March 05, 2015 Articles

New Limits to Bankruptcy Standing in the Seventh Circuit

Learn why the court limited the scope in the context of a debtor's attempt to settle with its primary insurer.

By Devoy Dubuque and David R. Doyle

The concept of “standing” plays an important role in bankruptcy cases because of the myriad parties potentially affected by the proceedings. By limiting the parties that may be heard in a case to “parties in interest,” the doctrine promotes the efficient administration of bankruptcy cases. In the recent case In re C.P. Hall Co., 750 F.3d 659 (7th Cir. 2014), the Seventh Circuit emphasized the limited scope of bankruptcy standing in the context of a debtor’s attempt to settle with its primary insurer. The court held that the debtor’s excess insurer lacked standing to object to the settlement, despite the possibility that the settlement could increase the excess insurer’s liability under its policy with the debtor. The court’s analysis suggests, however, that exceptions to this rule may exist, including when a settlement gives rise to allegations of fraud or alters the insurer’s contractual rights. But a settlement that merely increases the likelihood that an excess insurer will have to pay does not confer standing.

Standing as a “Party in Interest”
Section 1109 of the Bankruptcy Code limits the right to object to settlements to “parties in interest.” 11 U.S.C. § 1109. The section does not define “party in interest” but states that “[a] party in interest, including the debtor, the trustee, a creditor’s committee, an equity security holder’s committee, a creditor, an equity security holder, or any indenture trustee, may raise and appear and be heard on any issue in a case under this chapter.” Courts have long recognized that this is not an exhaustive list—the term “party in interest” is to be broadly construed and determined on a case-by-case basis. In re Johns-Manville Corp., 36 B.R. 743, 747–48 (Bankr. S.D.N.Y. 1984), aff’d, 52 B.R. 940 (S.D.N.Y. 1985); accord In re Martin Paint Stores, 207 B.R. 57, 61 (S.D.N.Y. 1997). However, courts have generally limited standing to “all persons whose pecuniary interests are directly affected by the bankruptcy proceedings.” Yadkin Valley Bank & Trust Co. v. McGee (In re Hutchinson), 5 F.3d 750, 756 (4th Cir. 1993).

The C.P. Hall Company
The C.P. Hall Company, a distributor of asbestos and asbestos products, filed for bankruptcy in the Northern District of Illinois in 2011. C.P. Hall ceased operations in the mid-1980s and, at the time of the bankruptcy filing, existed solely as a litigation shell for the thousands of asbestos lawsuits the company faced. C.P. Hall held both primary and excess insurance coverage for the defense and indemnity of the asbestos claims and succeeded in passing much of its liability to its insurers. Generally, in the event a primary insurance policy is exhausted, excess insurers can be liable for a portion of the remaining liability. During the bankruptcy, C.P. Hall moved to settle a claim of about $10 million against Integrity Insurance, one of its primary insurers, for $4.125 million.

Columbia Casualty, one of C.P. Hall’s excess insurers, objected to the settlement. Columbia argued that the settlement was “unnecessary” and not a valid exercise of its business judgment because C.P. Hall “[did] not face imminent trial or the need for settlement funds while it attempt[ed] to negotiate a chapter 11 plan.” As for standing to object, Columbia argued that “it is at least possible that funds not paid by Integrity . . . will increase Columbia’s indemnity obligations.” The bankruptcy court overruled Columbia’s objection for lack of standing.

The bankruptcy court held that “bankruptcy standing is limited” to those parties with a “pecuniary interest in a dispute.” Here, the mere possibility that the settlement would “increase[] the likelihood of Columbia having to honor its secondary coverage obligation” was insufficient to confer standing because it was “only probabilistic.” The bankruptcy judge approved the settlement and refused to consider Columbia’s objection on the grounds that it lacked standing to object. On appeal, both the district court and the Seventh Circuit court of appeals affirmed, holding that Columbia was not a “party in interest” under the Bankruptcy Code and thus had no standing to object to the settlement.

The Seventh Circuit’s Holding
Judge Posner, in his opinion affirming the bankruptcy court, recognized Columbia’s plight. The settlement posed “an imminent threat to [Columbia’s] financial assets, a threat . . . that could have been eliminated by the bankruptcy court’s enjoining the settlement.” C.P. Hall, 750 F.3d at 663. Even so, this “probabilistic harm” did not transform Columbia into a party in interest under the Bankruptcy Code. Rather, the code’s definition of “party in interest” “suggest[s] that such a party in interest is someone who has a legally recognized interest in the debtor’s assets,” namely the debtor, the trustee, and creditors. Id. at 661(citingIn re James Wilson, 965 F.2d 160, 169 (7th Cir. 1992)). Columbia was none of these—it was “just a firm that may suffer collateral damage from a ruling in a bankruptcy proceeding.” Id. As such, the court deemed this “injury” insufficient to confer standing as a party in interest.

