Restructuring

Contributed by Ginger Ellison.
In In re C.P. Hall Co., the Seventh Circuit Court of Appeals held that a secondary insurer holding a pecuniary interest in a bankruptcy settlement between the debtor and its primary insurer was too far removed to have standing to object to the settlement. Though the agreement created an imminent threat to the excess insurer’s financial assets, the Seventh Circuit feared that allowing the appellant to intervene would open the floodgates to countless complaints brought forward by “accidental victims” of settlements, thereby creating severe obstacles to the efficient execution of settlement agreements in bankruptcy. Therefore, the Seventh Circuit held that where a party lacks any “concrete stake” in the bankruptcy estate, it is prohibited from intervening in the proceeding to approve a settlement.
Background
In In re C.P. Hall Co., the debtor was a former distributor of asbestos products that was forced into bankruptcy in 2011. At that time, it held $10 million in insurance coverage from its primary insurer, which was also bankrupt. Naturally, the debtor sought to shift its liabilities to its insurers; yet its primary insurer raised a fuss over whether its policy actually covered the loss for which the debtor was seeking indemnity. The two parties agreed to settle for $4.125 million and brought their agreement to the bankruptcy judge for approval.
The appellant, Columbia Casualty Company, is an excess insurer of the debtor’s asbestos liabilities, with a maximum coverage of $6 million. It objected to the settlement agreement on the ground that the settlement significantly increased the probability that Columbia would need to honor its secondary-coverage obligation. The bankruptcy judge ignored the objection, holding that Columbia had no right to object. Columbia appealed to the district court and appealed, again, to the Seventh Circuit Court of Appeals.
The first issue at bar was whether Columbia qualified as a “party in interest” under section 1109(b) of the Bankruptcy Code, which provides a non-exhaustive list of parties that may raise and be heard on any issue in a chapter 11 proceeding. If not, should a nonparty to a bankruptcy proceeding be entitled to intervene?
The Seventh Circuit’s Analysis
Bearing in mind that the list of parties in interest enunciated under section 1109(b) is not exhaustive, the court nonetheless held that the statute suggests that a party in interest must have a legally recognized interest in the debtor’s assets. It found that, unlike that of a debtor, a creditor, or the U.S. Trustee, Columbia’s position in the bankruptcy proceeding was too far removed to permit intervention.
Columbia’s argument boiled down to the fact that it might suffer collateral damage if the judge approved the settlement. Turning Columbia’s reasoning on itself, the court noted that where an employee of Columbia was laid off because Columbia foresaw having to make a large payout to the debtor, under Columbia’s logic, the employee should be allowed to challenge the settlement. It reasoned that allowing Columbia’s objection on such a basis would motivate infinite claimants to object to bankruptcy settlements and ultimately defeat the settlement’s objective to distribute estate funds in an agreeable and orderly fashion.
The court also cited in In re Global Industrial Technologies, Inc., in which the Third Circuit heard liability insurers’ objection to the debtor’s plan to channel claims against the debtor to a trust and to have its liability insurance policies assigned to that trust. To obtain the claimants’ approval of the plan, the debtor had agreed to a large increase in the number of claims on the basis that the cost of the additional claims would be largely borne by the insurers. The Seventh Circuit distinguished Global on the basis that the insurers were alleging that they were targets of a scheme between the debtor and its creditors. In contrast, Columbia was alleging that it was the accidental victim of a scheme directed against other parties and did not allege that the settlement agreement threatened any of its existing rights.
Paper It!
Interestingly, the Seventh Circuit left open the possibility for a party that is neither debtor, creditor, nor U.S. Trustee to qualify as a party in interest under section 1109(b) when such party showcases its interest in the debtor’s assets by means of tactical contract drafting. It outlined two ways that a secondary insurer may protect itself against its insureds making settlements with their primary insurers that come to the secondary insurers’ disadvantage. First, the excess insurer can write a policy that does not require it to pay until the coverage limit of the primary policy has been reached. Second, it can write a provision into its policy providing that its coverage limit will drop down if the primary insurer proved to be insolvent.
Based on the facts before it, the court found that it is preferable to leave matters to private contracting than to allow sophisticated parties such as Columbia the opportunity to use an “eleventh hour” objection to rescue them from problems that could have been avoided through better drafting.