Whether the proceeds of an insurance policy constitute property of a debtor’s estate can have important ramifications. If policy proceeds are property of the bankruptcy estate under 11 U.S.C. § 541(a)(1), they are subject to the automatic stay, and insurers (or entities seeking payments from the policy) must seek relief from the automatic stay before making any advances or payments under the policy. Further, to the extent that policy proceeds are property of the estate, those proceeds increase the overall value of the estate for the benefit of creditors.
Section 541(a) of the Bankruptcy Code broadly defines a debtor’s bankruptcy estate to include “all legal or equitable interests of the debtor in property as of the commencement of the case.” Pursuant to that broad definition, courts throughout the country typically have considered a debtor’s insurance policies to become property of the estate upon the commencement of a bankruptcy case. But even as a debtor’s insurance policies themselves may be property of the estate, the proceeds of those policies may not. A split of authority has developed on this issue, and the answer generally appears to depend on the type of policy and policy language at issue, though the particular circumstances of a case may impact the result. Directors’ and Officers’ (D&O) liability policies purchased by a debtor are among those that raise more difficult questions, as they often provide different types of coverage to different entities.
When Are Insurance Proceeds Property of a Debtor’s Estate?
Determining what constitutes property of a debtor’s estate must be analyzed in light of the facts of each case. The “overriding question” in determining whether the proceeds of an insurance policy constitute 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.” In re Edgeworth, 993 F.2d 51, 55–56 (5th Cir. 1993). That inquiry turns on the nature of the policy and the specific provisions governing the parties’ interests in the payment of policy proceeds. As the Fifth Circuit has explained, “the question is not who owns the policies, but who owns the [ ] proceeds. Although the answer to the first question quite often supplies the answer to the second, this is not always so.” In re Louisiana World Exposition, Inc., 832 F.2d 1391 (5th Cir. 1987). Thus, if a debtor has no legally cognizable claim to the insurance proceeds – that is, where the proceeds are not payable to or for the direct benefit of the debtor – the proceeds generally are not considered property of the estate.
Policy Proceeds Payable to the Debtor Are Generally Property of the Estate
Insurance proceeds that are paid directly to a debtor pursuant to the terms of the insurance contract are generally held to be property of the estate. This is frequently the case in the context of so-called “first party” insurance coverage – i.e., insurance policies that provide coverage for losses sustained directly by the insured, such as casualty, collision, life, and fire insurance policies. Proceeds of such insurance policies, if made payable to the debtor rather than a third party such as a creditor, have been recognized to be property of the estate. But even where policy proceeds are considered property of the estate, those proceeds are not necessarily available for distribution to creditors on a pro rata basis. Indeed, courts have recognized that “property of the estate comes into the estate subject to all restrictions applicable to that property under state law,” and as a result, “insurance proceeds, if they were considered property of the estate, necessarily would be distributed only to those whom the state insurance law, or the policies themselves, gave a right to distribution.” Landry v. Exxon Pipeline Co., 260 B.R. 769, 787 n. 62 (Bankr. D. La. 2001).
Policy Proceeds Paid Only To Third Parties Are Generally Not Property of the Estate
In contrast, courts have recognized that policy proceeds are not property of a debtor’s estate where those proceeds are not payable to the debtor and cannot inure to the debtor’s pecuniary benefit. For example, proceeds paid from a commercial general liability (CGL) policy that provides coverage for losses sustained by others as a result of the insured’s business operations, payable to a third party, will likely not be considered part of the estate. Likewise, certain courts have distinguished indemnity insurance from general liability insurance on the grounds that proceeds of indemnity insurance – payable based upon debtor’s liability to a third party – are property of the debtor’s estate because the proceeds of such insurance are paid directly to the debtor.
Other Considerations: “Secondary Impact”
Courts in certain cases where liability insurance proceeds were insufficient to cover all tort claims potentially falling within the debtor’s insurance coverage either have held that the insurance proceeds fall within the scope of property of the estate or have enjoined litigation under 11 U.S.C. § 105 because of the “secondary effect” that payment of the insurance proceeds to tort claimants will have on the remaining claims against the estate and the debtor’s reorganization efforts. Under the “secondary effect” theory, the insurance proceeds themselves are not property of the estate insofar as they are payable directly to claimants; rather, some courts have found that having claims against the estate satisfied out of insurance proceeds has a “secondary effect” on the overall administration of the bankruptcy estate, since every dollar that an insurance policy pays for covered tort claims is an extra dollar for other, non-tort creditors and potentially for the debtor as well. See A.H. Robins Co., Inc. v. Piccinin, 788 F.2d 994, 1008 (4th Cir. 1986), cert. denied, 479 U.S. 876, 107 S.Ct. 251, 93 L.Ed.2d 177 (1986).
The “secondary effect” cases appear to involve Chapter 11 debtors seeking to reorganize by centralizing numerous lawsuits in a single forum and obtaining relief from tort liability through a Chapter 11 plan of reorganization that would provide for the resolution and payment of those tort claims. The “secondary effect” theory thus may not apply in cases involving liquidating debtors. Indeed, as the court explained in Correct Manufacturing, “[i]n contrast to the Chapter 11 debtor who has equitable interests in the proceeds of such policies because of its need to decrease liability from which third parties’ claims derive . . . and retain the ability to structure settlements of classes of claims,” a Chapter 7 debtor’s estate “has no such equitable interests,” such that the Chapter 7 debtor’s liability insurance proceeds would not be considered property of the estate. In re Correct Mfg. Corp., 88 B.R. 158, 162 (Bankr. S.D. Ohio 1988).
The court in Landry rejected the “secondary effect” approach as “utterly backwards,” finding that policy proceeds that are not otherwise payable to a debtor cannot somehow become property of the estate “merely because such property has the effect of reducing the estate’ s liability, or because of some other beneficial effect such property has on the estate.”