If the court had followed Columbia’s logic, Judge Posner noted, an employee that Columbia had laid off because it foresaw making a large payout to C.P. Hall could challenge the settlement. Settlements often have third-party effects, and allowing an objection based on an injury as speculative as that of Columbia would exponentially increase the number of parties entitled to object to settlements. “That way madness lies—settlements made impossible by crowds of objectors.” Id.

Columbia asserted that two recent decisions by the Third and Ninth Circuits—In re Global Industrial Technologies, Inc., 645 F.3d 201, 205–6 (3d Cir. 2011) (en banc), and In re Thorpe Insulation Co., 677 F.3d 869 (9th Cir. 2012)—supported its standing as a party in interest. The Seventh Circuit disagreed. C.P. Hall, 750 F.3d at 662–63. In Global, the debtor sought to confirm a Chapter 11 plan that channeled asbestos and silica claims into different trusts to which certain excess insurers’ policies were assigned. Global,645 F.3d at 205–6. The insurers objected, arguing that the debtor colluded with various plaintiffs’ firms to confirm the plan. According to the insurers, silica liability was not stated as a cause of the company’s Chapter 11 filing (whereas asbestos liability was), and the debtor had solicited votes from a list of silica claimants in another bankruptcy, the majority of which were found to hold suspect or duplicative claims in the Global case. The insurers claimed this caused an increase in the number of votes for the plan and a 27-fold increase in their stated prepetition liability. In light of the alleged scheme, the Third Circuit held that the insurers were “parties in interest” under the Bankruptcy Code and thus had standing to object to the chapter 11 plan. Id. at 214–15.

The Seventh Circuit found Global unpersuasive. The Global court made it clear the ruling was based on the insurers’ allegations that they were “targets in a scheme between the debtor and its creditors.” C.P. Hall, 750 F.3d at 662. No such facts were present in the C.P. Hall bankruptcy. Rather, C.P. Hall “was just trying to minimize the risk of coming up empty-handed in its suit against Integrity.” Id.

The Seventh Circuit also found Thorpe unpersuasive. In Thorpe, the debtors sought to confirm a Chapter 11 plan that channeled asbestos claims to a trust to which the insurers’ policies were assigned, despite having anti-assignment provisions. 677 F.3d at 878–89. The primary insurers objected to the plan as violating the terms of the policies’ anti-assignment provisions. The Ninth Circuit agreed with the bankruptcy court’s holding that insurers were “parties in interest,” emphasizing that if “insurer’s [contractual] rights are affected in any way, the insurer will have standing to object to the alteration of those rights.” Id. at 886(citing In re Combustion Eng’g, Inc., 391 F.3d 190 (3d Cir. 2004)).

The Seventh Circuit again distinguished the case on its facts. Unlike Thorpe, the settlement with Integrity did not alter Columbia’s rights under its policy with C.P. Hall. C.P. Hall, 750 F.3d at 662. Rather, Columbia sought to exercise a right that it did not have—objecting to a settlement to which it was not a party.

The Seventh Circuit noted that Columbia was not without protection. Id. An excess insurer could write a policy that did not require payout until the primary policy was fully exhausted—in this case, payment of the full $10 million. Alternatively, the excess policy could drop down in coverage if the primary insurer was insolvent. In any event, “[i]t is better to leave matters to private contracting where that is feasible than to permit parties, especially sophisticated parties like Columbia, to ask a court to ride to its rescue from an oversight.” Id.

In re C.P. Hall Company clarifies the limits of a party’s standing to object to a bankruptcy settlement in the Seventh Circuit. The court focused on judicial efficiency and was loath to “open the floodgates” for settlement objections. Unless a party has a “legally recognized interest” in the debtor’s estate, it has no standing. The Seventh Circuit did not question more expansive interpretations of “party in interest” employed by the Third Circuit in Global and the Ninth Circuit in Thorpe; rather, it stated that those decisions were based on unique facts not before the court. Those decisions may be read, however, as providing limited exceptions to typical standing requirements for settlements that defraud a third party or alter a third party’s contractual rights.

Keywords: bankruptcy and insolvency litigation, standing, excess insurer, settlement, objection, party in interest, In re C.P. Hall Co.

Devoy Dubuque and David R. Doyle – March 5, 2015