Contributed by Victoria Vron
In the December 22, 2010 post on the Taylor-Wharton decision, I noted that it was not clear why the debtor in Taylor-Wharton was so adamant about using the Philadelphia Newspapers case to show that the assumed liabilities were ongoing obligations that were subject to rejection.  Counsel for the seller, Jones Day, was kind enough to explain its understanding of the debtor’s motivations.
According to counsel for the seller, real dollars were at stake in determining whether the assumed liabilities survived rejection of the purchase agreement.  Plaintiffs’ claims (as well as those of various other products liability claimants of the debtor) are covered by insurance policies purchased prepetition and assumed by the debtor in the bankruptcy.  These are “fronting” policies under which the insurer is required to provide coverage from “dollar one” and is entitled to reimbursement from the reorganized debtor for amounts paid (as a result of the debtor’s assumption of the insurance policies).  The debtor arranged for the issuance of letters of credit to secure its reimbursement obligation.  As a result of the assumption of the insurance policies, the reorganized debtor likely would be required to replenish those letters of credit if they are drawn to cover reimbursement obligations.  By contrast, if the letters of credit are never drawn, the reorganized debtor at some point would be the residual claimant of the cash backing those letters of credit.  Accordingly, the debtor had the incentive to argue that rejection of the purchase agreement excused its obligation to assume the liabilities of the seller, thus ensuring that the insurance policies and the letter of credit were not drawn.
Indeed, according to counsel for the seller, the debtor argued in court that, if the rejection of the purchase agreement had resulted in the rejection of the assumption of liabilities, then the debtor would be viewed for legal purposes as having never assumed liability for the plaintiffs’ claims, the plaintiffs would not have any claim against the debtor grounded in its assumption of liabilities, and the debtor’s insurance policies thus would not be implicated for any claim based on the assumption of liabilities.  The seller argued that this amounted to “unringing the bell,” which was impossible.  The court agreed with the seller.
The seller’s explanation raises another interesting issue regarding the treatment of insurance policies in chapter 11 – are insurance policies executory contracts requiring assumption or not?  Given that the debtor’s reimbursement obligations under the insurance policies in Taylor-Wharton were backed by cash-collateralized letters of credit, the debtor likely had little incentive to treat the insurance policies as non-executory contracts that the debtor need not assume or reject, as some courts have held.  The debtor also may have been required to assume its prepetition insurance policies as a condition to renewing its insurance program during the bankruptcy.  Therefore, the debtor’s strategies may play out differently in other cases in which the debtor has less direct exposure to claims against its insurer or has the ability to make alternative insurance arrangements.