Opinion ID: 758543
Heading Depth: 2
Heading Rank: 1

Heading: the pay first provision

Text: 30 We agree with Judge Haight's conclusion that the recycling arrangement did not amount to payment under American Club's policy and thus failed to satisfy the policy's pay first provision. The American Club policies require it to indemnify [Prudential] against any loss, damage or expense which [Prudential] shall become liable to pay and shall pay. Because the American Club policy mandates payment prior to triggering the insurer's indemnification obligations, it is an indemnity policy. 31 Federal maritime law, which applies to this essentially maritime contract, does not speak to the issue of what constitutes payment under an indemnity policy. See Liman v. American Steamship Owners Mut. Protection and Indem. Ass'n, 299 F.Supp. 106, 108 (S.D.N.Y.1969), aff'd, 417 F.2d 627 (2d Cir.1969) (per curiam ). Because we see no need for a uniform federal rule (and because the parties have agreed that New York law governs), we apply New York law. 3 See Wilburn Boat Co. v. Fireman's Fund Ins. Co., 348 U.S. 310, 316-17, 75 S.Ct. 368, 372, 99 L.Ed. 337 (1955).
32 The recycling arrangement is patterned after a similar device approved by this court in Liman, which involved an identical American Club policy. In Liman, approximately 120 claims were presented by seamen and longshoremen against a bankrupt shipping company. Although the shipping company had sufficient funds to pay the claims, and although there was no reason to doubt that the company would be indemnified eventually by the insurer (net of the deductible), the Government (the bankrupt's chief creditor) opposed payment of the claims as illegal preferences because the estate would be diminished to the extent of the $1000 deductible which would be attributed to each of the claims to be defended. Liman, 299 F.Supp. at 107. 4 The district court in Liman described the financing mechanism adopted to obviate that objection: 33 The Trustee therefore propos[ed] to finance the $1,000 deductible in each case by defending each lawsuit pursuant to an agreement with the claimant to the effect that in the event of recovery or settlement in an amount in excess of $1,000, the estate will pay the full amount of the recovery to the claimant and the claimant will thereupon repay $1,000 to the estate, in exchange for which the claimant will become a general creditor of the estate in the sum of $1,000. 34 Id. at 108. The insurer objected that in order to be indemnified under the policies the estate must show that it actually 'absorbed' the $1,000 deductible. Id. 35 Liman summarized New York law on what constitutes payment under an indemnity policy (an interpretation which we adopted in our per curiam opinion affirming on the district court's opinion): [T]he test in New York is whether the assured has actually in good faith sustained the loss for which reimbursement is sought, and the insurer's obligation to indemnify may not be avoided because of the assured's insolvency. Id. at 109. Thus, an indemnifiable payment entails (i) satisfaction of the claim and (ii) the absorption of some loss thereby by the insured, (iii) both in good faith. See also Ahmed v. American Steamship Mut. Protection & Indem. Ass'n, 640 F.2d 993, 995 (9th Cir.1981) (noting that under New York law an insurer's obligation to pay under an indemnity policy does not arise until after the insured suffers an actual monetary loss); 8 John Alan Appleman & Jean Appleman, Insurance Law and Practice § 4856, at 519 (1981) (hereinafter Appleman) ([I]n an action upon an indemnity policy, not only must a judgment have first been recovered against the insured ... but it must also appear that the insured has suffered an actual monetary loss or damage.). 36 In holding that the deductible financing arrangement amounted to payment under this standard, the Liman court focused on the use of the challenged arrangement only to finance the deductible, the rest of each claim representing a cash loss out of pocket. Liman, 299 F.Supp. at 109-10. The court reasoned that: (i) the purpose of the deductible is to enable the insurer to avoid responsibility for small claims which are usually both numerous and costly and this purpose was not undermined by the arrangement; (ii) the source of the funds for paying the deductible is of no concern to the insurer because the insurer is not required to reimburse the policyholder for the deductible; (iii) other than the financing of the deductible, the Trustee would satisfy each judgment against the estate and actually pay out of the estate to the claimant all funds for which reimbursement will be sought from defendant, id. at 110; and (iv) given these factors, a failure to find that the insured had paid the claims would permit the insurer to reap a windfall and to take advantage of the financial status of its insured and deprive the ultimate beneficiary claimant of his judgment, id. at 109. Thus the court found that the purpose of the deductible in that case would be served, and that the Trustee would be seeking reimbursement only for losses actually sustained by the estate. Id. The court distinguished cases in which recovery on an indemnity policy was denied because in such cases there was neither a bona fide settlement of judgment obtained by the claimant against the assured nor a payment made by the assured of the amount for which reimbursement was claimed. Id. at 110. 37 Here, Prudential seeks to use the recycling arrangement to finance the whole of the claims, not the deductibles alone. This case thus differs from Liman in the essential respect that indemnity is sought for a loss that the policyholder has not incurred. See Ahmed v. American Steamship Owners Mut. Protection & Indem. Ass'n, 444 F.Supp. 569, 572 (N.D.Cal.1978) (distinguishing Liman by noting that the insured has never paid any of the claims against it or arranged to finance such payments), aff'd in part, remanded in part, 640 F.2d 993, 995 (9th Cir.1981).
