Strictly construing the arbitration clause in an insurance policy, the Second Circuit upheld the bankruptcy court by holding that the trustee of a liquidating trust was not compelled to arbitrate a claim against the insurer.

The corporate debtor confirmed a chapter 11 plan creating a liquidating trust. The trustee of the liquidating trust sued the debtor’s officers and directors. A settlement ensued in which the officers and directors assigned to the trustee their rights to pursue insurance coverage.

The liquidating trustee then sued the insurer for the officers’ and directors’ defense costs and indemnification rights. The insurer moved to compel arbitration.

The insurance policy called for arbitration of any “dispute between the insurer and the policyholder regarding any aspect of this policy.” As the Second Circuit said in its nonprecedential opinion on April 15, “policyholder” was defined to mean the debtor.

In bankruptcy court and on appeal, the insurer argued that the dispute was arbitrable based on the idea that the liquidating trustee was seeking relief in his capacity as the policyholder. The insurer also contended that the officers and directors were subject to the arbitration clause because they were asserting rights given them by the insurance policy.

Chief Bankruptcy Judge Alan S. Trust of Central Islip, N.Y., denied the arbitration motion. After affirmance in district court, the insurer appealed to the Second Circuit. The appeal was heard by a panel composed of José A. Cabranes, Gerard E. Lynch and Raymond J. Lohier, Jr.

Citing Second Circuit authority, the panel said that the “threshold question” was whether the parties agreed to arbitrate and whether the disputes were within the scope of the arbitration agreement.

Parsing the complaint, the panel said that the “allegations and claims for relief . . . relate entirely to [the insurer’s] duty to defend and indemnify the directors and officers in connection with the earlier adversary proceedings.” It was, the appeals court said, “a dispute between insureds and the insurer, not a dispute between the policyholder and the insurer” and “thus falls outside the scope of the Arbitration Provision.”

Contrary to the insurer’s idea that the trustee was acting in the shoes of the debtor-insured, the panel said that “the Trustee here is acting only as the assignee of the insureds, not as the policyholder.” The court added, “the directors and officers cannot be compelled to arbitrate their disputes with [the insurer] as third-party beneficiaries.” The policy, the panel said, was only an agreement to arbitrate between the insurer and the debtor, “not any disputes between [the insurer] and the directors and officers.”

The Second Circuit upheld the judgment of the district court affirming Bankruptcy Judge Trust’s denial of the arbitration motion.

Observation

The Second Circuit interpreted the arbitration agreement like any other contract.

The opinion doesn’t say a word about a federal policy favoring arbitration, an idea extinguished by the Supreme Court in Morgan v. Sundance, Inc., 596 U.S. 411 (May 23, 2022). For the unanimous Court, Justice Elena Kagan said, the “policy is to make ‘arbitration agreements as enforceable as other contracts, but not more so.’ Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 404, n. 12 (1967).” Id. at 418.

Justice Kagan added, “a court must hold a party to its arbitration contract just as the court would to any other kind. But a court may not devise novel rules to favor arbitration over litigation.” Id. To read ABI’s report, click here.