectuating proportionate distribution of the debtor's assets among its creditors, thereby preventing a transfer to one creditor that would diminish the estate of the debtor that otherwise would be available for distribution to all. [7] ¶ 12 To establish a voidable preference under the Liquidation Act, there must be a transfer of any of the property of an insurer to or for the benefit of a creditor, for or on account of an antecedent debt, made or allowed by the insurer within one year before the filing of a successful petition for rehabilitation or liquidation . . ., the effect of which transfer may enable the creditor to obtain a greater percentage of his debt than another creditor of the same class would receive. [8] ¶ 13 The only two of these elements in dispute are whether there was a transfer of SAIC's property and whether this transfer enabled Anchor Wate to receive a greater percentage of its debt than other SAIC creditors of the same class. We therefore confine our analysis to these issues.
¶ 14 Courts generally construe the transfer of property requirement broadly so that all legal or equitable interests are considered property of the debtor's estate. [9] Accordingly, funds paid by SAIC to Anchor Wate would be considered property of SAIC's estate unless Anchor Wate had a direct interest in the proceeds at the time SAIC received them from the reinsurers. For the reasons detailed below, we find that neither the reinsurance agreements nor any theory Anchor Wate advances establishes such an interest; therefore, the district court correctly determined that the reinsurance proceeds were part of SAIC's estate. ¶ 15 As a general matter, an insured has no legal interest in reinsurance proceeds. [10] Such a rule is consistent with the purpose of reinsurance contracts, which is to indemnify the insurer for any loss the insurer experiences, not to protect the insured. [11] Indeed, if the insurer chooses to purchase reinsurance protection, it does so for its benefit alone. [12] The reinsurance contract is not tied to the contract between the insurer and its insured; it is a completely separate and unrelated transaction. In fact, the original insured is seldom aware of the existence of the reinsurer. [13] ¶ 16 This general rule does not apply when a reinsurer has agreed to give an original insured a direct claim to the proceeds of a reinsurance policy. [14] But any such agreement must explicitly give the insured such an interest. Such agreements may state that the reinsurer itself takes charge of and manages the defense of suits against the original insured or in some other way provide that the original insured directly benefits from the reinsurance contract. [15] Absent such a provision, a reinsurer has no liability to the original insured. [16] ¶ 17 In this case, there is no agreement giving Anchor Wate any direct claim to the reinsurance proceeds or any cause of action against the reinsurers. The only parties to the reinsurance agreements are the reinsurers and SAIC, and those agreements clearly describe their purpose as indemnifying SAIC. Indeed, they explicitly specify that SAIC's insureds have no rights under these agreements. ¶ 18 Both the Net Retained Lines Reinsurance Agreement and the Quota Share and Excess of Loss Reinsurance Agreement provide that [t]his Agreement is to indemnify the Reinsured. The Casualty Agreement similarly provides that [t]his Agreement is solely between the Company [SAIC] and the Reinsurer. . . . In no instance shall any insured of [SAIC], or any claimant against an insured of [SAIC], have any rights under this Agreement. ¶ 19 The Net Retained Lines Reinsurance Agreement also specifically addresses the potential insolvency of SAIC. It states, Nor shall anything in this insolvency clause in any manner create any obligations or establish any rights against the Reinsurer in favor of any third parties or any persons not parties to this Agreement. Rather, in the event of insolvency, any money owed under the agreement shall be paid directly to the Reinsured or its liquidator. Language such as this is the basis on which other courts have concluded that a third-party original insured has no interest in the proceeds from a reinsurance policy. [17] Such provisions, bolstered by the fact that SAIC entered into the reinsurance agreements years prior to insuring Anchor Wate, demonstrate that the reinsurance proceeds were the property of SAIC and therefore subject to the preference statute. ¶ 20 Despite this contractual language, Anchor Wate argues that the proceeds never became part of SAIC's estate because SAIC did not have the right to disburse funds to whomever it wished. [18] To support this assertion, Anchor Wate points to correspondence between SAIC and its reinsurers suggesting that the reinsurance payments would go toward paying the Anchor Wate claim. It further contends that it was in the reinsurers' best interests to tender the policy amounts because, under at least one of the reinsurance agreements, the reinsurers' liability to SAIC include[d] any judgment rendered against an original insured which is in excess of the limits provided by the Reinsured's policy and for which the Reinsured is held liable as a result of alleged or actual bad faith . . . in the duty to defend. Anchor Wate also relies on the release it signed in which it released not only SAIC, but also its reinsurers. Because the reinsurers believed that SAIC would use the reinsurance proceeds to pay Anchor Wate, Anchor Wate argues that the proceeds were never the property of SAIC and were therefore not subject to the Liquidator's preference action. ¶ 21 Even assuming a belief on the part of the reinsurers that the reinsurance proceeds would go toward the Anchor Wate claim, there is still no evidence suggesting that Anchor Wate had a direct claim to the reinsurance proceeds. Indeed, Anchor Wate concedes that it did not have the right to demand payment directly from the reinsurers. The reinsurers' only responsibility was to indemnify SAIC for its losses. Once they fulfilled this responsibility, they were not required to ensure that SAIC distributed the funds to Anchor Wate and were not subject to bad faith exposure if SAIC failed to do so. And the Release purporting to absolve the reinsurers from any liability to Anchor Wate, to which the reinsurers were not party, does not establish that Anchor Wate ever had any basis for asserting a claim against the reinsurers in the first place. Because Anchor Wate has not established any facts indicating that Anchor Wate had any direct claim against the reinsurers, the district court properly concluded that the reinsurance proceeds were the property of SAIC. ¶ 22 Anchor Wate urges us to avoid this conclusion by adopting any one of three theories pursuant to which courts have declined to apply voidable preference statutes. We examine and reject each of these theories, concluding that the absence of any agreement giving Anchor Wate a direct claim to the reinsurance proceeds is dispositive.
