By: Michael Pitre
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
Many courts have held that section 524(a) of title 11 of the United States Code (the “Bankruptcy Code”) provides an exception that allows a court to lift the automatic stay where a creditor is pursuing a claim solely to collect insurance proceeds.[1]Notwithstanding that interpretation of section 524(a), in In re CJ Holding Co.,[2]the United States Bankruptcy Court for the Southern District of Texas refused to lift an automatic stay to allow personal injury claimants to pursue insurance where the claimants had failed to file a proof of claim and the reorganized debtor would incur substantial costs.[3]
The claimants, a married couple, were injured in a motor vehicle accident involving a vehicle driven by an individual employee of C & J Well Services, Inc. (the “Corporation”).[4]Subsequently, the claimants filed suit against the Corporation, its employee, and others, seeking damages for their injuries.[5]During the litigation, the Corporation filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code and listed one of the claimants as a creditor with a claim in an unliquidated amount.[6]Thereafter, the court entered an order confirming the debtor’s reorganization plan, which discharged all claims held by the claimants.[7]Additionally, all further efforts by the claimants to recover from the debtor corporation were “expressly prohibited under 11 U.S.C §§ 524(a)(2) and (3).”[8]Following confirmation of the plan, the claimants filed a motion seeking the authority to pursue litigation against the debtor corporation solely for the purpose of recovering proceeds from the debtor corporation’s insurance policies.[9]The debtor responded, arguing that the claimants were not entitled to the requested relief and that any claims held by the claimants were discharged.[10]A hearing was conducted and the Texas Bankruptcy Court denied the motion as to the debtor corporation, thus refusing to allow the litigation to proceed because “no legitimate argument exist[ed]” that the debtor corporation would not incur substantial costs that would frustrate “the financial fresh start policy underlying the bankruptcy process.”[11]
Under section 524(a)(2), a discharge of a debt under chapter 11 bankruptcy “operates as an injunction against the commencement or continuation of an action . . . to collect, recover, or offset any debt as a personal liability of the debtor.”[12]Even so, a “discharge in bankruptcy does not extinguish the debt itself, but merely releases the debtor from personal liability for the debt.”[13]Therefore, as specified by section 524(e), “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.”[14]Most courts have used both textual and equitable foundations to interpret section 524(a) and have held that “the scope of a section 524(a) injunction does not affect the liability of liability insurers and does not prevent establishing their liability by proceeding against a discharged debtor.”[15]The majority of courts, including the CJ Holding Co.court, have reasoned that “[t]he ‘fresh-start’ policy is not intended to provide a method by which an insurer can escape its obligations based simply on the financial misfortunes of the insured.”[16]The Fifth Circuit, in In re Edgeworth, firmly stated that “[s]uch a result would be fundamentally wrong.”[17]
The majority of courts, including the CJ Holding Co. court, noted that this exception to section 524, which allows a court to lift the automatic stay where a creditor is pursuing a claim solely to collect insurance proceeds, “is not available if the debtor is required to incur substantial costs in the litigation” that would “frustrate” the debtor’s discharge and the “fresh start policy engrafted into the Bankruptcy Code.”[18]That said, the CJ Holding Co.court stated that it was “convinced” that this situation had been recognized by the Edgeworth court as making the exception to section 524 unavailable to the creditor.[19]Thus, the CJ Holding Co.court denied the creditor’s motion for relief from the statutory discharge injunction under section 524 because the insurance policy of the debtor corporation required it to pay the first million and then five of the following six million dollars in related expenses and recoveries.[20]The court reasoned that “no legitimate argument exist[ed]” that the debtor corporation would not incur substantial costs that would frustrate “the financial fresh start policy underlying the bankruptcy process.”[21]
The CJ Holding Co. decision emphasized the rule as established by the Fifth Circuit of the United States Court of Appeals in In re Edgeworth.[22]Namely, that the “exception to § 524 is not available if the debtor is required to incur substantial costs in the litigation.”[23]If a debtor is required to incur such substantial costs, it would “frustrate” the debtor’s discharge and the “fresh start policy engrafted into the Bankruptcy Code.”[24]
[1]In re CJ Holding Co., No. 16-33590, 2018 WL 3965225, at *2 (Bankr. S.D. Tex. Aug. 15, 2018); see e.g., In re Edgeworth, 933 F.2d 51, 54 (5th Cir. 1993) (determining that “the scope of a section 524(a)injunction does not affect the liability of liability insurers and does not prevent establishing their liability by proceeding against a discharged debtor”).
