“Bankruptcy is about financial death and financial rebirth. Bankruptcy is the great American story rewritten. We’re a nation of debtors.” -Elizabeth Warren
Amid the Coronavirus (COVID-19) pandemic and related economic turmoil, bankruptcy filings in the United States are on the rise. Insurers should review contractual arrangements with US insureds and brokers, and establish a plan to deal with bankruptcy filings across the United States in a consistent fashion.
As of May 1, 2020, US unemployment is above 20%; most businesses, churches and schools are still closed; and months more of economic and financial markets turmoil are in prospect. Against this backdrop, it is not unreasonable to expect a surge in business bankruptcy filings around the country. For the first three weeks of April 2020, the American Bankruptcy Institute reports 442 commercial filings, up 32.7% over the same period in 2019.
Insurers will see more insureds filing for bankruptcy protection, and may well see a number of agents, brokers, “MGAs” and coverholders filing for bankruptcy as well.
What should insurers know about the US bankruptcy system? What should insurers be paying attention to when insureds file? When business partners do so?
Let’s start with the basics:
Federal versus State.Insurers that are in financial difficulty—unable to pay debts when due or whose liabilities exceed assets—will be dealing with state insurance regulators and state courts, rather than federal bankruptcy courts. Insolvent commercial entities (other than insurers) most likely will be handled in the federal bankruptcy system.
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 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. 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.
“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 setoff amounts payable to debtors against amounts due from debtors. There are a multitude of issues arising and extensive case law to consider.
Practice Tip: 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 setoff in a particular case.
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 or may not be possible for you to become a committee member; in general, the larger the creditor, the more likely the creditor will want to be a member and will be selected as a member.
Practice Tip: 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.
In general, insurers should be able to file claims along with all other general creditors for unpaid insurance premiums for coverage periods prior to a bankruptcy filing. Unpaid premium amounts may be more significant now than they would have been absent Coronavirus (COVID-19) orders from insurance regulators, given the many states that have imposed cancellation/nonrenewal moratoriums and/or premium payment deferrals for insureds affected by COVID-19 since early March 2020 (and that may extend and/or reimpose such moratoriums and deferrals).
Practice Tips: Consider the following issues: Are you working with brokers to track insureds that are deferring premium payments? Particularly 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? 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.
In general, debtors continuing in business (Chapter 11 filers) will seek to confirm a variety of commercial contracts, including insurance contracts. If you are 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 debtor converts to a Chapter 7 bankruptcy, there is renewed exposure for pre-conversion premiums due).
Practice Tips: Consider the following issues: Are you tracking or working with brokers to track bankruptcy filings by insureds? Have you put in place notification procedures with brokers so that you are aware of filings in the first place and going forward, so that you are aware of important dates during the bankruptcy process—e.g., “bar dates” for filing claims? Meetings of creditors? Formation of creditors’ committees?
Policy Buybacks. 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).
Every US insurance intermediary is required to deposit premiums owed to insurers in a premium trust account. This segregated account should protect pipeline premiums.
Practice Tips: Consider stepping up monitoring of coverholders’ financial health and perhaps the financial health of significant producers of open market business. Presumably your coverholder agreement requires the broker to submit annual audited financials, but you may wish to obtain unaudited financials on a quarterly basis. Is your premium held in a specific trust account or commingled with premiums due other insurers? Are you receiving regular periodic financial statements for all trust accounts or perhaps just those with an average balance in excess of an amount that you deem material? Does the coverholder also handle claims funds and/or have signing authority for a claims payment account? If so, you should review existing arrangements to ensure that you or a representative has access to those funds.
Overriding Practice Issue: With the bankruptcy of a US-based “MGA” or coverholder, one key issue for a non-US insurer and the non-US broker that introduced the coverholder is to ensure that the portfolio of business is handled appropriately by a successor to the MGA or coverholder. Careful analysis of the MGA or coverholder agreement is necessary. 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 coverholder 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?
Regardless of the many factors unique to you and your commercial relationships with US insureds and brokers, particularly with brokers upon which you have conferred underwriting and/or claims-handling authorities, now would be an excellent time to review and consider those contractual arrangements, particularly as to handling of funds and rights available to non-US insurers and brokers upon a bankruptcy filing. Contracts drafted or signed during periods when softer market conditions prevailed should merit enhanced attention today in light of prevailing and expected economic and financial market conditions. Most importantly, have a plan in place to deal with bankruptcy filings nationwide in a consistent fashion, and consult US counsel that can provide you with coordinated bankruptcy, litigation and insurance advice when needed.