The Fifth Circuit clarified its prior opinions by specifically holding that proceeds of an insurance policy are estate property when claims against the policy exceed policy limits.
The debtor was a bus operator in chapter 7 because an accident resulted in nine fatalities. Before bankruptcy, the families of a few of the victims settled with the insurer for amounts that would exhaust the $5 million policy limit.
Families of victims who had not settled filed an involuntary bankruptcy petition. Bankruptcy Judge Eduardo V. Rodriguez of McAllen, Texas, enjoined the carrier from paying out any insurance proceeds.
The non-settling claimants contended that the policy and proceeds were estate property, but the settling claimants argued that the proceeds were not estate property and were beyond the reach of the bankruptcy court. Judge Rodriguez granted summary judgment in favor of the non-settling claimants and ruled that insurance proceeds were estate property. He certified a direct appeal to the Fifth Circuit.
In an opinion on August 24 by Circuit Judge Thomas M. Reavley, the Fifth Circuit upheld Judge Rodriguez and clarified the treatment of insurance proceeds, which “has a complicated history,” he said.
Judge Reavley began from the proposition that property of the estate under Section 541(a) is “broadly construed.” Insurance policies themselves, as distinguished from insurance proceeds, “are generally property of the estate,” he said.
The Fifth Circuit’s 1993 decision in Houston v. Edgeworth (In re Edgeworth), 993 F.2d 51 (5th Cir. 1993), was a roadblock to the bankruptcy court’s ability to distribute the proceeds to all claimants. In Edgeworth, the circuit court held that proceeds of a medical malpractice policy were not estate property when there was only one claimant.
However, Edgeworth contained dicta that Judge Reavley converted into settled law in the Fifth Circuit. The Edgeworth opinion implied that the result might be different if the policy limit “was insufficient to cover . . . competing claims to proceeds.” Id. at 56.
Judge Reavley said that Edgeworth was “careful to leave open the possibility that liability proceeds are property of the estate in cases like this.”
Making “official what our cases have long contemplated,” Judge Reavley held that in “limited circumstances” where “a siege of tort claimants threaten the debtor’s estate over and above policy limits, we classify the proceeds as property of the estate.” He was careful to add that the holding would “not bestow upon the debtor a right to pocket the proceeds.”
Judge Reavley said that his holding was consistent with the Second Circuit’s decision in MacArthur Co. v. Johns–Manville Corp., 837 F.2d 89, 92 (2d Cir. 1988). He cited the Collier treatise, which says that the bankruptcy court should be able to oversee the allocation of proceeds when there are multiple claimants.