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There is a growing trend toward allowing a claimant relief from the automatic stay in bankruptcy if a claimant forsakes a defendant’s other assets and agrees to satisfy its judgment solely from the proceeds of a defendant’s liability insurance policy. Landry v. Exxon Pipeline Co., 260 B.R. 769 (M.D. La. 2001), exemplifies this trend and addresses the pros and cons of allowing such recoveries, concluding that the public policies underlying insurance law can and should be harmonized with the policies underlying bankruptcy to allow recovery of insurance proceeds by victims of the debtor’s wrongdoing while general creditors take nothing from the insurance policy. Courts have struggled to balance the public policy of ensuring that tort victims receive timely compensation for their injuries, with the policy behind � 362 of the Bankruptcy Code. 11 U.S.C. 362. Section 362 is designed to ensure an orderly and equitable distribution of a debtor’s assets by halting all creditors’ “races to the courthouse” through the automatic stay. Couch on Insurance� 101.18 (3d ed. CD-Rom July 2001). In particular, courts have struggled with the bankruptcy court’s jurisdiction over liability insurance policy proceeds. If insurance proceeds are “property of the bankruptcy estate” under the Bankruptcy Code, they are subject not only to the automatic stay, but also potentially to claims of all of the estate’s creditors. The Bankruptcy Code’s definition of “property of the estate” contained in � 541(a) has seven subsections, including subsection (1), which states that estate property includes “all legal or equitable interests of the debtor in property as of the commencement of the case;” and subsection (6), which brings within the estate “[p]roceeds, product, offspring, rents or profits of or from property of the estate.” Although courts have almost universally held that debtors have both legal and equitable interests in their insurance policies (thereby making them property of the estate), courts have labored over whether those interests sweep proceeds into the estate. Collier on Bankruptcy, � 362.04[3] (15th ed. 1996). Section 541(a)(6) seems to suggest that the answer is yes, since if the policy is estate property, shouldn’t its “proceeds” be included as well? EARLY VIEWS INCLUDE PROCEEDS Fifteen years ago, proceeds were held to be estate property simply because of the mass tort, multiple-plaintiff circumstances involved. See e.g., A.H. Robbins Co. v. Piccinin, 788 F.2d 994 (4th Cir.), cert. denied, 479 U.S. 876 (1986); MacArthur Co. v. Johns-Manville Corp., 837 F.2d 89, 92 (2d Cir. 1988). Similarly, the court in Bradt v. Woodlawn Auto Workers, 757 F.2d 512, 515 (2d Cir. 1985), finding that Congress intended � 541(a)(6) to have a broad scope, included within estate property a check to repair damage to an insured car. The 1st U.S. Circuit Court of Appeals similarly ruled that proceeds are “estate property,” because a bankruptcy court might convince creditors “through negotiation” “in an orderly reorganization” to satisfy their claims by looking only to the policy proceeds and not the debtor’s assets. Tringali, 796 F.2d at 561. The 8th Circuit took another approach and included proceeds in the estate merely “because the estate is worth more with them than without them.” In re Titan Energy Inc., 837 F.2d 325, 329 (8th Cir. 1988). Fortunately, the 5th Circuit offered some clarity in In re Louisiana World Exposition, 832 F.2d 1391 (5th Cir. 1987). The court held that directors and officers (D and O) liability policy proceeds were not estate property because the policy “does not cover the liability exposure of the corporation at all, but only of its directors and officers and is payable only to them.” Id.at 1400. And, unlike the mass tort cases, the court noted there was no evidence that the policy proceeds would be exhausted or that the corporation’s assets would be used to indemnify its directors and officers. Further, the court rejected the argument that � 541(a)(6)’s term “proceeds” meant the same thing as “proceeds” of a liability insurance policy. Since an insured debtor never could own liability policy proceeds, the court held that they are not property of the estate even if the insurance policy itself is property of the estate. Louisiana World Expositionfocused the debate precisely where it should have been — on exactly what rights a debtor owns in policy proceeds. The 11th Circuit extended this analysis in In re Jet Florida Systems Inc., 883 F.2d 970 (11th Cir. 1989). There, the court allowed a defamation plaintiff to proceed with a suit in order to seek a judgment of liability despite a permanent injunction having been entered pursuant to � 524 of the Bankruptcy Code, and the debtor having been discharged of all liabilities pursuant to 11 U.S.C. 1141. The court held that an action could proceed against an insurer despite the Bankruptcy Code’s permanent injunction in � 524 because “the purpose of Section 524 … is to protect the debtor and not to shield third parties such as insurers who may be liable on behalf of the debtor.” Id.at 975. In 1991, the 7th Circuit expanded the conceptual framework of Louisiana World Expositionwhen it held that although the proceeds of a property liability policy were “nominally” property of the estate, a stay was not justified because the plaintiff had agreed to limit its potential recovery to the liability policy’s proceeds. In re Fernstrom Storage and Van Co., 938 F.2d 731, 735-36 (7th Cir. 1991). A SHIFT TO EXCLUDE PROCEEDS It took several more years for courts to directly dispel the notion that bankruptcy does not magically expand an insured’s rights to liability policy proceeds. Thus in In re Edgeworth, 993 F.2d 51 (5th Cir. 1993), the same court that decided Louisiana World Expositionruled that liability proceeds were not estate property because “under the typical liability policy, the debtor will not have a cognizable interest” in the proceeds; they “normally” are “payable only for the benefit of those harmed by the debtor.” Id. at 56. Although the same court later in In re Vitek, 51 F.3d 530 (5th Cir. 1995), tried to limit Edgeworth‘s holding to D and O policies, Vitek‘s conclusion that policy proceeds were estate property was dicta. Vitek‘s holding rested upon Texas insurance law. Subsequent courts agreed