Does a personal injury claim survive bankruptcy when the defendant has liability insurance that will defend and indemnify the defendant for the claim?

(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of-

(1) the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title;

(2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title;

(3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate;

(4) any act to create, perfect, or enforce any lien against property of the estate;

(5) any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title;

(6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title;

(7) the setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor; and

(8) the commencement or continuation of a proceeding before the United States Tax Court concerning a tax liability of a debtor that is a corporation for a taxable period the bankruptcy court may determine or concerning the tax liability of a debtor who is an individual for a taxable period ending before the date of the order for relief under this title.

(a) The commencement of a case under section 301, 302, or 303 of this title creates an estate. Such estate is comprised of all the following property, wherever located and by whomever held:

(1) Except as provided in subsections (b) and (c)(2) of this section, all legal or equitable interests of the debtor in property as of the commencement of the case.

[...]

The filing of a bankruptcy petition creates a bankruptcy estate, which is protected by an automatic stay of actions by all entities to collect or recover on claims. 11 U.S.C § 362(a). "The automatic stay is self-executing, effective upon the filing of the bankruptcy petition." Gruntz v. County of Los Angeles (In re Gruntz), 202 F.3d 1074, 1081 (9th Cir. 2000) (en banc).

As we have noted, "[t]he scope of the stay is quite broad." Hillis Motors, Inc. v. Haw. Auto. Dealers' Ass'n, 997 F.2d 581, 585 (9th Cir. 1993). It is designed to provide breathing space to the debtor, prevent harassment of the debtor, assure that all claims against the debtor will be brought in the sole forum of the bankruptcy court, and protect creditors as a class from the possibility that one or more creditors will obtain payment to the detriment of others. Id. at 585–86. The stay "prevents any collection activity against property of the estate." Temecula v. LPM Corp. (In re LPM Corp.), 300 F.3d 1134, 1136 (9th Cir. 2002). It applies to "almost any type of formal or informal action

[862 F.3d 747]

against the debtor or property of the estate." Stringer v. Huet (In re Stringer), 847 F.2d 549, 552 n.4 (9th Cir. 1988). The automatic stay "imposes an affirmative duty to discontinue post-petition collection actions." Eskanos & Adler, P.C. v. Leetien, 309 F.3d 1210, 1215 (9th Cir. 2002). Any continuation of a collection action against the debtor or property of the estate after a bankruptcy filing constitutes a violation of the stay. Id. at 1214. Indeed, the Bankruptcy Code requires parties to "automatically dismiss or stay such proceeding." Id. And, as the district court noted, "the automatic stay imposes on non-debtor parties an affirmative duty of compliance," which includes alerting the court of potential conflicts between an order and the automatic stay. Sternberg v. Johnston, 595 F.3d 937, 943 (9th Cir. 2010), overruled on other grounds by Am. Servicing Co. v. Schwartz–Tallard (In re Schwartz–Tallard), 803 F.3d 1095, 1100 (9th Cir. 2015) (en banc).

Actions taken in violation of the automatic stay are void. Schwartz v. United States (In re Schwartz), 954 F.2d 569, 571 (9th Cir. 1992). This rule applies to judicial proceedings. Gruntz, 202 F.3d at 1082; Phoenix Bond & Indemnity Co. v. Shamblin (In re Shamblin), 890 F.2d 123, 125 (9th Cir. 1989). "Any state court modification of the automatic stay would constitute an unauthorized infringement upon the bankruptcy court's jurisdiction to enforce the stay." Gruntz, 202 F.3d at 1082.

Under section 362(a)(3), an automatic stay is imposed as of the petition date and stays "any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate...." Section 541(a)(1) defines property of the estate as "all legal or equitable interests of the debtor in property as of the commencement of the case." Property of the estate is to be construed broadly (U.S. v. Whiting Pools, Inc., 462 U.S. 198, 204-05, 103 S.Ct. 2309, 76 L.Ed.2d 515 (1983)), and the Ninth Circuit has determined that a debtor's insurance policies are property of the estate. Minoco, 799 F.2d at 519.

