Receiver’s Settlement Powers Aren’t Greater than a Bankruptcy Trustee’s, Circuit Says

Setting aside a settlement in receivership for the R. Allen Stanford Ponzi scheme, the Fifth Circuit equated the powers of the receiver with those of a bankruptcy trustee when it comes to cutting off the rights of third parties to sue the debtor’s insurers.

In her June 17 opinion, Circuit Judge Edith H. Jones ruled that the limitations on the jurisdiction of bankruptcy courts under 28 U.S.C. § 1334(b) do not mean that receivers have greater powers to settle claims and enter bar orders based on the receivership court’s in rem jurisdiction.

Beyond the circuit’s highfalutin caselaw analysis, the appeals court nixed the deal because the settlement was simply unfair to officers and directors, who came away with nothing despite their claims against insurers.

By the way, Stanford’s investors lost more than $5 billion. He is serving a 110-year prison sentence.

The Settlement

The Securities and Exchange Commission put Stanford International Bank into a federal receivership in Dallas. The debtor had a variety of insurance policies provided by several carriers covering the company and its officers and directors. According to Judge Jones, the insurers had already paid $30 million toward the insureds’ defense costs.

By final order, the district court had assumed exclusive in rem jurisdiction over the insurance policies and proceeds.

For almost a decade, the receiver had been pursuing the insurers. The receiver contended there was $101 million in remaining coverage, while the insurers argued it was only $46 million. Ultimately, they reached a settlement for the insurers to pay $65 million to the receiver.

Approved in district court, the settlement included a bar order precluding suits against the insurers relating to the policies or the debtor. The settlement released the receiver’s claims against 16 officers and directors, but not against everyone the receiver was suing who might be covered by the policies.

The settlement did not release claims in pending lawsuits brought by the receiver against other Stanford employees, officers and directors, some of whom claimed they had each already incurred more than $10,000 in unreimbursed defense costs. The settlement would bar them from seeking recovery of their defense costs from the insurers. The settlement also would have barred their direct claims against the insurers for bad faith, even though the claims were against the insurers directly and not against insurance proceeds.

Judge Jones identified what she called an “oddity” in the settlement. She said the receiver released his claims “only against those directors and officers who were among the most culpable for the Ponzi scheme,” but not against those with lesser roles whom the receiver was continuing to sue. Judge Jones said, “This oddity should have been considered [by the district court] when addressing the fairness of the settlement.”

Among others, former Stanford managers and employees appealed the district court’s bar order and approval of the settlement. Although they still were being sued by the receiver, the settlement cut off their rights as insureds and purported to bar them from collecting from the insurers.

The Reasons for Reversal

Judge Jones said that the bar order and the fairness of the settlement are both reviewed for abuse of discretion. There is no abuse of discretion, she said, if the findings of fact are not clearly erroneous and there is no legal error.

Judge Jones said that a receiver has discretion to impose bar orders to prevent dissipation of receivership assets. Like bankruptcy courts, receivership courts approve settlements that are fair and equitable and in the best interests of the estate.

Citing Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416, 92 S. Ct. 1678 (1972), Judge Jones said that a receiver, like a bankruptcy trustee, may only sue to recover for injuries to the debtor. Resulting from limitations on the court’s in rem jurisdiction, she said the court “may not exercise unbridled authority over assets belonging third parties to which the receivership estate has no claim.”

According to Judge Jones, the Fifth Circuit and other courts therefore “have held that a bankruptcy court may not authorize a debtor to enter into a settlement with liability insurers that enjoins independent third-party claims against insurers . . . . The prohibition on enjoining unrelated, third-party claims without the third party’s consent does not depend on the Bankruptcy Code.”

The limit on a bankruptcy court’s jurisdiction under 28 U.S.C. § 1334(b), Judge Jones said, does not mean that receivership courts have greater settlement powers, because “bankruptcy and receiverships share common legal roots.” She went on to say that “federal district courts have no greater authority in equity receiverships . . . .”

Because the officer and director defendants were not allowed to file claims in the receivership, Judge Jones ruled that the district court abused its discretion by barring the insured’s contractual claims to policy proceeds “while making no provisions for them to access the proceeds through the Receiver’s claims process.” Barring their access to the policies and then precluding them from filing claims in the receivership, she said, “undermines the fairness of the settlement.”

Judge Jones also said that the district court legally erred and abused its discretion by ignoring the distinction between the defendants’ contractual and non-contractual claims. The defendants’ bad faith claims, she said, “do not involve proceeds from the insurance policies or other receivership assets.” Therefore, “the Receiver lacked standing to settle independent, non-derivative, non-contractual claims of these [defendants] against the [insurers].”

The settlement “violated fundamental limits on the authority of the court and Receiver” because they “could not abrogate contractual claims of these [defendants] to proceeds of the . . . policies without affording them an alternative compensation scheme similar, if not identical, to the claims process or Stanford investors.”

The appeals court vacated the settlement and remanded the matter for further proceedings.