How to Help Clients Work Through the Challenges of Business Bankruptcy

By Dean Mortilla | July 30, 2009

Bankruptcy. It’s a word agents and brokers will need to get used to hearing from their business clients. It’s not just occurring on Wall Street; it’s happening every day on Main Streets across the country and in industries as broad as our economy, from auto dealers to retailers. Helping clients work through this critical stage requires agents and brokers to quickly get up to speed on how bankruptcy works so they can properly structure a client’s insurance program.

Need for Insurance

Whether your client is contemplating a Chapter 11 or Chapter 7 bankruptcy filing, conservation of the assets of the debtor is vital and considered one of the principal duties of the debtor in possession or trustee. Uninsured losses obviously reduce the assets of the debtor, and thus fail to conserve the assets that are to be available to creditors.

In addition, while a business operates under Chapter 11 reorganization or is being liquidated under Chapter 7, compulsory insurance requirements continue to apply. In other words, the filing of bankruptcy does not relieve the business of any state or federal insurance or financial responsibility requirements. For example, in most situations, workers’ compensation and automobile liability insurance must be kept in effect.

Further, contracts with lenders, suppliers, customers or others often necessitate property and liability insurance, including umbrella insurance. In sum, even a business in bankruptcy should have insurance — not only to properly discharge the duties of the debtor (or trustee) in conserving assets, but also because insurance is often required by law or a requirement found within a contract.

Maintaining Insurance

Based on your improved understanding of bankruptcy, you can now advise your client that they should maintain most if not all of their insurance. While this recommendation may take some explanation, convincing your client is really only the first step.

Once your client’s current insurers learn that your client has filed for bankruptcy protection, they will likely send your client a notice of cancellation (or refusal to renew). Most insurers consider an insured’s financial strength as an important underwriting factor for a variety of reasons, including the insured’s ability to fund loss control objectives, such as proper maintenance of its premises or its equipment, timely payment of premium or premium audits, and payment of deductibles.

Bankruptcy laws do not prevent an insurer from canceling or refusing to renew. Rather state laws or specific policy cancellation or non-renewal terms control whether the insurer may terminate coverage. Even in states with restrictive cancellation laws, a bankruptcy filing may be considered a material change in hazard, which many states recognize as a legitimate reason for mid-term policy termination with the proper advance notice.

The Dilemma

As soon as you recommend to your client to continue insurance after the bankruptcy filing, your client’s insurance is terminated by its insurers. Can your client even buy insurance while in bankruptcy? In other words, if your client’s obligation to pay can be reduced or eliminated by bankruptcy, does that mean your client may be relieved of its obligation to pay premium for its insurance? If this is true, why would any insurer offer insurance to your client?

Allowance of Administrative Expenses

Here is where knowing a bit about bankruptcy can help answer this common question. Recall that the “automatic stay” was for debts incurred prior to the bankruptcy filing. Collection of debts incurred after the bankruptcy filing (called post-petition debts) is not prevented by bankruptcy. In fact, post-petition debts are addressed in the Bankruptcy Code, specifically §503 entitled “Allowance of Administrative Expenses.”

After proper notice and a hearing, administrative expenses are allowed to be paid, including “actual, necessary costs and expenses of preserving the estate…” While subject to approval, the cost of insurance premiums is generally not subject to the automatic stay and is usually approved as allowable administrative expenses. Thus, the “debtor in possession” in Chapter 11 bankruptcy filing should be able to obtain permission to disburse funds to purchase the insurance as needed to continue to operate during reorganization.

Available Insurance

Of course, the fact that your client can obtain approval to pay its premiums may not be the least bit persuasive to the insurers you represent. As noted earlier, their underwriting approach may prohibit them from providing insurance to an insured in bankruptcy, despite your explanations. This leaves you searching the market on behalf of your client. You need to find an insurer that not only understands the bankruptcy process but is willing to provide adequate and reasonably priced insurance coverage for your client who has or will be filing for bankruptcy protection.

The good news is that there are insurers, A.M. Best “A” rated insurers, that offer special insurance programs for businesses in bankruptcy. Finding and accessing such insurers, including the program managers with expertise in bankruptcy and insurance issues, is crucial. Drawing on the expertise of those who routinely handle businesses in bankruptcy is invaluable to both you and your longtime client.