The Bankruptcy Code also recognizes that certain circumstances require the court to respond to other interests and permits a flexible approach to the stay as the circumstances may require. Section 362(d)(1) authorizes the bankruptcy court broad discretion to grant relief from the automatic stay imposed under section 362(a) for "cause." Such relief may include "terminating, annulling, modifying, or conditioning such stay." Mataya v. Kissinger (In re Kissinger), 72 F.3d 107, 108-09 (9th Cir.1995).

The Trustee contends that the bankruptcy court erroneously held that the proceeds were not property of the estate.

Page 543

However, he also concedes that the court "did not explicitly hold whether the policy proceeds are estate property." See Trustee's Op. Br. at 10:11-12. Despite this seemingly contradictory position, he argues that the bankruptcy court abused its discretion in holding that cause existed to modify the stay because it erroneously concluded that the estate had no interest in the Policy's proceeds in contradiction to Minoco, that its B-side indemnification right is purely derivative, and, consequently, that the proceeds are not protected by the stay.

At oral argument, the Trustee conceded that the issue before the Minoco court was only whether the policies were property of the estate subject to the automatic stay, not the policies' proceeds. The Minoco court stated as much. 799 F.2d at 519-20. Further, the Minoco court speculated that perhaps if or when Minoco received money from the insurer to satisfy indemnification claims, such proceeds might fall under section 541(b)—property held in trust by debtor solely for another—and thus would not constitute property of the estate. Id.

Moreover, a Washington bankruptcy court has stated that whether D & O policy proceeds are an estate asset has not been decided in the Ninth Circuit. See Metro. Mortg. & Sec. Co., Inc. v. Cauvel (In re Metro. Mortg. & Sec. Co., Inc.), 325 B.R. 851, 855 (Bankr.E.D.Wash.2005) ("The applicability of § 541 to proceeds of insurance policies is not yet a settled question in the Ninth Circuit."). See also Imperial Corp. of Am. v. Milberg (In re Imperial Corp. of Am.), 144 B.R. 115, 118-19 (Bankr.S.D.Cal.1992) (expressly stating that Minoco does not control when the question presented is whether or not policy proceeds are estate property); In re Daisy Sys. Sec. Litig., 132 B.R. 752, 755 (N.D.Cal.1991) (same).

Contrary to Trustee's assertions, the bankruptcy court did not determine that the proceeds are not estate property; it ruled that regardless of the proceeds' status Sapp had shown requisite cause to be granted relief from stay. Recognizing this alternative ruling, the Trustee has requested that we declare the proceeds are estate property. We decline the Trustee's invitation to render an opinion on this issue because it is not essential to our decision here.

Despite the bankruptcy court's silence on the proceeds' status, it did make certain findings with respect to the proceeds in order to ultimately decide if Sapp was entitled to relief from stay. In making these findings, the bankruptcy court followed the reasoning set forth in cases which have decided the "policy vs. proceeds" issue and then went on to ultimately conclude whether or not a party was entitled to relief from stay, or some other relief. As explained below, even assuming that the proceeds are property of the estate, it was proper for the bankruptcy court to consider these factors in its analysis.

In cases involving D & O policy proceeds, the bankruptcy court must balance the harm to the debtor if the stay is modified with the harm to the directors and officers if they are prevented from executing their rights to defense costs. See In re Allied Digital Techs. Corp., 306 B.R. 505, 514 (Bankr.D.Del.2004); In re

Page 544

CyberMedica, Inc., 280 B.R. 12, 18 (Bankr. D.Mass.2002). Even in cases where the D & O policy proceeds were considered property of the estate, courts have nonetheless granted relief from stay to allow the insurer to advance defense costs payments when the harms weigh more heavily against the directors or officers than the debtor. See In re CyberMedica, Inc., 280 B.R. at 18.

One factor courts consider, especially in cases of a "wasting" policy, is whether defense costs payments made to directors and officers under the A-side coverage might exhaust B-side policy limits and potentially expose the estate to liability for obliged indemnification claims. See In re Metro. Mortg. & Sec. Co., Inc., 325 B.R. at 855-57; In re Leslie Fay Cos., Inc., 207 B.R. 764, 785 (Bankr.S.D.N.Y. 1997).

