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The U.S. Court of Appeals for the Fifth Circuit has issued a decision in a case that, it found, presented the “limited circumstances” in which the proceeds of a debtor's liability insurance policy were property of the debtor's bankruptcy estate.

Background: Insurance Proceeds and Bankruptcy in the Fifth Circuit

The treatment of insurance proceeds in the Fifth Circuit has a complicated history.

In Louisiana World Exposition, Inc. v. Federal Insurance Co. (In re Louisiana World Exposition, Inc.), 832 F.2d 1391 (5th Cir. 1987), a corporate debtor purchased liability insurance for its individual directors and officers. The policies covered the directors' personal liability and legal expenses incurred by reason of their positions with the corporation. Importantly, the directors and officers were the “named [] and only insureds,” and the policy did “not cover the liability exposure of the corporation at all.”

The Fifth Circuit held that the liability proceeds were not property of the estate. In doing so, the circuit court distinguished between ownership of insurance policies and insurance proceeds.

The Fifth Circuit next faced the policy/proceeds distinction in Houston v. Edgeworth (In re Edgeworth), 993 F.2d 51 (5th Cir. 1993). In that case, Dr. Edgeworth filed for Chapter 7 protection shortly after a woman died under his care. After Dr. Edgeworth received a discharge, the woman's daughter sought bankruptcy court approval to file a claim against Dr. Edgeworth's malpractice policy.

The Fifth Circuit held that the daughter could pursue her claim because the malpractice carrier was not protected by Dr. Edgeworth's discharge and the proceeds of the policy were not property of his estate. The circuit court explained:

The overriding question when determining whether insurance proceeds are property of the estate is whether the debtor would have a right to receive and keep those proceeds when the insurer paid on a claim. When a payment by the insurer cannot inure to the debtor's pecuniary benefit, then that payment should neither enhance nor decrease the bankruptcy estate. In other words, when the debtor has no legally cognizable claim to the insurance proceeds, those proceeds are not property of the estate.

(Footnotes omitted.)

Under this framework, the policy itself was property of the Chapter 7 estate but the proceeds of the policy were not. The circuit court, however, also stated:

Dr. Edgeworth has asserted no claim at all to the proceeds of his medical malpractice liability policy, and they could not be made available for distribution to the creditors other than victims of medical malpractice and their relatives. Moreover, no secondary impact has been alleged upon Edgeworth's estate, which might have occurred if, for instance, the policy limit was insufficient to cover appellants' claims or competing claims to proceeds. Consequently, in this case the insurance proceeds were not part of the estate.

(Emphasis added.)

Other decisions by courts in the Fifth Circuit have applied the framework laid out in Edgeworth. See, e.g., Sosebee v. Steadfast Ins. Co., 701 F.3d 1012 (5th Cir. 2012) (applying Edgeworth to determine whether proceeds of a liability insurance policy were property of the estate); see, also, Kipp Flores Architects, L.L.C. v. Mid-Continent Casualty Co., 852 F.3d 405, 413 n.11 (5th Cir. 2017).

The Fifth Circuit has observed that the inquiry remains a fact-specific one. See, Edgeworth, 993 F.2d at 56; In re Sfuzzi, Inc., 191 B.R. 664, 668 (Bankr. N.D. Tex. 1996) (“[T]he question of whether the proceeds are property of the estate must be analyzed in light of the facts of each case.”).

The Case

In May 2016, a bus owned by OGA Charters, LLC, rolled over while on its way to the Kickapoo Lucky Eagle Casino in Eagle Pass, Texas. The single vehicle crash killed nine passengers and injured more than 40 others. The accident gave rise to personal injury, wrongful death, and survival claims against OGA, which owned only two buses.

Through New York Marine & General Insurance Company (“NYM”), OGA owned an insurance policy that provided $5 million in liability coverage for “covered autos.” The policy also provided collision and comprehensive coverage. A small group of victims and their representatives (the “Settled Claimants”) quickly entered into settlements with NYM that, if valid and enforceable, would have exhausted the $5 million in liability coverage.

Less than two months after the accident, the victims without settlements (the “Unsettled Claimants”) filed an involuntary bankruptcy petition against OGA in the U.S. Bankruptcy Court for the Southern District of Texas. The Unsettled Claimants also initiated an adversary proceeding against OGA and NYM. The Settled Claimants intervened in the adversary proceeding. The bankruptcy court preliminarily enjoined NYM from paying out any policy proceeds.

Following the appointment of a Chapter 7 trustee, the parties filed cross-motions for summary judgment, disagreeing over whether the proceeds of the insurance policy were property of the OGA bankruptcy estate under Section 541(a) of the Bankruptcy Code, 11 U.S.C. § 541(a).

The bankruptcy court granted summary judgment in favor of the trustee and Unsettled Claimants, ruling that the proceeds were property of the OGA bankruptcy estate. The Settled Claimants sought a direct appeal to the Fifth Circuit, and the bankruptcy court certified the following question under 28 U.S.C. § 158(d)(2):

Are proceeds of a debtor-owned liability insurance policy property of the debtor's bankruptcy estate when: (1) the policy covers the debtor's liability to third parties; (2) the debtor cannot make a legally cognizable claim against the policy; and (3) the claims by third parties exceed the coverage limits of the policy[?]

The Settled Claimants argued that the policy proceeds were not property of the OGA bankruptcy estate, meaning they should be allowed to recover the full $5 million despite OGA's pending bankruptcy proceedings. Conversely, the Unsettled Claimants argued that the proceeds should be subjected to the bankruptcy court's process of equitable distribution among creditors.

