On August 24, 2018, the Fifth Circuit Court of Appeals issued a decision that will alter the analysis of whether proceeds of an insurance policy issued to an insured who files bankruptcy are property of the bankruptcy estate under 11 U.S.C. § 541. The results-oriented decision produced a more equitable outcome for the debtor’s many creditors, but it may lead to unintended consequences that could wreak havoc on insurers.
The Facts: OGA Charters, LLC (“OGA”) operated a charter bus service. While on a route to a casino in Eagle Pass, Texas, one of its buses was involved in a single-vehicle rollover crash that killed nine passengers and injured more than 40 others. OGA had a single relevant insurance policy that provided $5 million of liability coverage for “covered autos.” A small group of claimants quickly entered a settlement with the insurer that would have exhausted limits, leaving the remaining claimants with possible recourse only against OGA’s very limited other assets. The total claims asserted by the accident victims exceeded $400 million.
Faced with a prospect of no recovery on their claims, a group of the non-settled claimants filed an involuntary bankruptcy petition against OGA and initiated an adversary proceeding asking the bankruptcy court to enjoin the insurer from paying the pre-bankruptcy settlement. The non-settled claimants argued the proceeds were property of the OGA bankruptcy estate that must be equitably distributed to all claimants. The Bankruptcy Court held the proceeds were property of the estate, and a direct appeal was taken to the Fifth Circuit.
Historical Treatment of Policies and Proceeds: It is well known that insurance policies issued to a debtor are considered property of the estate, but the treatment of proceeds is another matter. In the Fifth Circuit the latter question has historically been resolved by asking who owns—or is entitled to receive—the proceeds when a claim is paid. See, e.g., In re Louisiana World Exposition, Inc., 832 F.2d 1391 (5th Cir. 1987) (proceeds of policies purchased by the debtor but providing coverage for its directors and officers were not property of the estate.). Where the debtor has no right to receive and retain the proceeds of the policy, the proceeds are not property of the estate. In re Edgeworth, 993 F.2d 51 (5th Cir. 1991). Proceeds of first party policies and coverages are generally considered property of the estate, while proceeds of liability policies generally are not.
From a bankruptcy perspective, the purpose of asking who is entitled to retain the proceeds is to determine whether those proceeds might enhance or deplete the debtor’s estate. If paying the proceeds would neither enhance or deplete the estate—as would occur when proceeds of a liability policy are paid to a third-party claimant—the proceeds are not property of the estate under 11 U.S.C. § 541.
While the question of who is ultimately entitled to policy proceeds is sometimes complicated by the particular circumstances, for instance when a policy provides both first party and third party coverage, the answer has typically been predictable. That may no longer be the case after In re OGA Charters.
The holding: The Fifth Circuit acknowledged the policy at issue in OGA Charters was a liability policy whose proceeds could not be retained by the Debtor. Historically, this would lead one to conclude the proceeds were not property of the estate, leaving the insurer free to perform under the settlement and exhaust its limits unimpeded by the Bankruptcy Code’s automatic stay provisions. Here, however, the Fifth Circuit held that because the amount of claims far exceeded OGA’s coverage limits, OGA had “an equitable interest” in having the proceeds applied to satisfy as many of the pending claims as possible. The proceeds were property of the estate subject to the bankruptcy policy of equitable distribution among creditors, notwithstanding the fact that OGA would never be entitled to retain any of the proceeds.
How this holding could impact insurers: We believe this holding could have a number of unintended consequences for insurers. Some of those include the following: