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Insuring a company in bankruptcy

Summer 2000

The United States Supreme Court recently granted certiorari on a case out of the Eighth Circuit that will be of great interest to insurance companies. The case involves the ability of an insurer to obtain payment for unpaid worker's compensation premiums from a company in bankruptcy. Hartford Underwriters Ins. Co. v. Union Planters National Bank, 99-409.

Insurers always run the risk of non-payment of premiums, and need to remain vigilant to cancel policy benefits as quickly as the relevant state law will allow in order to minimize losses. That risk is greater when an insured is in financial difficulties or has filed a Chapter 11 bankruptcy.

The story behind the Hartford case may seem familiar to insurers doing business with companies in receivership or reorganization. The Magna Bank had made various loans to the debtor and had a security interest in all of the debtor's real and personal property. The debtor filed a Chapter 11 bankruptcy in September 1991 and at that time owed Magna more than $4 million. After the bankruptcy was filed, Magna agreed to lend the debtor an additional $300,000 to help finance its ongoing reorganization efforts. One item in the monthly budget approved by the court was the payment of the debtor's worker's compensation premiums of approximately $8,000 per month to Hartford.

The reorganization efforts failed and 15 months later, in January 1993, the debtor's business closed and the case was converted to a Chapter 7 liquidation. Other than some initial premium payments, the debtor failed to pay the monthly worker's compensation premiums. When the business closed, Hartford was owed more than $50,000.

When a reorganization effort fails, often only the secured creditors are paid. Usually there is nothing left to compensate creditors who did business with the debtor during the bankruptcy. In this case, there appeared to be no assets from which Hartford could obtain repayment; all of the assets were pledged to Magna. Therefore, Hartford attempted to "surcharge" Magna's collateral on the theory that Magna had benefited from the business functioning during the reorganization and that without the worker's compensation policy, the reorganization could never have been attempted. Because the debtor would not have been allowed to stay in business if it did not have worker's compensation coverage during the reorganization, Hartford argued that the secured creditor should pay the debtor's premiums.

The United States Supreme Court will decide whether Hartford has standing to bring a motion seeking such relief. Section 506(c) of the Bankruptcy Code allows the bankruptcy trustee to force the holder of a secured claim to pay certain expenses of a reorganization to the extent the creditor has benefited. Several circuit courts have held that creditors may force the surcharge as well, but the Eighth Circuit held in its June 1999 opinion that the term "trustee" must be read narrowly and literally to exclude anyone other than the bankruptcy trustee from bringing the surcharging motion. Hartford Underwriters Ins. Co. v. Magna Bank, 177 F.3d 719 (8th Cir. en banc 1999). The United States Supreme Court has taken the case to resolve the split in the circuits.

Hartford will have to persuade the Supreme Court to deviate from its recent trend in bankruptcy cases of applying the Bankruptcy Code according to its plain language. Despite the technical standing arguments, Hartford has all of the equities on its side. The Bankruptcy Court had approved the payment of worker's compensation premiums in the debtor's budget and, as the en banc dissent points out, Magna had agreed to the continued operation of the business in the hope that it would receive a greater return through reorganization than through liquidation. Magna provided additional financing for this purpose, and there was no dispute that having an in-force worker's compensation policy was a necessary condition to the reorganization. As the dissent in the Eighth Circuit case argued, the secured lender in this case should have to pay the post-petition expenses related to that risk if it benefited from the attempted reorganization.

The Supreme Court will not decide the case until later this year, but whatever the result, the case points out the critical issues relating to insuring debtors in Chapter 11. There are techniques and financing arrangements that can protect insurers from the risk of unpaid insurance premiums by the reorganizing debtor. Any insurer that has an insured in financial difficulties or is in Chapter 11 bankruptcy needs to plan its post-petition insurance scheme carefully. This is particularly important when the reorganization effort may fail, leaving the unsecured creditors unpaid.

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If you have a media request or need an attorney with particular knowledge for comment, please contact Susan Steberl, Director of Marketing, at 414.287.9556 or ssteberl@gklaw.com.

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