Answers: Let’s start with the basics:

• State versus federal. Insurers that are in financial difficulty – those unable to pay debts when due or whose liabilities exceed assets – will typically deal with state insurance regulators and state courts, rather than federal bankruptcy courts. Insureds – whether commercial entities or individuals – most likely will be handled in the federal bankruptcy system.
• Federal bankruptcies: Chapter 7 versus chapter 11. Some debtors can recover financial health, but others will not be able to do so. Chapter 7 bankruptcies result in the liquidation of the bankrupt company. Chapter 11 provides a mechanism for a company to be reorganized, recapitalized, and relaunched as a solvent enterprise.
• Automatic stay. A bankruptcy filing – regardless of whether the petition is filed under chapter 7 or chapter 11 of the Bankruptcy Code – prevents creditors from pursuing the debtor with respect to pre-filing or pre-petition debts; all litigation and all collection actions against the debtor are stayed.
• Contracts. Contractual provisions that effectuate a forfeiture, modification, or termination of the contract upon a bankruptcy filing are not enforceable after the filing of a bankruptcy petition.

Practice tips: Pay close attention to all notices received from bankruptcy courts and require all brokers to forward immediately all notices received from bankruptcy courts. Ensure that MGAs and surplus lines brokers require retail producers to forward all notices they receive from bankruptcy courts. Within days of a bankruptcy filing, the debtor (in the case of a chapter 11 filing) or the court-appointed trustee (in the case of a chapter 7 filing) will notify all creditors by mail that a filing has occurred. Subsequent notices will advise creditors about (i) filing claims against the estate and of the “bar date” (the date by which such claims must be filed), and (ii) the statutorily mandated meeting of creditors, at which meeting a representative of the debtor will be examined under oath regarding the debtor’s reported assets and liabilities. Failure to assert a claim in accordance with the notice of the bar date will result in discharge of the claim.

Additional issues to consider include the following:

• Preferences. Subject to certain statutory defenses (including the defense that such payments were made “in the ordinary course”), payments by a debtor to a creditor during the 90 days prior to a bankruptcy filing may be clawed back by the bankrupt estate.
• Offset/setoff. The Bankruptcy Code recognizes the common law right of creditors to set off amounts payable to debtors against amounts due from debtors. There are a multitude of issues arising and extensive case law to consider.

Practice tips: Consult a competent bankruptcy lawyer to evaluate available defenses in litigation brought to recover a payment received within the 90 days prior to a bankruptcy filing and/or rights to set off in a particular case. Take into consideration:

• Official committees. In larger chapter 11 cases, an official committee of unsecured creditors will be appointed to participate in the proceedings. On request of a party in interest, the court also may order the appointment of additional committees of creditors or equity security holders. It may be possible for you to become a committee member; as a general matter, the larger the claim against the estate, the more likely the creditor will want to bea member of such committee.

Practice tips: The Office of the US Trustee, the “bankruptcy watchdog” arm of the US Department of Justice, is tasked with appointing official committees. After a case is filed, the US trustee will mail questionnaires to a debtor’s top 30 unsecured creditors to determine each creditor’s interest in serving on the official committee of unsecured creditors. Also, consider the following:

• Bankrupt insureds. It is common practice for businesses seeking to reorganize under chapter 11 to seek court permission to continue to pay insurance premiums during the course of a bankruptcy case. If there are premiums due and owing upon filing that are not paid pursuant to bankruptcy court relief, insurers should, as a general matter, be able to file claims along with all other general creditors for unpaid insurance premiums for coverage periods prior to a bankruptcy filing. Pay attention to unpaid premium amounts when states declare emergencies after natural catastrophe events, particularly if regulators have declared cancellation/nonrenewal moratoriums and/or premium payment deferrals for insureds affected by a catastrophic event.

Practice tips: Ask – and answer – these questions: Are you working with brokers to track insureds that are deferring premium payments – in particular, those with approaching anniversary/renewal dates? Do you have processes in place to negotiate and implement revised premium payment plans once moratoriums/deferral periods end? Can you offer renewal on a “premium fully earned at inception” basis? Can you offset pre-petition claims and/or return premium obligations against pre-petition premiums owed? Note that when an insured is in bankruptcy, the automatic stay prohibits the cancellation of an insurance contract based solely upon the non-payment of pre-petition premiums owed.

Take a particularly close look at:

• Policy buybacks. These are essentially commutations, potentially useful in situations in which claims against the chapter 7 (or equivalent) bankrupt debtor far exceed available policy limits (e.g., clergy, educational, or sports-related sex abuse cases; batch claims arising from multiple medical malpractice incidents).
• Commercial contracts. In general, debtors continuing in business (chapter 11 filers) will seek to assume a variety of commercial contracts, including insurance contracts. Insurers may decide to oppose a debtor’s request to continue an insurance contract but must do so in a timely fashion. Once a bankruptcy court confirms a plan that includes confirmation of insurance coverage it is usually too late to object. To reiterate: when insureds are in bankruptcy, the automatic stay generally prohibits insurers (and MGAs/coverholders) from canceling coverages absent bankruptcy court approval to do so. If an insurer is happy to continue to insure the debtor, premium payments for coverage periods after a bankruptcy filing generally should be protected during the chapter 11 process (but if the case converts to a chapter 7 bankruptcy, there is renewed exposure for pre-conversion premiums due).

Practice tips: Require your MGAs/coverholders to require retail producers to forward immediately all bankruptcy filings, so that you are aware of important dates during the bankruptcy process (e.g., “bar dates” for filing claims, meetings of creditors and formation of creditors’ committees). Note the following concern:

• Bankrupt brokers/MGAs/coverholders. Every US insurance intermediary is required to deposit premiums owed to insurers in a premium trust account. These segregated accounts should protect pipeline premiums.

Practice tips: Consider stepping up monitoring of the financial health of significant business partners. Ask the following questions:

• Do you require MGAs and coverholders to require significant producers to submit annual audited financials? At a minimum, when working with MGAs and coverholders, consider revisiting the issue of requiring significant producers to provide unaudited financials on a periodic basis.
• Is your premium held in a specific trust account or commingled with premiums due other insurers? For those intermediaries whose trust accounts exceed an amount that you deem to be material, consider revisiting the issue of whether your premiums should be segregated. If any intermediary also handles claims funds and/or has signing authority for a claims payment account, review existing arrangements to ensure that you or a representative has access to those funds.

Overriding practice issue: With the bankruptcy of an MGA or a coverholder, one key issue for insurers is to ensure that the portfolio of business is handled appropriately by a successor. Careful analysis of the MGA or coverholder agreement is necessary. Ask the following questions: Do you own the right to renewals in the event of MGA or coverholder bankruptcy? Do you have the right to approve or reject an assignment of contract rights? Can the bankruptcy court order the sale of assets/business of the intermediary to a third party? Should you bid on those assets if a sale is ordered? How much control do you have with respect to handling claims arising under your policies?

Conclusion

Given deteriorating economic conditions, increasing credit delinquencies, and rising volumes of bankruptcy filings – regardless of the many factors unique to you and your commercial relationships with US insureds and MGAs/coverholders – now would be an excellent time to review with MGAs/coverholders (and for MGAs/coverholders to review with producing brokers) procedures to be followed when any business partner receives a notice from a bankruptcy court concerning an insured.

The key point for insurers is to require all intermediaries to forward immediately any and all bankruptcy court notices. It is important to have a plan in place to handle bankruptcy filings nationwide in a consistent fashion and to consult US counsel that can provide you with coordinated bankruptcy, litigation, and insurance advice when needed.