Insurer Has the Right to Oppose Plan that Exposes it to Potential Fraud

SCOTUS Unanimously Gives Insurer Right as a “Party in Interest” to a Chapter 11 Bankruptcy

Barry Zalma

Jun 11, 2024

Transcript

FACTUAL BACKGROUND

Truck sought to oppose the Plan under §1109(b) of the Bankruptcy Code, which permits any “party in interest” to “raise” and “be heard on any issue” in a Chapter 11 bankruptcy. Among other things, Truck argued that the Plan exposes it to millions of dollars in fraudulent claims because the Plan does not require the same disclosures and authorizations for insured and uninsured claims. Truck also asserts that the Plan impermissibly alters its rights under its insurance policies.

SOTOMAYOR, JUSTICE issued the opinion for 8 members of the court with Justice Alito not participating.

FACTS

Chapter 11 Bankruptcy offers individuals and businesses in financial distress a fresh start to reorganize, discharge their debts, and maximize the property available to creditors. Chapter 11 is designed to strike a balance between a debtor’s interest in reorganizing and restructuring its debts and the creditors’ interest in maximizing the value of the bankruptcy estate.

A “party in interest” enjoys certain rights in the proceedings, including the ability to file a Chapter 11 plan when a trustee has been appointed, 11 U.S.C. §1121(c)(1); request the appointment or removal of a trustee, §§1104, 1105; challenge the good faith of persons voting to approve a plan, §1126(e); and object to confirmation of a plan, §1128(b).

Truck was the Debtors’ primary insurer. It issued policies that covered the Debtors from 1965 through 1983. Truck is contractually obligated to defend each covered asbestos personal injury claim and typically indemnify the Debtors for up to $500,000 per claim. The Debtors have to pay a $5,000 deductible per claim and assist and cooperate with Truck in defending against the claims. The Plan required the Bankruptcy Court to make a finding that the Debtors’ conduct in the bankruptcy proceedings neither violated this assistance-and-cooperation duty nor breached any implied covenant of good faith and fair dealing (Plan Finding).

The Plan treated insured and uninsured claims differently.

Truck was the only party involved in the bankruptcy that did not support the Plan. It advanced three main objections.

the Plan was not “proposed in good faith,” 11 U.S.C. §1129(a)(3), “because it reflected a collusive agreement between the Debtors and claimant representatives,” and did not require “the same disclosures and authorizations” for insured and uninsured claims. Truck claimed that this “disparate treatment would expose [Truck] to millions of dollars in fraudulent tort claims.”
The Plan Finding impermissibly altered Truck’s rights under its insurance policies “by relieving the Debtors of their assistance-and-cooperation obligations and by barring Truck from raising the Debtors’ bankruptcy conduct as a defense in future coverage disputes.”
The Trust did not comply with various provisions of §524(g), including the requirement to “deal equitably with claims and future demands,” as required by §524(g)(2)(B)(ii)(III).

Following the Bankruptcy Court’s recommendation, the District Court confirmed the Plan.

a large white building with columns with United States Supreme Court Building in the background — Photo by Fine Photographics on Unsplash

ANALYSIS

“Party” in this context is best understood as “[a] person who constitutes or is one of those who compose . . . one or [the] other of the two sides in an action or affair; one concerned in an affair; a participator; as, a party in interest.” Webster’s New International Dictionary 1784 (2d ed. 1949).

The Court held that insurers such as Truck with financial responsibility for bankruptcy claims are parties in interest. Bankruptcy reorganization proceedings can affect an insurer’s interests in myriad ways. A reorganization plan can impair an insurer’s contractual right to control settlement or defend claims. A plan can abrogate an insurer’s right to contribution from other insurance carriers. Or, as alleged here, a plan may be collusive, in violation of the debtor’s duty to cooperate and assist and impair the insurer’s financial interests by inviting fraudulent claims. An insurer with financial responsibility for bankruptcy claims can be directly and adversely affected by the reorganization proceedings in these and many other ways, making it a “party in interest” in those proceedings.

Truck will have to pay the vast majority of the Trust’s liability-up to $500,000 per claim for thousands of covered asbestos-injury claims. The proposed Plan would have Truck stand alone in carrying the financial burden, because the injunction “permanently and forever stay[s], restrain[s] and enjoin[s]” any action against Debtors. A plan that lacks the disclosure requirements for the uninsured claims risks exposing Truck “to millions of dollars in fraudulent tort claims.” That potential financial harm-attributable to Truck’s status as an insurer with financial responsibility for bankruptcy claims-gives Truck an interest in bankruptcy proceedings and whatever reorganization plan is proposed and eventually adopted.

The fact that Truck’s financial exposure may be directly and adversely affected by a plan is sufficient to give Truck (and other insurers with financial responsibility for bankruptcy claims) a right to voice its objections in reorganization proceedings. Moreover, §1109(b) provides parties in interest only an opportunity to be heard-not a vote or a veto in the proceedings. A party in interest is “not intended to include literally every conceivable entity that may be involved in or affected by the chapter 11 proceedings. There may be difficult cases that require courts to evaluate whether truly peripheral parties have a sufficiently direct interest. This case is not one of them. Insurers such as Truck with financial responsibility for claims are not peripheral parties.

Section 1109(b) provides parties in interest a voice in bankruptcy proceedings. An insurer with financial responsibility for bankruptcy claims is a “party in interest” that may object to a Chapter 11 plan of reorganization.

The judgment of the United States Court of Appeals for the Fourth Circuit was reversed.

ZALMA OPINION

It is important to those of us involved in the fight against insurance fraud that SCOTUS, even Justice Sotomayor, writing for the full court, recognized that insurance fraud is a problem and that an insurer has the right to dispute a Chapter 11 Bankruptcy plan that could expose it to many fraudulent claims without the ability to protect itself. The decision does not change the Plan, it just gives Truck the right to oppose the plan and work to adjust the plan to protect its interests as well as the interest of the petitioners.