[2]In re CJ Holding Co., 2018 WL 3965225, at *2-3.
[3]See id. (citing In re Edgeworth, 933 F.2d at 54) (noting that “threats to [a debtor’s] pocketbook might require a different result”) (alteration in original).
[4]In re CJ Holding Co., 2018 WL 3965225, at *1.
[5]See id.
[6]Seeid.The corporation’s refusal to list the other claimant as a creditor is not at issue in the case or relevant to the topic discussed in this comment. See id. (explaining that the Debtors listed Mrs. Nunez as a creditor with a disputed, contingent claim in an unliquidated amount” and that the Debtors did not list Mr. Nunez as a creditor).
[7]See In re CJ Holding Co., 2018 WL 3965225, at *1(reasoning that the claimants never filed a proof of claim, never “cast a vote” on the debtor’s proposed reorganization plan, and never “objected to the proposed plan or otherwise participated in the confirmation process”).
[8]See id. at *2; see also 11 U.S.C. §§ 524(a)(2) and (3).
[9]See In reCJ Holding Co.,2018 WL 3965225, at *1.
[10]See id. at *2.
[11]Id.at *2-3.
[12]11 U.S.C. §524(a)(2). Section 524(a)(3) has the same effect as section 524(a)(2), but concerns the interests of the debtor and debtor’s spouse in community property as of the commencement of a case and is not at issue here.
[13]In re Edgeworth, 933 F.2d 51, 53 (5th Cir. 1993).
[14]11 U.S.C. §524(e).
[15]In re Edgeworth, 933 F.2d at 54; see e.g., First Fidelity Bank v. McAteer,985 F.2d 114 (3d Cir.1993); Green v. Welsh,956 F.2d 30, 35 (2d Cir.1992); In re Fernstrom Storage & Van Co.,938 F.2d 731, 733-34 (7th Cir.1991); In re Jet Florida Systems, Inc.,883 F.2d 970, 976 (11th Cir.1989) (per curiam) (adopting the district court opinion); In re Beeney,142 B.R. 360, 362 (9th Cir. BAP 1992); In re Greenway,126 B.R. 253, 255 (Bankr.E.D.Tex.1991);In re Peterson,118 B.R. 801, 804 (Bankr.D.N.M.1990); In re Traylor,94 B.R. 292, 293 (Bankr.E.D.N.Y.1989); In re Lembke,93 B.R. 701, 702-03 (Bankr.D.N.D.1988); In re White,73 B.R. 983 (Bankr.D.D.C.1987); In re Mann,58 B.R. 953, 956 (Bankr.W.D.Va.1986). But see In re White Motor Credit,761 F.2d 270 (6th Cir.1985) (barring continuation of personal injury claims that would have been paid by the debtor's insurers). The holding of In re White Motor Creditwas explicitly rejected by the courts in Greenand In re Jet Florida Systems, Inc.
[16]In re Edgeworth, 933 F.2d 51, 54 (5th Cir. 1993); see also In re CJ Holding Co., No. 16-33590, 2018 WL 3965225, at *2 (Bankr. S.D. Tex. Aug. 15, 2018) (discussing the “balancing of the financial fresh start policy underlying the bankruptcy process”).
[17]In re Edgeworth, 933 F.2d at 54 (citing In re Lembke, 93 B.R. 701, 703 (Bankr. D.N.D. Nov. 10, 1988)).
[18]In re CJ Holding Co., 2018 WL 3965225, at *2-3; see also In re Edgeworth, 933 F.2d at 54 (noting that this exception to § 524 is not available if the debtor would incur substantial costs).
[19]See In re CJ Holding Co., No. 16-33590, 2018 WL 3965225, at *2–3 (Bankr. S.D. Tex. Aug. 15, 2018);
[20]See id. at *3.
[21]Id.at *2-3.
[22]See id. at *2 (finding “the resolution of the parties' dispute squarely encompassed within the Fifth Circuit's decision” in In re Edgeworth); see alsoIn re Edgeworth, 933 F.2d 51, 54 (5th Cir. 1993) (“Thus, as long as the costs of defense are borne by the insurer and there is no execution on judgment against the debtor personally, section 524(a)will not bar a suit against the discharged debtor as the nominal defendant.”).
[23]In reCJ Holding Co.,2018 WL 3965225, at *2; see also In re Edgeworth, 933 F.2d at 54 (noting that “threats to [a debtor’s] pocketbook might require a different result”) (alteration in original).
[24]In reCJ Holding Co.,2018 WL 3965225, at *2–3.