Supreme Court Rules That Insurers with Financial Responsibility for Bankruptcy Claims Have a Right to Be Heard in Chapter 11 Cases

On June 6, the U.S. Supreme Court issued its opinion in Truck Insurance Exchange v. Kaiser Gypsum Co. Inc., ruling unanimously that insurers with financial responsibility for bankruptcy claims have the right to “appear and be heard on any issue” in Chapter 11 cases. In so ruling, the Court held that a “party in interest” is any entity whose interests may be directly and adversely affected by the reorganization proceedings. The Court confirmed that the “party in interest” definition is broad, but it declined to opine on the outer bounds of the term under Section 1109 of the Bankruptcy Code.

Background

Defendants facing liability for a mass tort—such as product-liability claims—may file for bankruptcy and seek to have the claims against them discharged outside of the traditional tort system in bankruptcy courts. In such cases, plans of reorganization may be structured in ways that significantly impact the size and number of potential claims against a debtor that are ultimately paid by the debtor’s insurers. Often, debtors have little or no incentive to fight these claims in bankruptcy because the plans assume that virtually all of the payments to tort creditors will come from insurers. Despite insurers potentially being on the hook for payments, bankruptcy courts in many cases have refused to allow insurers to object to confirmation of these plans as “parties in interest” unless the plans expressly impair the insurers’ contractual rights under the policies.

Supreme Court’s Decision

In Truck Insurance, the bankruptcy court confirmed the reorganization plan proposed by Kaiser Gypsum, a construction-materials manufacturer driven into insolvency by thousands of asbestos-related litigation claims. Truck Insurance Exchange (“Truck”)—a unit of Farmers Insurance Group and one of the company’s insurers—objected to Kaiser’s plan of reorganization, arguing that it would expose the insurer to unchecked fraudulent claims because fraud protections applicable to uninsured claims were not also accorded to insured claims. The district court, and later the U.S. Court of Appeals for the Fourth Circuit, ruled that Truck had no standing to object to the plan because it was not a “party in interest.” The lower courts reasoned that the plan was “insurance neutral,” meaning it would “not materially alter” Truck’s express contractual rights and obligations.

The Supreme Court reversed, agreeing with Truck that the Fourth Circuit had adopted too narrow a definition of “party in interest.” The Court clarified that a “party in interest” is any entity with an interest that may be directly and adversely affected by the reorganization proceedings. This broad definition of “party in interest,” the Court explained, coheres with Congress’s consistent efforts to “promote greater participation in reorganization proceedings,” and it reflects Congress’s understanding that “[b]road participation promotes a fair and equitable reorganization process.” The Court then held that insurers with financial responsibility for bankruptcy claims, such as Truck, are “parties in interest” that may object to reorganization plans, as well as virtually any other contested matter in a bankruptcy case where their interests are implicated.

The Court also rejected the use of the “insurance neutrality” doctrine to deny insurers standing as parties in interest. Under that doctrine, insurers are parties in interest only if the reorganization plan increases their pre-petition obligations or impairs their pre-petition policy rights. The Court concluded that the doctrine is “conceptually wrong” because the proper “party in interest” inquiry asks whether the reorganization proceedings may possibly affect a prospective party, not how a specific plan actually affects the party. And the doctrine makes “little practical sense,” the Court explained, because it ignores other ways Chapter 11 proceedings can affect insurers’ obligations beyond those impacting their pre-petition obligations and policy rights.

Looking Ahead

As a result of the Supreme Court’s Truck ruling, insurers with financial responsibility for bankruptcy claims have a right to be “heard on any issue” in Chapter 11 cases, including by objecting to reorganization plans. It is yet to be seen how great an impact these rights will have, given that insurers still do not typically have the right to vote on these reorganization plans, even if they affect insurance rights. But at least insurers now will have a seat at the table.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Tancred Schiavoni, an O’Melveny partner licensed to practice law in New York; Justine Daniels, an O’Melveny partner licensed to practice law in California; Steve Warren, an O’Melveny partner licensed to practice law in California; Adam P. Haberkorn, an O'Melveny counsel licensed to practice law in New York; Samantha M. Indelicato, an O'Melveny counsel licensed to practice law in New York; Alexandra J. Wolter, an O'Melveny counsel licensed to practice law in California; Alexander C. Miller, an O'Melveny associate licensed to practice law in New York; and Danny Hirsch, an O'Melveny associate licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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