American States v. Symes of Silverdale

• Decision Date: 03 May 2002
• Docket Number: No. 26472-2-II.,26472-2-II.
• Citation: 111 Wash.App. 477,45 P.3d 610
• Parties: AMERICAN STATES INSURANCE COMPANY, Respondent/Cross Appellant, v. SYMES OF SILVERDALE, INC. dba Symes Cigar Bar; Evergreen Restaurant Development, Inc., dba Symes Family Restaurant; Symes of Port Orchard, Inc.; McKenzies of Puyallup Inc.; Thomas R. Lepre aka Lennie Lepre, Defendants, Kathryn Ellis (in the capacity as Bankruptcy Trustee), Appellant/Cross-Respondent.
• Court: Washington Court of Appeals

45 P.3d 610

111 Wash.App. 477

AMERICAN STATES INSURANCE COMPANY, Respondent/Cross Appellant, v. SYMES OF SILVERDALE, INC. dba Symes Cigar Bar; Evergreen Restaurant Development, Inc., dba Symes Family Restaurant; Symes of Port Orchard, Inc.; McKenzies of Puyallup Inc.; Thomas R. Lepre aka Lennie Lepre, Defendants, Kathryn Ellis (in the capacity as Bankruptcy Trustee), Appellant/Cross-Respondent.

No. 26472-2-II.

Court of Appeals of Washington, Division 2.

May 3, 2002.

Thomas Lether, Clarke, Bovingdon, Cole, Mills, Lether, Pc, Scott Michael Collins, Clarke, Bovington, Cole, Seattle, for Respondent.

Kennard M. Goodman, Ryan, Swanson & Cleveland, Seattle, for Appellant.

BRIDGEWATER, J.

Kathryn A. Ellis, Symes of Silverdale's bankruptcy trustee, and American States Insurance Company both appeal the trial court's orders denying Ellis' motion for partial summary judgment and granting in part American States' cross-motion for partial summary judgment. This is an action to determine whether an insurance company owes policy proceeds to a bankruptcy estate when the insured company's loss occurred because of arson, possibly caused by the company's officer.

We hold that bankruptcy law places the trustee (or debtor-in-possession) in the same shoes as the debtor; state law, not bankruptcy law, determines contractual terms between the parties, even if one is in bankruptcy and, thus, the insurer can raise an arson defense against the trustee in bankruptcy. Further, we hold, following the Supreme Court's holding in Ellwein v. Hartford Accident & Indem. Co., 142 Wash.2d 766, 15 P.3d 640 (2001), that the insured, here the estate in bankruptcy, had the burden of showing that there was no reasonable basis for the insurer's action; that both the insured and insurer agreed that the business was destroyed by arson, a defense if committed by the insured, with the only fact in dispute being the identity of the perpetrator. Thus, the insurer had reasonable grounds to dispute the coverage-determining facts and there was no possibility of bad faith on its part. The insurer was entitled to summary judgment on the bad faith claim. We affirm in part, reverse in part, and remand for trial on the claim.

FACTS

Our commissioner granted both Kathryn A. Ellis, Symes of Silverdale's bankruptcy trustee, and American States Insurance discretionary review of the separate issues they each raised. Trustee Ellis' issues on appeal are (1) whether American States wrongfully denied her claim for insurance proceeds after arson destroyed Symes and consequently whether federal law applies to allow a bankruptcy trustee to recover insurance proceeds resulting from a debtor-in-possession's intentional wrongdoing committed after the bankruptcy petition is filed and (2) whether the trial court erred in not declaring Symes' insurance policy property of its bankruptcy estate. American States' issue on appeal is whether Trustee Ellis' bad faith claim against it should have been dismissed under the summary judgment standard recently set forth in Ellwein. This court consolidated the parties' appeals for consideration.

On April 9, 1997, Symes, a family restaurant and sports bar located in Silverdale, Washington, filed a Chapter 11 bankruptcy petition for reorganization. Before filing the bankruptcy petition, Symes obtained an insurance policy from American States that was effective from March 10, 1997, until March 10, 1998. On March 10, 1998, Symes renewed this insurance policy with American States. The renewal policy, which was effective March 10, 1998, until March 10, 1999, included an increase in policy limits on Symes' personal property at the restaurant. Symes was a named insured and paid the policy's premiums.

On June 3, 1998, a fire severely damaged Symes. The Bureau of Alcohol, Tobacco and Firearms determined that the fire was incendiary and that there were no signs of forced entry. On June 4, 1998, the bankruptcy court heard a creditor's motion to convert the matter to a Chapter 7 liquidation and, with knowledge of the fire, it ordered conversion of Symes' bankruptcy proceedings from Chapter 11 reorganization to Chapter 7 liquidation.¹ Symes' president, Thomas R. Lepre, acting on behalf of Symes, initiated the claim for property and business interruption losses with American States. To determine coverage under the policy, American States conducted an independent investigation.