¶ 23 Relying on In re Edgeworth, [19] a Fifth Circuit case involving the proceeds of a malpractice liability insurance policy, Anchor Wate argues that the proceeds of the reinsurance contracts never became the property of SAIC. Because the proceeds of many liability policies are payable only for the benefit of those harmed by the debtor under the terms of the insurance contract, the Edgeworth court reasoned that the debtor does not have a cognizable interest in the proceeds and, therefore, the proceeds do not become part of the debtor's estate. [20] ¶ 24 We decline to apply Edgeworth's rationale here because we disagree with its premise. Rather, we align ourselves with those courts holding that the proceeds of insurance policies are part of the property of the debtor's estate. [21] Indeed, subsequent cases from the Fifth Circuit have characterized Edgeworth as an outlier to this general line of jurisprudence. [22] ¶ 25 Moreover, were we inclined to agree with Edgeworth's reasoning, it simply does not apply here. In concluding that the insurance proceeds at issue never became part of the debtor's estate, the Edgeworth court relied on the fact that the policy at issue was a liability policy. In Edgeworth, the proceeds were made payable to a third party; the debtor was not a beneficiary of the policy and had no cognizable interest in it. [23] Neither of these facts is present in this case, which involves an indemnity policy that does give the debtor an interest in the proceeds and, in fact, specifically disclaims any interest in the original insured.
¶ 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.
¶ 34 Anchor Wate next asserts that the reinsurance proceeds were never the property of SAIC because SAIC was merely holding them in constructive trust for Anchor Wate. Courts recognize a constructive trust as a matter of equity where there has been (1) a wrongful act, (2) unjust enrichment, and (3) specific property that can be traced to the wrongful behavior. [41] Such trusts are usually imposed where injustice would result if a party were able to keep money or property that rightfully belonged to another. [42] In bankruptcy, where a debtor holds funds in constructive trust, those funds are not subject to preference claims. [43] But we decline to impose a constructive trust here because Anchor Wate has failed to establish the requisite elements. ¶ 35 First, Anchor Wate has failed to show the existence of any wrongful act. To establish a wrongful act under Utah law, an entity must have obviously received funds by mistake or participated in active or egregious misconduct. [44] In this case, no wrongful act has been perpetrated by SAIC against Anchor Wate. The reinsurance agreements expressly state that third parties, like Anchor Wate, have no interest in any reinsurance proceeds. SAIC legally received the reinsurance proceeds and deposited them into its own bank account. Although Anchor Wate suggests that it should have been paid before SAIC made cash calls on the reinsurers, the reinsurance agreements specifically state that SAIC has a right to receive an advance of funds on claims over $100,000. And even assuming some fraud was perpetrated by SAIC in the receipt of these funds, the fraud was perpetrated against the reinsurers, not Anchor Wate. In short, Anchor Wate cannot show illegal or egregious conduct directed against its interests. ¶ 36 Anchor Wate likewise cannot show that SAIC was unjustly enriched. Under its contract with the reinsurers, SAIC was entitled to indemnification for amounts paid on Anchor Wate's claims. Although SAIC's liquidation allowed it to avoid paying off Anchor Wate's claim in full, such a circumstance does not constitute unjust enrichment. The same rationale applies here as in the bankruptcy context, where the federal courts have recognized that [w]henever a debtor retains a benefit afforded it by a creditor without paying that creditor in full, the estate is arguably unjustly enriched. Yet this situation is a result of a congressional policy choice incorporated into the Bankruptcy Code, and born of the reality that an insolvent debtor, by definition, is unable to satisfy in full the debts owed to its creditors. In light of this congressional policy choice and the reality that other similarly situated creditors are also receiving less than full payment of their claims, the estate's retention of the Disputed Funds subject to pro-rata distribution is not unjust under the circumstances. [45] ¶ 37 We accordingly hold that SAIC was not unjustly enriched in the manner contemplated by the unjust enrichment prong of the constructive trust test when it retained the reinsurance proceeds. Having determined that Anchor Wate can establish neither a wrongful act nor unjust enrichment, we conclude that Anchor Wate did not establish the elements required for the imposition of a constructive trust. We therefore need not address the third requirement for imposition of a constructive trust  the tracing requirement. ¶ 38 In summary, Anchor Wate cannot establish the elements of a constructive trust or any other theory that would provide it with a direct claim to the reinsurance proceeds. We therefore hold that the reinsurance proceeds were property of SAIC's estate and that this property was transferred when it was passed to Anchor Wate.
¶ 39 Having determined that the reinsurance proceeds were part of SAIC's estate, we now address whether SAIC's transfer of the $3.5 million to Anchor Wate enabled Anchor Wate to receive a greater percentage of its debt than creditors of the same class, thus allowing the Liquidator to establish a voidable preference under the Liquidation Act. ¶ 40 As a general matter, a transfer enables a creditor to receive more than another similarly situated creditor when the transfer diminish[es] the fund to which other creditors can legally resort for the payment of their debts, thus making it impossible for other creditors of the same class to obtain as great a percentage as the favored one. [46] Concerns about equity necessitate the well-recognized policy that a debtor should not be able to make transfers on the eve of liquidation that deplete the debtor's assets to the detriment of the other creditors. [47] In determining whether there was such a voidable transfer, [t]he focus of the court must be on the effect of the payment. [48] ¶ 41 In this case, the effect of SAIC's payment to Anchor Wate was to directly deplete SAIC's estate. The $3.5 million that would have been available for division among all of SAIC's creditors went solely to Anchor Wate. We therefore hold that the entire $3.5 million must be brought back into SAIC's estate to be distributed pro rata among all creditors of the same class.