38 As Liman notes, the test in New York is whether the assured has actually in good faith sustained the loss for which reimbursement is sought. 299 F.Supp. at 109. The only detriment assumed by Prudential vis-a-vis each Claimant is a wholly non-recourse debt, which in financial terms is--and is intended to be--nothing. 39 The Fifth Circuit has concluded that Liman does not stand for the proposition that 'payment' can be made by the use of a promissory note worthless from the day it is executed. Conoco, Inc. v. Republic Ins. Co., 819 F.2d 120, 122 (5th Cir.1987). Conoco had paid the salvage cost of raising a vessel that sank while on charter from the shipowner, Bonanza. Conoco was unable to recover the salvage cost directly from an insurer that had issued a policy protecting the ship and naming both Bonanza and Conoco as assureds because (as the Fifth Circuit held sitting in banc in a prior case) Conoco had no obligation to perform the salvage operation. Trying again, Conoco arranged for Bonanza (which presumably was obliged to pay the salvage costs of its vessel) to execute a demand promissory note in Conoco's favor for the salvage costs, secured by an assignment of any policy proceeds recovered from the insurer. Bonanza sought indemnification from the insurer on the theory that the note was payment under the policy. Id. at 121. However, [a]t the time [the loan] documents were signed, [Conoco] assured Bonanza's president that it would not attempt to collect the promissory note. Id. The court held that the bankrupt's satisfaction of the claim with a non-recourse note did not amount to payment under the indemnification policy:Since the bankrupt assured in Liman was not completely bereft of assets, the Liman court was not faced with the situation we face in this case, where Bonanza is literally incapable of sustaining a loss.... Bonanza not only had no intention of paying the promissory note, but offered no hope of eventually providing any value at all in exchange for the note. The company was dormant. Bonanza was gone, and it was not coming back. 40 Id. at 122-23. 41 Prudential is blocked by the same obstacle in this suit. The underlying claims were satisfied with non-recourse notes that entail for Prudential no actual loss incurred in good faith. The only difference between the present case and Conoco is that here Prudential issues boomerang payments from the $300,000 account. But as these funds immediately came home, the Asbestosis Claimants received nothing of value from Prudential, and Prudential sustained no true loss. We do not think that this sham transaction triggered an indemnification obligation under New York law. 42
43 It is obvious for reasons previously stated that the Claimants are the only parties with an interest in the indemnification from American Club. Our holding is therefore independently supported by the doctrine of New York law that bars direct actions by claimants against marine indemnity insurers. See Ahmed, 444 F.Supp. at 572 (Under New York common law, an insurer under an indemnity insurance policy is not liable to an injured person who has obtained a judgment against the insured even though the insured is insolvent and cannot pay the judgment.). Although New York has broadly altered this common law rule by statute, the statute expressly preserves application of the common law rule to marine insurance contracts, such as P & I policies. See N.Y. Insur. Law § 3420(i) (McKinney 1985) (referencing § 2117(b)(3) which incorporates marine insurance contracts); Ahmed, 640 F.2d at 995-96. The exception was consciously made by the New York legislature to eliminate a perceived competitive disadvantage to which New York's marine insurers were placed by the direct action statute. Miller v. American Steamship Owners Mut. Protection and Indem. Co., 509 F.Supp. 1047, 1049 (S.D.N.Y.1981). 44 We have previously barred a suit by an insured's judgment creditor against a marine policy on the ground that the suit closely resembled a direct action. See Wabco Trade Co. v. S.S. Inger Skou, 663 F.2d 369, 371 (2d Cir.1981) (holding that N.Y. C.P.L.R. § 5201(a), which provides for a money judgment against any debt, affords no basis for maintaining a direct action against a marine insurer of a judgment debtor); see also Cowan v. Continental Ins. Co., 86 A.D.2d 646, 647, 446 N.Y.S.2d 412, 414 (2d Dep't 1982) (noting that judgment creditor of insured could not bring declaratory judgment against insured's insurer). We will not permit the Claimants, who are the only parties in interest, to evade this bar via an illusory transaction that is of no financial consequence or interest to Prudential as the supposed insured. 45 New York's approach to insolvent insureds under the common law rule barring direct actions is quite categorical and firm in terms of the type of actual loss required to trigger an indemnification obligation: 46 [I]f the insured was insolvent, so that the person injured or the estate of one killed was unable to satisfy the judgment against him, the insurer in effect would be released. The policy being one of indemnity against loss suffered by the principal, it followed that the insured having suffered no damage, there was no loss for the insurer to indemnify. 47 Jackson v. Citizens Cas. Co., 277 N.Y. 385, 389, 14 N.E.2d 446 (1938); see 175 East 74th Corp. v. Hartford Accident & Indem. Co., 51 N.Y.2d 585, 591, 435 N.Y.S.2d 584, 586, 416 N.E.2d 584 (1980) (The insolvency or bankruptcy of an insured, which prevented payment, necessarily relieved the insurer of any obligation to the insured and the injured party was left without a source of recovery.); see also In re F.O. Baroff Co., 555 F.2d 38, 41 (2d Cir.1977) (noting that prior to the enactment of the direct action statute, courts held that in the event of his bankruptcy, the insured, although liable to a third person, suffered no loss since he was unable to pay the one he had injured. Because the insured had not sustained a loss, the insurance company had no liability to the insured.). Thus, as the law stood under New York common law--and as it still stands in relation to marine insurance policies--the insured's lack of assets to satisfy claims against the bankrupt estate typically leaves the insured unable sustain a loss and pay the claim. This is simply one consequence of purchasing a marine policy of indemnity rather than a liability policy.
