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Your policyholder just filed bankruptcy — What next?

Commercial policyholder's bankruptcy filing can raise many questions, not only for its insurer but also for its agent or broker, claim administrator and premium financing lender. This article is intended as a brief introduction to the issues that should be considered when a policyholder files bankruptcy under chapter 7 or 11 of the Bankruptcy Code.

First, the policyholder's bankruptcy filing creates an “automatic stay” against actions to recover prepetition debts and enforcement against property of the policyholder's bankruptcy estate. Therefore, an insurer may not attempt to collect premium or other amounts owed prepetition unless it first obtains a court order granting it relief from the automatic stay. Similarly, because an insurance policy becomes property of the policyholder's bankruptcy estate, an insurer may not cancel the policy for nonpayment of premium without first obtaining stay relief. Because the automatic stay likewise prevents claimants under liability or other third-party policies from pursuing prepetition claims against the policyholder, an insurer that has been defending a prepetition third-party claim should not continue to adjust, settle or litigate the claim until the claimant has obtained stay relief.

Second, if an insurance policy is pending at the time of the policyholder's bankruptcy filing, it is an “executory contract” that the policyholder may assume or reject. A policyholder that has filed a chapter 11 reorganization case usually will need ongoing insurance coverage, and must pay all unpaid premium as a condition to maintaining a pending insurance policy. If a policyholder that files a chapter 11 case fails to promptly assume a pending policy and pay all unpaid premium, the insurer should file a motion to compel the policyholder to assume or reject the policy, or alternatively for relief from the automatic stay to cancel the policy. If the policyholder has filed a chapter 7 liquidation case, however, the trustee ordinarily will allow insurance policies to be rejected, and may cancel policies early and request payment of any unearned premium.

Third, the insurer should file a claim in the policyholder's bankruptcy case for any unpaid premium or other amounts, such as retrospective premium, deductibles or loss reimbursements, that are owed under a policy. Prepetition claims usually will be unsecured claims entitled to payment pro rata with other unsecured claims. Postpetition claims may be entitled to payment as administrative expense priority claims. If collateral such as cash, a trust or a letter of credit is held to secure the policyholder's obligations, the claim will be a secured claim to the extent of the value of collateral. However, relief from the automatic stay must be obtained before applying the collateral to satisfy the claim.

Finally, in large chapter 11 cases, debtors often will file a “first-day” motion asking the court to allow payment of outstanding obligations to insurers, agents, brokers, claim administrators and premium financing lenders. Insurers and other insurance industry counterparties that become aware that a policyholder is considering a chapter 11 filing should encourage the policyholder to file such a motion, either directly or through counsel.

The key to realizing the best outcome in a policyholder bankruptcy case is to be proactive. As a first step, insurers and insurance industry counterparties should consult with experienced bankruptcy counsel.

• Meltzer Purtill & Stelle LLC has offices in Schaumburg and Chicago. Tim Brink is a partner in the firm's Bankruptcy and Restructuring Practice Group resident in the firm's Chicago office. He regularly advises clients in all aspects of bankruptcy cases and out-of-court workouts, creditors' rights litigation, and distressed transactions. He specializes in representing insurance companies, brokers, agents, claim administrators and premium financing lenders in policyholder bankruptcy cases in courts across the country.

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