On June 9, 1998, after converting Symes' bankruptcy proceedings to Chapter 7, the bankruptcy court appointed Ellis as Symes' trustee. Ellis, as trustee for Symes' bankruptcy estate, took responsibility for the insurance claim with American States. The insurance policy proceeds are Symes' only significant asset.

In March 1999, American States denied Ellis' claim for coverage under the policy for the following reasons: (1) the fire was intentionally set by or at the behest of Symes; (2) the trustee's proof of loss was fraudulent; and (3) Symes failed to cooperate. American States later filed a declaratory judgment action in which it alleged that Lepre set fire to the restaurant. Trustee Ellis responded with breach of contract, Consumer Protection Act violation, and insurance bad faith counterclaims against American States.

On January 14, 2000, Trustee Ellis moved for partial summary judgment to dismiss American States' claim that it properly denied coverage based on arson. Ellis argued that even if Lepre set the fire, his actions as a debtor-in-possession could not be attributed to the estate because arson is outside the scope of the debtor-in-possession's authority.

I. Trustee Ellis' Appeal

The first issue is succinctly stated by the trustee in bankruptcy: "If an insured corporation declares bankruptcy, continues to operate as a debtor-in-possession, and then one of its officers intentionally burns its property, does the estate in bankruptcy have a right to recover for the loss from the bankrupt corporation's insurance?" Brief of Appellant at 8. Trustee Ellis asserts that federal law preempts state law and that under federal law, Symes' bankruptcy estate cannot be bound by the debtor-in-possession's unauthorized acts.

As American States notes, this is an issue of first impression. There are no Washington cases and the federal cases are few, with none from the Ninth Circuit.

A. Choice of Law

American States argues that state law should apply because state law controls contracts and property interests and this is a breach of contract claim. Trustee Ellis, on the other hand, argues that the issue is not one of contract, but one of capacity controlled by federal bankruptcy law.

The United States Constitution expressly grants the federal government the power to make uniform laws regarding bankruptcy. U.S. CONST. art. I, § 8, cl. 4. Where the Constitution expressly grants power to the federal government, any state statute that conflicts with federal law must yield to the federal rule of law. U.S. CONST. art. 6. A state has no power to make or enforce any law that conflicts with federal bankruptcy laws. Int'l Shoe Co. v. Pinkus, 278 U.S. 261, 263-64, 49 S.Ct. 108, 73 L.Ed. 318 (1929). Thus, state court decisions that define property rights are not binding on federal bankruptcy courts when they are contrary to the policy and proper construction of bankruptcy laws. In re Lahman Mfg. Co., 33 B.R. 681, 687 (Bankr.D.S.D.1983).

While federal law creates a bankruptcy estate, the right to recover proceeds from an insurance policy is determined from the insurance policy itself. See 11 U.S.C.A. § 541 (commencement of a bankruptcy case creates an estate); In re Light (Dery v. Citizens Ins. Co. of Am.,) 23 B.R. 482, 483 (Bankr.E.D.Mich.1982) (right to recover on an insurance policy is determined by the rights provided by the contract of insurance). The bankruptcy trustee's interest in a debtor's insurance policy is no more or no less than the debtor's interest, for the trustee stands in the debtor's shoes. Light, 23 B.R. at 484. This is consistent with the proposition that state law should be used to decide property and contract issues that state law would govern absent a bankruptcy context. In re Madeline Marie Nursing Homes, 694 F.2d 433, 439, 438 (6th Cir.1982). Thus, Washington law must control whether the trustee can recover. Further, the trustee brought a breach of contract action under the insurance policy and asked the trial court and this court to determine the rights and liabilities of the parties under that contract.

Therefore, Trustee Ellis is correct that federal law clearly controls the creation of a bankruptcy estate and a debtor-in-possession's duties and capacity. But state law governs insurance policies as contracts absent a conflict with federal bankruptcy law. We see no conflict with federal law and hold that we are to look at Washington law to see whether the trustee can recover.

B. Whether the Insurance Policy is Part of Symes' Bankruptcy Estate

Because neither Trustee Ellis nor the bankruptcy estate was a named insured on the policy, we address whether the policy is a part of Symes' bankruptcy estate. When a debtor files a petition for bankruptcy, all of the debtor's property becomes property of the bankruptcy estate. In re Jones, 768 F.2d 923, 926 (7th Cir.1985). The bankruptcy estate is thus comprised of "all legal or equitable interests of the debtor in property as of the commencement of the case." 11 U.S.C.A. § 541(a)(1). The definition of "property of the estate" is intentionally broad so as to allow the bankruptcy court to administer completely all of the debtor's property, no matter how tangential the debtors interest in the particular property. Harvey R. Miller & George A. Davis, The Interplay of Insurance Companies & The Bankruptcy Code, 659 PLI/COMM 247, 271-72 (1993), citing United States v. Whiting Pools, Inc., 462 U.S. 198,103 S.Ct. 2309, 76 L.Ed.2d 515 (1983). The underlying theory of 11 U.S.C.A. § 541 is to bring into the bankruptcy estate all...