COVID Chronicles: Bankruptcy Edition
We are now over six months into the pandemic, but the full economic implications are still far from even hazy.
At least to date, it appears that Council members are weathering the economic storm fairly well and much better than we initially feared at the onset of the state-mandated shutdowns.
Unfortunately, the same cannot be said about many of our clients. Academics are reporting, for example, that over 100,000 small businesses have permanently shut their doors, including over 3% of all restaurants (according to the National Restaurant Association). In addition, more than 25,000 retail stores owned by major retailers have closed or are slated to close this year (up from about 9,000 in 2019) as part of complete corporate shutdowns or massive bankruptcy-driven reorganizations. Airlines and hotels also are in free fall, and real estate owners are in distress, as their tenants cannot or will not pay their rent. Bankruptcy filings are an inevitable outcome for many of these businesses.
What can your firm do to protect your clients and yourself at this perilous moment? And—more opportunistically—what might you be able to do to benefit from the financial dislocation?
Following a bankruptcy filing, an automatic stay goes immediately into effect. The automatic stay is very broad and prohibits parties, including insurers and brokers acting on their behalf, from taking steps to enforce outstanding pre-petition payment obligations. The automatic stay also prohibits an insurer from sending a notice of cancellation following the bankruptcy filing.
Most well counseled companies will file a motion shortly after submitting their initial bankruptcy filing seeking court permission to pay insurance premiums on the terms set forth in the policy. Obtaining this order early in the case provides some protection against a gap in payment, and in-force insurance is a requirement in almost all bankruptcy cases.
It also is important to note that, in a bankruptcy, the inability of the debtor to pay a self-insured retention does not excuse the insurer from satisfying claim obligations that may otherwise be conditioned on that deductible. Rather, the insurer may have a claim against the debtor’s estate for advanced costs that typically would have been paid by the policyholder. In bankruptcy, a proof of claim is the equivalent to a motion or application for payment and is an often-missed opportunity to pursue unpaid bills.
A debtor also cannot obtain or use financing—including premium financing arrangements—without court approval. Obtaining an order authorizing the use of premium financing (for policies put in place post bankruptcy, prior to issuance) is critical to avoiding court interference with future payments.
Issues also may arise when third parties have a right to debtor policy proceeds. The most common situation where this issue arises is in lawsuits naming debtor officers and directors. Although the bankruptcy case stays the litigation as to the company, it does not stay the litigation as to the individual defendants, who need the insurance proceeds to fund their defense.
Courts are split on the issue of whether the proceeds of such policies are property of the estate, with decisions often turning on the specific language of the policy. Obtaining a “comfort order” from the bankruptcy court to ensure the proceeds are available is the recommended path.
Insurance-related issues also may arise in connection with a debtor’s plan of reorganization. Most plans will seek releases for parties related to the debtor, including officers and directors, to the broadest extent possible. Despite these provisions, however, many officers and directors will want to continue to be covered by insurance as a precaution through the end of the applicable statutes of limitation. Obtaining an extension on policies may require special court permission, and inclusion of authorizing language in the reorganization plan is recommended.
When it comes to agencies themselves, some may be facing financial difficulties of their own. Bankruptcy can provide some options. For example, the bankruptcy code provides an opportunity for a sale of the debtor’s assets free and clear of all liens. These sales can occur very early in the bankruptcy case and can be completed on a short timeline. This provides an option for a debtor to pursue a quick sale in order to preserve value as much as possible, as well as an opportunity for an interested party to purchase assets (like an agency) at a discounted price and free and clear of claims and liens. These are just a few of the opportunities that a bankruptcy may offer to parties on either side.
Financial distress also provides more opportunities to sell policies. When a counterparty is financially unstable, representation and warranty insurance is more desirable. As mentioned above, so are insurance tails and even specialized insurance to deal with data breaches by third-party providers (such as assignees).
These obviously are turbulent economic times. With respect to bankruptcy-related issues, it is critical to be proactive and remain vigilant to ensure that you are taking all steps necessary to best protect your clients’ interests and your firm’s position—and perhaps occasionally to even seize on an unexpected opportunity.
Jeffrey Reisner and Kerri Lyman also contributed to this article. Reisner is Steptoe & Johnson partner and chair of Steptoe’s Insolvency & Restructuring Practice; Lyman is of counsel in Steptoe’s Insolvency & Restructuring Practice.