Secured Credit Rights in Insurance Policies for Commercial Real Estate

California faces a common, unfortunate and alarming reality: wildfires. So far in 2022, California has faced approximately 6,739 fires covering almost 365,895 acres. [1] Beyond and often as a consequence of damaging property, land and wilderness, wildfires can also lead to bankruptcy. One California fire did lead to bankruptcy, and it poses complex questions surrounding the rights of secured creditors in insurance policies for commercial real estate.

The 2020 “Glass Fire” served as the unfortunate precursor to Spring Mountain Vineyard, Inc.’s [2] recently filed chapter 11. As a result of the Glass Fire, Spring Mountain faced extensive damage to its buildings and portions of its crop, with estimated damages totaling $38 million. This prompted Spring Mountain to file claims with both its primary insurer and excess insurer(s). Spring Mountain received advanced payments from its primary insurers payable to both Spring Mountain and MGG California, LLC (MGG), the secured lender. On the other hand, the claims submitted to the excess insurers received varying responses. This forced Spring Mountain to commence a lawsuit against all of the excess insurers. [3]

In the midst of motion practice, Spring Mountain sought relief under chapter 11. This gave rise to the question of how (if at all) would the chapter 11 filing impact MGG’s rights to enforce its lien rights against the prospective policy proceeds from the respective excess insurers, and whether the potential insurance proceeds are property of the chapter 11 estate. As many readers are aware, the property of a bankruptcy estate is broadly defined and interpreted. If MGG is the only identified loss payee on the respective excess insurer’s policies, then it is more likely that any distribution from the excess policies are not property of the estate. Equally as important is whether the automatic stay prevents MGG from enforcing its lien rights as to the policy proceeds. Does the value of the MGG’s collateral impact these considerations? If there is an equity cushion or other adequate protection given by Spring Mountain, does it weaken the MGG’s ability to enforce its lien?

The interplay among various bankruptcy principles poses a challenge in these cases. It has become fairly common for a lender to require that the borrower identify the lender as a loss payee on the borrower’s insurance policies covering the collateral that has been pledged to secure the underlying loan. While it may initially appear to be a tried and tested issue, the Spring Mountain case is a good reminder to consider the entanglement of insurance coverage, jurisdiction concerns and potential intervening bankruptcy filing. Simultaneously present among these concerns, it is predominantly agreed that the business (or borrower) is more valuable as an operational business.

“In order to determine the parties’ respective rights with regard to the insurance proceeds from the destruction of the [secured collateral], one must consider the nature and type of insurance policy involved, and its relationship to the property of the bankruptcy estate.” [4] A lender relying on In re Asay [5] would maintain that the proceeds are not property of the estate and there is no stay. Yet the reach of the automatic stay is much more expansive. Plainly stated, it is highly likely that a bankruptcy court would err on the side of caution and conclude that the automatic stay applies to the insurance proceeds if the lender is listed as an additional loss payee. In Spring Mountain, the loss did occur prior to the commencement of the bankruptcy, but it was not a total loss. MGG received a portion of the advanced insurance proceeds paid out by the primary insurers.

Bankruptcy courts defer to state law when it relates to property interest. Thus, if MGG is named as an additional loss payee, it is highly likely that a bankruptcy court would conclude that Spring Mountain still has an interest in the insurance proceeds (or claim related thereto), which fall within the purview of estate property. Spring Mountain’s first-day motion states that MGG is adequately protected by the value of the non-damages collateral (equity cushion) coupled with additional funds the principal of SMV will contribute to the chapter 11. Where a secured creditor is deemed to have an interest in insurance proceeds, that interest “flowing from the destruction of the secured collateral” cannot exceed the secured creditor's interest in the collateral itself. [6]

Presently, MGG has not filed any motion with the bankruptcy court seeking to terminate the automatic stay. Similarly, SMV has not filed a motion seeking the bankruptcy court’s determination that the insurance proceeds are property of the estate. The determination of whether the insurance proceeds are property of the estate is very fact-specific. One must consider how the lender is identified on the insurance policy (if at all), coupled with whether the damages to the collateral occurred pre- or post-bankruptcy filing.