Considering that business bankruptcy filings for the first quarter of 2009 increased 64.3 percent compared to the first quarter 2008, your long-time client might not be the only business that needs your assistance in areas of bankruptcy and insurance.

Bankruptcy Terms to Know
(Sources: United States Bankruptcy Courts; American Bankruptcy Institute)

Bankruptcy – General Bankruptcy is a legal process that provides relief to those who can no longer pay all of their debts. The goal of the bankruptcy laws is to give debtors a “fresh start” by releasing debtors from specific debts and prohibiting creditors from taking action against the debtor to collect those specific debts. The release of the debtor is accomplished through the bankruptcy discharge, which is a release of a debtor from personal liability for certain debts set forth in the Bankruptcy Code.

Bankruptcy – Authority – Title 11 of the United States Code (11 U.S.C. §§ 101-1330) is the federal bankruptcy law and is generally known as the Bankruptcy Code. Bankruptcy is federal law and not state law, although some state law (such as what property may be exempt from bankruptcy) is considered in the process. The bankruptcy process is governed by the Federal Rules of Bankruptcy Procedure, or “Bankruptcy Rules.” The court official with decision-making power over federal bankruptcy cases is the United States bankruptcy judge, a judicial officer of the United States District Court. The Bankruptcy Code and Bankruptcy Rules comprise the formal legal procedure for dealing with debt problems of persons and businesses.

Automatic Stay – The filing of bankruptcy results in an “automatic stay,” which is an injunction that automatically stops lawsuits, foreclosures, garnishments, and all collection activity against the debtor the moment a bankruptcy petition is filed. However, debts incurred after the bankruptcy filing are not subject to the automatic stay. Post-petition debts are called administrative expenses of the bankruptcy and must be fully satisfied before the bankruptcy case is closed.

Bankruptcy – Chapter 11 – Generally know as “Reorganization,” Chapter 11 under Title 11 allows businesses to continue to operate and repay creditors while operating through a court-approved plan of reorganization. The Chapter 11 debtor is required to provide creditors with a disclosure statement that provides enough information so the creditors may evaluate the reorganization plan. The bankruptcy court either approves or disapproves the debtor’s plan of reorganization. Under the approved plan, the debtor can reduce its debts by repaying a portion of its obligations and discharging others. By this process, the debtor may be able to terminate certain contracts and leases, recover assets, and rescale its operations to try and return to profitability. It is common for Chapter 11 debtors to go through a period of consolidation, with the objective of reducing debt and reorganizing its business in order to emerge from bankruptcy.

Bankruptcy – Chapter 7 – This Chapter of Title 11 is called “Liquidation” and is intended as an orderly court-supervised procedure in which a trustee takes over the debtor’s assets, reduces the assets to cash, and makes distribution to creditors. Distributions of assets are subject to the rights of secured creditors as well as the debtor’s rights to retain certain exempt property. Exempt property varies by state, but may include the debtor’s primary residence or “tools of the trade” used by the debtor to make a living. However, many Chapter 7 cases are “no-asset” cases, which mean the debtor has little or no property that is not exempt and thus the creditors will not receive any distribution from the trustee.

Your Client as “Debtor in Possession” – Upon filing a petition under Chapter 11, the debtor automatically assumes an additional identity as the “debtor in possession.” The term refers to a debtor that keeps possession and control of its assets while undergoing reorganization under Chapter 11, without the appointment of a trustee. A debtor remains a debtor in possession until their plan of reorganization is confirmed, their case is dismissed or converted to Chapter 7, or a Chapter 11 trustee is appointed. The appointment or election of a trustee occurs only in a small number of cases. Generally, the debtor, as “debtor in possession,” operates the business and performs many of the functions that a trustee performs in cases under other chapters.

The Bankruptcy Code places the debtor in possession in the position of a fiduciary, with the rights and powers of a Chapter 11 trustee.

Mortilla is president of NIP Specialty Brokerage, a wholesale brokerage operation targeting non-standard commercial risks underwritten by admitted and non-admitted specialty carriers. NIP Specialty Brokerage recently launched a facility to help brokers insure clients facing bankruptcy. Keystone Risk Partners (www.keystonerisk.com) also contributed to this article.

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