with Edgeworth‘s analysis and conclusion. See In re Sfuzzi Inc., 191 B.R. 664 (Bankr. N.D. Texas 1996); In re Scott Wetzel Services Inc., 243 B.R. 802 (Bankr. M.D. Fla. 1999). Recently, the 5th Circuit decided Landry, and exhaustively tackled the issue of insurance proceeds as part of a debtor’s estate. In Landry, property owners filed an environmental tort action and sought to recover only against the debtor’s comprehensive general liability (CGL) policies. Id.at 774. The court first had to decide whether the action had been properly removed from state court. In so doing, the 5th Circuit found it necessary to examine whether the outcome of the state court action against the CGL policies could affect the rights of one defendant who had been forced into an involuntary bankruptcy after the state suit was filed. Landry held that liability proceeds are not property of the bankruptcy estate for several reasons. The court primarily held that the mass tort cases were built upon the circular logic of assuming that proceeds were estate property simply because a contrary holding might start a race to the courthouse. Id.at 791. This “sound-bite surely generates knowing nods of near archetypical recognition” but adds nothing to the analysis. Property does not become part of a bankruptcy estate merely because victims are racing to the courthouse to get to it or because a debtor might find it useful. Id.at 792. Property is included only if the debtor has a legal or equitable interest in it — something missing where insurance policy proceeds are concerned. Further, the court noted that the alleged unfairness of some claimants losing a race to the courthouse, or some claimants recovering insurance money while other creditors take nothing, doesn’t matter, because “[t]he balance of claims remaining against the estate res will remain the same.” Id.at 792-93 and n. 74. Supporting the argument in favor of an orderly administration of the estate, Landryheld that actions against insurance proceeds are “related to” the insurance policy and, therefore, a bankruptcy court may “issue any order, process or judgment that is necessary” under Section 105 of the Bankruptcy Code. Id.at 796. Thus, order can be preserved by an initial stay which should be quickly lifted if recoveries are limited to policy proceeds. Finally, Landryrejected expansive readings (like Brandt‘s) of the term “proceeds” in � 541(a)(b). The court held that proceeds means, for example, the money generated by selling a piece of real estate. Id.at 799. PROCEEDS ARE OUT By contrast, “[w]hen an insurer pays a claim covered under the policy, the policy is not converted in substance or form from incorporeal contractual rights to money.” Id.Instead, the proceeds come from the insurer’s assets, not the debtor-insured’s. Id. Landrypotentially puts to rest the notion that general creditors can classify liability insurance proceeds as “property of the estate.” See alsoQueenan, J., Jr., Hendel, P., and Hillinger, Ingrid, Vol. 1, Chapter 11 Theory and Practice: A Guide to Reorganization, � 9.32, at 9:49 (LRP Publications, Horsam, Penn. 1994). Landrymakes clear that actions against insurers with insureds named as “nominal” defendants remain subject to bankruptcy jurisdiction and the automatic stay. But actions against insurers should be allowed to proceed and the automatic stay lifted, when there is an agreement that only the policy proceeds will be used to satisfy any judgment ultimately obtained. This is consistent with the approach of most courts outside of the bankruptcy context that approve settlements between insureds and claimants. In such settlements, coverage and bad faith claims are assigned to the claimant in exchange for a release of the insured. This is particularly appropriate where the insurer is providing some form of defense and is part of the settlement process. Seenote, Judicial Approaches To Stipulated Judgments, Assignments of Rights And Covenants Not To Execute In Insurance Litigation, 47 Drake L. Rev. 853, 859 and n.30-32 (1999) (collecting cases). Given adequate procedural and evidentiary safeguards, it also can be appropriate where insurers are not part of the settlement process. Id.at 870-871. Difficulties could arise if the debtor objects. Here, the “fresh start” bankruptcy policy may conflict with both the public policy of compensating victims through insurance and the private contract duty of cooperation owed by insureds. Although debtors should be given every reasonable opportunity to start afresh, that should not bar a victim from proceeding in court, simply because the debtor might be inconvenienced by defending a lawsuit. Indeed, barring a claim from proceeding would work a perverse benefit to the insurer, who would keep both the policy premiums and the policy proceeds without having to pay out on what may well have been a victorious claim. For these reasons, one court in an analogous context has allowed a third-party claim to proceed so long as it did not “impair” the debtor’s reorganization effort. In re Fernstrom, supra, 938 F.2d at 736. Another court suggested that the impairment must be more substantial than merely imposing defense costs on a debtor. In re Jet Florida Systems Inc., 883 F.2d 970, 976 (11th Cir. 1989); compare In re Columbia Gas Transmission Corp., 219 B.R. 716, 721 (S.D. W.Va. 1998). An appropriate suggested test, not yet addressed by any court, could be whether there is a substantial likelihood of a serious impairment to a reorganization — something that should not be present where the insurer is paying the defense costs or in the liquidation context generally. This means that in the typical workout or restructuring, a victim of the debtor’s wrongdoing that already has a judgment should be allowed to collect it from an insurance carrier. If the victim has not established the debtor’s liability, and the debtor is defended by the carrier, the action should proceed as long as there is no substantial likelihood that requiring the debtor to provide witnesses and evidence will result in a serious impairment to the reorganization process. If there is such a likelihood, or the debtor is funding his own defense, it would be appropriate to continue the stay. Hugh J. Totten is a partner specializing in commercial litigation at Chicago’s Kirkland & Ellis.

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