When claims against an insurance policy vastly exceed the policy limits, one tort claimant who empties the policy can be faced with receipt of a voidable preference if other claimants would receive nothing, according to the Fifth Circuit.
As Circuit Judge Stephen A. Higginson said in his October 6 opinion, the appeal arose from a “terrible tragedy.”
A tractor-trailer owned by the debtor collided with a car, killing two occupants of the car. The debtor was covered by a $1 million insurance policy.
The family of one victim sued, but the family of the other didn’t. Instead, the non-suing family demanded the policy limits from the insurer under what Judge Higginson called a Stowers demand.
In the settlement of the tort claim, the insurer acquiesced to the demand by paying out the $1 million policy limit to the IOLTA account of the claimant’s lawyer. The same day, the insurance company notified the other family that the policy had been exhausted. A few days later, $320,000 went to the attorney for attorneys’ fees, and $680,000 went to the claimant’s family.
A week later, the family that received nothing filed an involuntary bankruptcy petition against the debtor. The trustee filed a preference suit under Section 547 against the family that received the settlement and the attorney for that family.
The lawyer and the family that settled filed a motion to dismiss, contending there was no preference because estate property was not used to make the payment. Specifically, Judge Higginson characterized the defendants as arguing that “the Debtor had neither legal title in nor a contractual right to receive the Policy Proceeds, and otherwise lacked control over their disbursement.”
Chief Bankruptcy Judge Eduardo V. Rodriguez of the Southern District of Texas denied the motion to dismiss. He found that the $8 million in claims against the $1 million policy satisfied the “limited circumstances” test in Martinez v. OGA Charters, L.L.C. (In re OGA Charters), 901 F.3d 599 (5th Cir. 2018), giving the debtor an equitable interest in the policy proceeds, thereby classifying them as property of the estate.
When an appeal was filed by the family that was paid and their lawyer, the district court certified a direct appeal to the circuit, which the court of appeals accepted.
On appeal, the lucky family again argued that the debtor had no equitable property interest in the insurance proceeds. “But critically,” Judge Higginson said,
Appellants fail to contend with In re OGA Charters, in which we held that “[i]n the ‘limited circumstances,’ as here, where a siege of tort claimants threaten the debtor’s estate over and above the policy limits, we classify the proceeds as property of the estate.” 901 F.3d at 604.
Judge Higginson went on to say that OAG
does not bestow upon the debtor a right to pocket the proceeds,” but “[i]nstead . . . ‘serve[s] to reduce some claims and permit more extensive distribution of available assets in the liquidation of the estate.’” Id.
Because “the present case is still clearly one in which ‘the policy limit is insufficient to cover [the] multitude of tort claims’ faced by the estate,” Judge Higginson held that Bankruptcy Judge Rodriguez “correctly concluded that . . . the Policy Proceeds would be considered property of the estate.”
In his holding, Judge Higginson said that Bankruptcy Judge Rodriguez correctly recognized that OAG only held that the insurance proceeds were estate proceeds, not a voidable transfer, because the insurance proceeds had not been distributed. In the case on appeal, the proceeds had been distributed two weeks before the involuntary filing.
Judge Higginson found that “this pre-petition payment of the Policy Proceeds does not affect the Debtor’s equitable interest in them at the time the petition was filed.” Were it not for the transfers, he said that the policy proceeds “would have been property of the estate.”
Affirming, Judge Higginson upheld the ruling by Bankruptcy Judge Rodriguez “that the trustee had properly alleged a transfer of the Debtor’s property as required by § 547.”
Note
The family that received the payment argued in the circuit that OAG was wrongly decided because Texas law gives insureds no interest in insurance proceeds. In response, Judge Higginson said the panel was bound by circuit precedent.
Of greater importance, Judge Higginson said in a footnote that federal law governed, not state law. He noted that OAG “explicitly rejected” the same argument about controlling state law.
When claims against an insurance policy vastly exceed the policy limits, one tort claimant who empties the policy can be faced with receipt of a voidable preference if other claimants would receive nothing, according to the Fifth Circuit.
As Circuit Judge Stephen A. Higginson said in his October 6 opinion, the appeal arose from a “terrible tragedy.”
A tractor-trailer owned by the debtor collided with a car, killing two occupants of the car. The debtor was covered by a $1 million insurance policy.
The family of one victim sued, but the family of the other didn’t. Instead, the non-suing family demanded the policy limits from the insurer under what Judge Higginson called a Stowers demand.