Here, the bankruptcy court rejected Trustee's concern about Sapp's defense costs payments exhausting the $1 million proceeds and thereby jeopardizing the estate's ability to be indemnified. It found that because Sapp is likely the only director or officer to receive payments, "the likelihood of ... leav[ing] insufficient proceeds ... to pay claims for which the estate might seek B coverage appears to be remote." Although this may be somewhat speculative, it is not clearly erroneous based on the facts before the court. Generally, exhausting policy limits is only a concern when multiple parties are trying to access the proceeds, not just one officer and one trustee.⁶ See Circle K Corp. v. Marks (In re Circle K Corp.), 121 B.R. 257, 260-62 (Bankr.D.Ariz.1990) (three civil actions pending in district court against both the debtor and its directors and officers; indemnification claims from the directors and officers pending with additional claims to come, further exposing debtor to liability should the policy limits be exhausted).

Filing a bankruptcy petition does not expand or change a debtor's interest in an asset; it merely changes the party who holds that interest. Further, a trustee takes the property subject to the same restrictions that existed at the commencement of the case. To the extent an interest in property is limited in the hands of the debtor, it is equally limited as property of the estate.³⁴ See In re Sanders, 969 F.2d 591, 593 (7th Cir.1992) (citations and quotations omitted). Accord, Weinman v. Graves (In re Graves), 609 F.3d 1153, 1156 (10th Cir.2010); Mourad v. Commissioner Internal Revenue, 387 F.3d 27, 30 (1st Cir.2004).

In the Ninth Circuit, as with most other circuits, a debtor's rights in an insurance policy are considered property of the estate. See In re Mila, Inc., supra, 423 B.R. at 542. See also The Minoco Group of Companies, Ltd. v. First State Underwriters Agency of New England Reins. Corp. (In re The Minoco Group of Companies, Ltd.), 799 F.2d 517, 519 (9th Cir.1986); ACandS, Inc. v. Travelers Casualty & Surety Co., 435 F.3d 252, 260 (3rd Cir.), cert. denied, 547 U.S. 1159, 126 S.Ct. 2291, 164 L.Ed.2d 833 (2006); Houston v. Edgeworth (In re Edgeworth), 993 F.2d 51, 55 (5th Cir.1993). However, the principal threshold question in this case revolves around whether the Policy proceeds that are potentially going to be paid to injured third-parties are property of the Debtors' estates. The Ninth Circuit has not yet resolved this issue.³⁵ See In re Mila, Inc., supra, 423 B.R. at 540, citing Metropolitan Mortgage & Securities Company, Inc. v. Cauvel (In re Metropolitan Mortgage and Securities Company, Inc.), 325 B.R. 851, 857 (Bankr.E.D.Wash.2005); Imperial Corporation of America v. Milberg, Weiss, Bershad, Specthrie & Lerach (In re Imperial Corporation of America), 144 B.R. 115, 118 (Bankr.S.D.Cal.1992); In re Daisy Systems Securities Litigation, 132 B.R. 752, 755 (N.D.Cal.1991).

The type of coverage provided by the insurance policy and the terms under which the policy proceeds will be paid are determinative of the question regarding whether the proceeds are property of the estate. Although potentially numerous in description, most insurance policies fall into two general categories: liability policies and indemnification policies. Some policies provide for payments only to third parties on behalf of the insured (liability), and some permit payments of proceeds to the insured to reimburse the insured itself for, among other things, costs incurred in defending claims or suits (indemnification). See, e.g. In re Mila, supra, 423 B.R. at 540. In addition, some individual policies combine both liability and indemnity coverage components; for example, some directors and officers (“D & O”) policies provide for not only liability coverage for the carrier to defend the various company directors or officers from suits from third parties (liability coverage) but also include a component that requires the carrier to reimburse the company for the cost of providing the defense to the directors or officers (indemnity coverage). Id.

