Theoretically, a discharge injunction does not preclude a creditor from suing a debtor as a nominal defendant when the aim is to recover from insurance. That’s known as the “insurer exception” to the discharge injunction.

A February 4 opinion by Bankruptcy Judge Marvin Isgur of Houston shows that the insurer exception is more theoretical than real when the debtor’s insurance policy has a large self-insured retention.

The creditor, an individual, was injured while working on the debtor’s offshore drilling rig. One year later, the company filed a chapter 11 petition and confirmed a plan. During the case, the creditor received nine notices about the bankruptcy but did not file a claim.

Six months after confirmation, the creditor sued the debtor in federal district court, alleging personal injury and tort claims. One month after the debtor filed a motion to dismiss, the creditor filed a motion asking Judge Isgur to grant relief from the discharge and plan injunctions.

Judge Isgur denied the motion, holding that the insurer exception did not apply.

The Insurer Exception

Judge Isgur explained that the discharge injunction in “Section 524 shields a debtor from personal liability on claims that are discharged in bankruptcy,” although the “debt itself is not extinguished.” The discharge, he said, “acts as an injunction against any action pursued by creditors to recover on a claim against the debtor.”

Judge Isgur went on to explain that the insurer exception arises because “Section 524(a) does not prevent a creditor from seeking payment of a claim from a debtor’s liability insurer by pursuing an action against the debtor for nominal liability.”

While the creditor had a theoretical right to pursue the insurance policy, Judge Isgur pointed out that “access to [the debtor’s] insurance coverage requires satisfaction by [the debtor] of a large self-insured retention.” Specifically, the policy obliged the debtor to contribute up to $10 million for each occurrence, subject to an aggregate retention of $20 million. In other words, a claim must exceed $10 million before being counted toward the $20 million aggregate retention.

While the debtor had spent about $600,000 as a consequence of the creditor’s claim, Judge Isgur said that the debtor “must incur another $9.4 million to meet the [self-insured retention] requirement for [the creditor’s] claim.” Even so, he went on to say that the debtor “also must incur an additional $20 million in aggregate claims before the policy covers any amount of [the creditor’s] claim.”

If Judge Isgur were to modify the discharge injunction, the debtor would have $9.4 million in personal liability before the insurance policy would kick in. Because the debtor had come nowhere near exhausting the self-insured retention, he held that “the insurer exception does not apply” to allow suit against the debtor.

Judge Isgur went to find as a fact that the creditor had received multiple notices of the bankruptcy. Because the creditor had received “adequate notice” and had not filed a claim before the bar date, he ruled that the claim had been discharged, and there were no grounds for proceeding against the insurance policy.