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Law360 (April 30, 2020, 5:31 PM EDT) --
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| Gregory Brown |
After several months, the firm's creditors failed to agree to a reorganization plan, and the firm entered Chapter 7 liquidation and closed its doors. Though the firm no longer existed, its professional liability insurance policy still covered the claims and we found ourselves handling the litigation defense of a nonexistent entity.
Our experience in defending the architectural firm comes to mind with the economic distress caused by the COVID-19 pandemic. In light of recent events, claims and litigation involving bankrupt or liquidated insureds stand to become more frequent, and defense counsel should be prepared to address the novel issues that come into play when a claim enters the bankruptcy or liquidation setting.
The Bankruptcy Stay
Under Section 362 of the Bankruptcy Code, the commencement of a bankruptcy case by a debtor acts as an automatic stay on any judicial proceeding against the debtor "that was or could have been commenced" before the filing of the bankruptcy case. Often, the imposition of a Section 362 stay delays underlying litigation for a period of months or longer. However, there is no guarantee that the stay will remain in place until the bankruptcy proceeding ends.
Section 362(d) of the Bankruptcy Code allows an interested party to file a motion with the bankruptcy court to terminate, annul, modify or condition the stay "for cause." Thus, defense counsel should be prepared for another party in the underlying litigation to request the bankruptcy court for relief from the stay based on the availability of insurance to cover the claim against the insured.
The bankruptcy court may grant relief from the stay while the bankruptcy proceedings continue, with the caveat that any recovery in the underlying action would be limited to the proceeds of the insurance policy.
In evaluating a motion for relief from a Section 362 stay, a bankruptcy court may consider the characteristics of the insurance policy and the disposition of the policy's deductible or self-insured retention. When an insured enters liquidation and ceases to exist, its insurance policy may continue to respond to a pending claim as if the insured were still a going concern.
An issue that may arise in a motion for relief from a Section 362 stay is whether the payment of the insured's deductible or self-insured retention would come from the bankrupt insured's assets, which are the subject of competing claims by creditors. In many cases, the carrier will absorb the insured's deductible or self-insured retention, which resolves the issue.
It is useful for defense counsel to gain an early understanding of how the carrier will dispose of the insured's deductible or self-insured retention to facilitate an efficient response to inquiries by the bankruptcy court or other parties in the underlying litigation.
While the Section 362 stay is in place, defense counsel should monitor the bankruptcy docket and establish a working relationship with the insured's bankruptcy counsel. Staying up to date on the progress of the bankruptcy proceeding allows defense counsel to be prepared for the emergence of the case from the stay and to anticipate changes in the bankruptcy's status that could affect litigation strategy.
Evidence Preservation and Witnesses
If a debtor enters liquidation, as occurred with the architectural firm, its assets are placed in the custody of a trustee appointed by the bankruptcy court. The trustee moves quickly and methodically to sell the debtor's assets at auction, such as computers, servers, printers and wireless devices.
Other electronic data, most conspicuously email, may be maintained in a cloud by a third-party vendor. In the age of electronic discovery, the contents of electronic devices, even printers, can contain a trove of discoverable information that may become irretrievably lost if steps are not taken to preserve it.
The spoliation of discoverable evidence in civil litigation can result in an adverse inference and place the insured at a disadvantage in the litigation. Thus, if possible, it is prudent to preserve the contents of such devices. It is also prudent to identify and preserve any data that is in the hands of a third-party vendors that may be erased if the insured ceases to pay for the vendor's service.
If the value of the claim justifies the expense, defense counsel should consider the retention of an electronic discovery vendor to retrieve the insured's electronic data from any devices that may be sold or lost by the bankruptcy trustee in the liquidation process. A qualified electronic discovery vendor can provide valuable assistance in establishing the chain of custody of the electronic data to avoid a spoliation inference.
A reputable vendor can also provide a credible estimate of the formidable cost of processing the collected data. Such a cost estimate can be used to support a legal argument that the probative value of the preserved, unprocessed data is not proportionate to the cost of processing, reviewing and preparing it for production.
If the client's physical file is not yet preserved upon the initiation of Chapter 7 proceedings, it should be immediately secured by counsel. In some cases, a business stores its files off-site with a private vendor. The location of such files should be determined early before unpaid storage fees threaten to make the documents irretrievable or expensive to obtain. If necessary, the client's insurance carrier may provide the resources necessary to secure the release such materials.
Identifying and staying in touch with key witnesses is another priority. Very often, civil litigation requires the involvement former employees who are no longer under the control of the insured. When a business terminates, the problem is compounded and may even extend to the principals.
Accordingly, it is vital to identify important witnesses early and to obtain their personal contact information. In our experience, former employees are cooperative and happy to help. In complex matters, though, the litigation can place significant demands on a former employee's time.
Professional witnesses in new employment positions rarely have a strong incentive to spend significant time in aiding fact investigation or preparing for and attending depositions. To minimize the burden of the witness' lost time, the carrier may provide a reasonable hourly fee to ensure that he or she remains meaningfully engaged.
Settlement
Settlement of a claim against a bankrupt insured may be complicated by the need to secure bankruptcy court approval. Federal Rule of Bankruptcy Procedure 9019 provides a mechanism to facilitate the bankruptcy court's approval of the settlement. Bankruptcy Rule 2002(a)(3) requires the moving party to provide 21 days' notice of the hearing on the motion to all creditors, the bankruptcy trustee, the debtor and indenture trustees.
As securing bankruptcy court approval may consume an unpredictable amount of time, any settlement agreement in the underlying proceeding should contain language that renders the agreement contingent on bankruptcy court approval. Such language avoids disputes on the timing of the payments under the settlement agreement motions to enforce the settlement agreement.
In sum, litigation involving a bankrupt insured presents a host of challenges, but with foresight and active engagement, defense counsel can steer such matters to a favorable outcome for the client and carrier.
Correction: A previous version of this article incorrectly listed a second article on the byline. The error has been corrected.
Gregory F. Brown is an attorney at Kaufman Dolowich & Voluck LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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