The claims against the OGA bankruptcy estate exceeded $400 million. Other than the accident victims and their representatives, OGA had one other creditor, with a claim for less than $9,000.

The Fifth Circuit's Decision

The Fifth Circuit affirmed.

In its decision, the circuit court explained that the issue in the OGA case was whether, under Edgeworth, liability policy proceeds were property of the estate when the policy limit was insufficient to cover a multitude of tort claims.

The Fifth Circuit then disagreed with the Settled Claimants that no such fact-specific exception existed and that, if it did, it contravened both the Bankruptcy Code and state law.

The Fifth Circuit pointed out that, in its previous decisions, it left open the possibility that liability proceeds were property of the estate in cases such as the OGA case. It then ruled that, in the “limited circumstances” where a “siege of tort claimants threaten the debtor's estate over and above the policy limits,” the proceeds were property of the estate.

Here, the Fifth Circuit reasoned, over $400 million in related claims threatened OGA's bankruptcy estate over and above the $5 million policy limit, giving rise to an “equitable interest of the debtor in having the proceeds applied to satisfy as much of those claims as possible.” (The circuit court added that this interest did “not bestow upon the debtor a right to pocket the proceeds,” but that they should be used to “reduce some claims and permit more extensive distribution of available assets in the liquidation of the estate.”)

The Fifth Circuit rejected the Settled Claimants' argument that treating the proceeds as property of OGA's bankruptcy estate violated the Bankruptcy Code. It reasoned that Bankruptcy Code Section 541(a)(1), which provides that a debtor's bankruptcy estate is comprised of “all legal or equitable interests of the debtor in property as of the commencement of the case,” was broad enough to cover an interest in liability insurance – namely, the debtor's right to have the insurance company pay money to satisfy debts accrued through the insured's negligent behavior.

The circuit court also rejected the Settled Claimants' contention that its ruling constituted a “collateral attack” on state law, explaining that, under Texas law, insurers did not incur independent liability solely by reason of entering into reasonable settlements that exhausted or diminished the proceeds available to satisfy other claims.

Accordingly, the Fifth Circuit concluded that this case presented the “limited circumstances” in which the proceeds of a debtor's liability insurance policy were property of the debtor's bankruptcy estate.

The case is In re Charters, No. 17-40920 (5th Cir. Aug. 24, 2018). Attorneys involved include: For MYRA LYNN MARTINEZ, Individually and as Representative of the Estate of Maricela Vega Lopez, Deceased, JORGE LOPEZ, Individually and as Representative of the Estate of Maricela Vega Lopez, Deceased, ELIZABETH NAVARRO, Individually and as surviving child of Jaime Navarro, Sr., Deceased, JAIME NAVARRO, Individually and as surviving child of Jaime Navarro, Sr., Deceased, JESUS NAVARRO, Individually and as surviving child of Jaime Navarro, Sr., Deceased, MARIA DEL ROSARIO NAVARRO, Individually and on behalf of the Estate of Jaime Navarro, Sr., Deceased, Maria Elva Cantu, MARIA EUGENIA MARTINEZ, Individually and as surviving child of Dora N. Gonzalez, Deceased, MARIBEL CAMPA, Individually and as surviving child of Dora N. Gonzalez, Deceased, YVETTE AGUILAR, Individually and as surviving child of Altagracia Torres, Deceased, George Garza, Olga Garza, ODELLA RICKARD, Individually and on behalf of the Estate of Emma R. Samudio, Suzanne Hughes, Appellants: Eric B. Terry, San Antonio, TX. For Beatrice Garcia, Appellant: Tracy Spillman, Kittleman Thomas, P.L.L.C., McAllen, TX; Eric B. Terry, San Antonio, TX; [*2] Michael A. McGurk, Walsh McGurk Cordova Nixon, P.L.L.C., McAllen, TX. MICHAEL B. SCHMIDT, Trustee, Appellee, Pro se, Corpus Christi, TX. For MICHAEL B. SCHMIDT, Trustee, Appellee: Kay B. Walker, Law Office of Kay B. Walker, Corpus Christi, TX. For Marta Villareal, Idolina Rivera, Mario Alberto Zuniga, Lizbeth Rangel, Thelma Hernandez, Manuel Salinas, Carlota Salinas, Guadalupe Carrillo, Elizabeth Cristina Carrillo, Jose Cardenas, Irma Cardenas, Dora Pena, IMELDA GUERRERO OCHOA, as Representative of the Estate of Francisca Guerrero, Deceased, Hortencia Robles, Natalie Alaniz, JAIME GARZA, on behalf of the Estate of Adelfa Garza, JOMARA WEATHERBY, on behalf of the Estate of Maria de Jesus Musquiz, Deceased, Lisa Garza, Appellees: Shelby Arthur Jordan, Nathaniel Peter Holzer, Jordan, Hyden, Womble, Culbreth & Holzer, P.C., Corpus Christi, TX.

Steven A. Meyerowitz, Esq., is the Director of FC&S Legal, the Editor-in-Chief of the Insurance Coverage Law Report, and the Founder and President of Meyerowitz Communications Inc. As FC&S Legal Director, Mr. Meyerowitz, a member of the team that conceptualized FC&S Legal, provides daily analysis and commentary on the most significant insurance coverage law decisions from courts across the country and news regarding legislative and regulatory developments. A graduate of Harvard Law School, Mr. Meyerowitz was an attorney at a prominent Wall Street law firm before founding Meyerowitz Communications Inc., a law firm marketing communications consulting company.