The Policy in the instant case is a “claims made” liability policy. The Policy's Insuring Agreement provides in pertinent part:

[NMIC] agree[s] to pay on behalf of each insured all sums which such insured shall become legally obligated to pay as damages because of any medical incident which occurs after the retroactive date applicable to such insured and which is first reported during the policy period; ...

Dismissal Motion Exhibit “A,” Section I at NMIC00015 (bold in original). Thus, NMIC has, under the Policy, agreed to pay damages on behalf of the Debtors to any third party injured by Debtors because of a medical incident(s) during the policy period. NMIC pays the sums directly to the injured parties on behalf of the Insureds; NMIC does not reimburse or pay any Policy proceeds directly to the Insureds. Under no set of circumstances can the Debtors or other Insureds seek or obtain payment from NMIC under the Policy; nor can they be reimbursed from or by Policy proceeds. Since Debtors apparently have no ability to reach the proceeds directly, or even indirectly, the question of how the proceeds could be part of

[451 B.R. 544]

Debtors' estates becomes the focus. ³⁷

In Edgeworth, supra, the Fifth Circuit was one of the earliest courts to consider the distinction between a debtor's equitable interest in the insurance policy itself as compared with an interest in the proceeds flowing from that policy.³⁸ 993 F.2d at 55. The case involved a physician, Dr. Edgeworth, whose patient died while under his care. A month later, the physician filed for bankruptcy protection. A question arose whether the family of the deceased could sue Dr. Edgeworth for malpractice in state court, looking only to his medical malpractice insurance proceeds for recovery. 993 F.2d at 55. The debtor's medical malpractice liability insurance policy would only pay injured third parties. On that basis, the court concluded that Dr. Edgeworth had no equitable interest in the policy proceeds. The Fifth Circuit panel noted that the proceeds could not be made available for distribution to creditors other than victims of medical malpractice and their relatives. Additionally, the court found that no secondary impact ³⁹ would affect the debtor's bankruptcy estate. The court concluded that the policy proceeds were not part of the physician's bankruptcy estate and allowed the state court suit to proceed. Id.

The Edgeworth court offered significant guidance when it determined that proceeds of a typical liability insurance policy are not property of the bankruptcy estate.⁴⁰ 993 F.2d at 55. The court took pains to distinguish liability policies from policies where the insured/debtor is the beneficiary and has a pecuniary interest in the proceeds of the policy, explaining:

The overriding question when determining whether insurance proceeds are property of the estate is whether the debtor would have a right to receive and keep those proceeds when the insurer paid on a claim. When a payment by the insurer cannot inure to the debtor's pecuniary benefit, then that payment should neither enhance nor decrease the bankruptcy estate. In other words, when the debtor has no legally cognizable claim to the insurance proceeds, those proceeds are not property of the estate.

Examples of insurance policies whose proceeds are property of the estate include casualty, collision, life, and fire insurance policies in which the debtor is a beneficiary. Proceeds of such insurance policies, if made payable to the debtor rather than a third party such as a creditor, are property of the estate and may inure to all bankruptcy creditors.

[451 B.R. 545]

But under the typical liability policy, the debtor will not have a cognizable interest in the proceeds of the policy. Those proceeds will normally be payable only for the benefit of those harmed by the debtor under the terms of the insurance contract.

Edgeworth, 993 F.2d at 55–56 (citations and quotations omitted). ⁴¹ As in Edgeworth, the Debtors and the Insured in the instant case appear to “have [no] cognizable interest in the proceeds of the policy. Those proceeds will ... be payable only for the benefit of those harmed by the [D]ebtor under the terms of the insurance contract.” Id.

Eight years after the Fifth Circuit's decision in Edgeworth, an extremely thorough and well-written decision on this issue was reached in Landry v. Exxon Pipeline Co., supra. In Landry, property owners had filed environmental tort actions in state court against Exxon. The actions were removed to federal court on the ground that the property owners were asserting claims against the debtor's liability insurers under Louisiana's direct action statute. The Landry court ultimately found that the insurance proceeds were not property of the estate and remanded to state court.