48 The several New York cases upon which claimants rely either support our conclusion or are distinguishable. In Campbell v. London & Lancashire Indemnity Co., 168 N.Y.S. 300 (N.Y.Sup. 1917), the insured under an indemnity policy, being insolvent, paid a claim with funds borrowed for that purpose from a third party, secured initially by a promissory note, and later (after the funds were used to pay the claimant) by an assignment of the insurance claim for indemnification. The court found that this arrangement satisfied the pay first provision of the policy, but added: It must be admitted that, if there had been no payment of the judgments to the judgment creditor, but the moneys were to be held by the judgment creditor to await the result of this action, such a pretended payment would be in bad faith, and would defeat plaintiff's right of recovery. Id. at 301. In Campbell, the funds were actually transferred to the claimant as a bona fide payment of the claim and the party that had been assigned the indemnity right had actually paid the claim and sustained a monetary loss in good faith. That transaction was no doubt facilitated by the permissibility of an assignment of indemnity rights under the policy. The American Club policy prohibits such assignment. 5 49 Finally, Feldman v. New York City Health & Hospitals Corp., 107 Misc.2d 145, 437 N.Y.S.2d 491, 496 (N.Y.Sup. 1981), rev'd, 84 A.D.2d 166, 445 N.Y.S.2d 555 (2d Dep't 1981), rev'd, 56 N.Y.2d 1011, 453 N.Y.S.2d 683, 439 N.E.2d 398 (1982) (adopting New York State Supreme Court opinion), a case having nothing to do with insurance, held efficacious a financial arrangement by which a tort plaintiff financed the payment by a tort defendant. The tort defendant was found 10% liable for the injury, while the third-party defendant was found 54% liable. Under the rule announced in Klinger v. Dudley, 41 N.Y.2d 362, 393 N.Y.S.2d 323, 361 N.E.2d 974 (1977), the plaintiff could not recover directly from the third-party defendant, and was in a bind because the defendant was largely insolvent and could not afford a 64% payment. The plaintiff therefore arranged for a lender to finance the defendant's payment of the 64%, and to take in return (i) an assignment of the defendant's contribution rights from the third-party defendant, (ii) a demand note from the defendant guaranteed by the plaintiff without prior recourse to the (insolvent) defendant, and (iii) 25% of any recovery from the third-party defendant as the lender's reward. Feldman, 437 N.Y.S.2d at 494. In finding that the arrangement satisfied Klinger and triggered the third-party defendant's contribution obligation, the court ruled that: (i) no disservice would be done to the limited policy behind Klinger, i.e., to avoid the defendant simply keeping the contribution funds it receives from the third-party defendant without paying the plaintiff, id. at 495; (ii) both the plaintiff and the defendant would be harmed by application of the Klinger rule in the circumstances, id. at 495-96; and (iii) the defendant's payment to the plaintiff had been financed through a bona fide loan, the proceeds of which were used to fully pay and satisfy the plaintiff's judgment, id. at 496. 50 As the Claimants in the present appeal point out, the Feldman court deemed the arrangements made between the plaintiff and the lender to be irrelevant to the bona fide nature of the loan between the defendant and the lender. We think Feldman is no help to Claimants here because the non-party lender in Feldman performed a real financial service for a real financial reward, whereas the recycling of funds by the Trustee here is an illusion; and the obstacle removed in Feldman was a doctrine (Klinger ) that was intended to protect plaintiffs but in the circumstances had backfired to that plaintiff's detriment, see id. at 497 (The Court will not permit the 'shield' of Klinger to be used as a 'sword' by a culpable third party defendant who seeks to escape a judgment against it through an inflexible construction of Klinger.); see also Reich v. Manhattan Boiler & Equip. Co., 91 N.Y.2d 772, 778, 676 N.Y.S.2d 110, 698 N.E.2d 939 (1998) (The Feldman loan agreement was sanctioned for the limited purpose of alleviating the burdens created by Klinger in the specific factual circumstances of Feldman.), whereas the obstacle faced by Claimants here is a bargained for contract clause, see Harris v. Standard Accident & Ins. Co., 297 F.2d 627, 631 (2d Cir.1961), that protects an insurer unwilling to waive it. 51 Claimants invoke New York's general policy of preventing an insurer from taking advantage of an insured's bankruptcy; but we cannot find that the recycling arrangement adopted by Prudential and the Claimants amounts to payment of the claims under New York law. Accordingly, we hold that the pay first provision of American Club's policy is not satisfied, and affirm the district court. 52