In reaching its decision, the court analyzed many issues that are directly analogous to the Debtors' instant case. The Landry court observed:

In the liability insurance context the debtor has no cognizable claim to the proceeds paid by an insurer on account of a covered claim. The proceeds are paid to the victim of the insured's wrongful act. The insured debtor cannot ask the insurance company to pay him, or determine on its own how the proceeds of the policy should be distributed, nor can any creditor of the insured seize the proceeds in satisfaction of a claim not falling within the terms of the insurance contract.

As pointed out in Edgeworth, the proceeds could not be made available for distribution to the creditors other than those who have claims under the policies.... When a covered claim arises, the injured debtor may have an interest, albeit a self-serving interest, in having a third party (the insurance company) pay for its wrongdoing, but this is not a legal or equitable interest in the property used to pay the claim. The interest the insured debtor has is the contractual right to have its own assets protected from exposure by means of the insurance coverage, according to the terms of the contract.

260 B.R. at 786–787 (bold in original, footnotes omitted), citing Edgeworth, 993 F.2d at 56. Thus, the court in Landry examined (1) whether the debtor could ask the insurance company to pay him, (2) whether the debtor could determine on its own how the proceeds of the policy should be distributed, and (3) whether any creditor of the insured could seize the proceeds in satisfaction of a claim not falling within the terms of the insurance contract. All of these factors were answered in the negative and each factor weighed against including

[451 B.R. 546]

the policy proceeds as property of the estate. 260 B.R. at 783–800.

The value of the asset side of an insured debtor's estate is not enriched by the existence of coverage or the payment by a liability insurer to a tort victim. The property which the debtor or estate holds, or the interests of the debtor or estate in property, remains the same; it is the underlying claim base for which the estate is liable that is affected. Because of the insurance, the estate property is liable for a smaller amount of claims (calculated by subtracting from the entirety of the claims base the amount of insurance coverage). However, to hold that the debtor has a legal or equitable interest in property used to pay the covered claims because payment of the covered claims by some other party with that party's property may decrease the debtor's overall liability, is utterly backward.

* * * * *

Property, however, does not become property of the estate merely because such property has the effect of reducing the estate's liability, or because of some

[451 B.R. 547]

other beneficial effect such property has on the estate. The estate must have a legal or equitable interest in the property which benefits the estate.

260 B.R. at 787, 789 (bold in original). Even if the court was inclined to consider secondary impacts as one of the factors in determining if the Policy proceeds are part of the Debtors' estates, the court need not consider it here. The secondary impact issue simply does not apply to these instant cases, as the Debtors' individual bankruptcy estates have very few, if any, remaining assets that can be protected.⁴² In light of the express terms of the Policy, the factors identified and considered above, and the arguments of the parties, the court concludes that the Debtors have no equitable interest in the proceeds from the Policy and that the proceeds would not be property of the Debtors' bankruptcy estates.

Section 362(a)(3) provides an automatic stay as of the date of the petition that stays "any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate . . . ." In this circuit, "a debtor's insurance policies are property of the estate." Groshong v. Sapp (In re MILA, Inc.), 423 B.R. 537, 542 (9th Cir. BAP 2010) (citing The Minoco Grp. Cos., Ltd v. First State Agency of New England Reinsurance Corp. (In re The Minoco Grp. Cos., Ltd.), 799 F.2d 517, 519 (9th Cir. 1986)); In re Somerset, Inc., 13.3 IBCR 81, 82 (Bankr. D. Idaho 2013). Whether the proceeds of a debtor's insurance policies are also

Page 11

property of the estate is an unsettled question. In re MILA, Inc., 423 B.R. at 543; see also Pintlar Corp. v. Fid. and Cas. Co. of New York (In re Pintlar Corp.), 124 F.3d 1310, 1314 (9th Cir. 1997).

Assuming, without deciding, the proceeds of the Policy are property of the bankruptcy estate,⁹ the Court concludes that good cause has been established by the Movants under § 362(d) for relief the automatic stay.