In re Automotive Professionals, Inc.

• Decision Date: 12 June 2007
• Docket Number: No. 07 B 06720.,07 B 06720.
• Parties: In re AUTOMOTIVE PROFESSIONALS, INC., Debtor.
• Court: United States Bankruptcy Courts. Seventh Circuit. U.S. Bankruptcy Court — Northern District of Illinois

370 B.R. 161

In re AUTOMOTIVE PROFESSIONALS, INC., Debtor.

No. 07 B 06720.

United States Bankruptcy Court, N.D. Illinois, Eastern Division.

June 12, 2007.

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Erich S. Buck, Kenneth G. Kubes, Stephen T. Bobo, Reed Smith LLP, Chicago, IL, for Debtor.

MEMORANDUM OPINION

CAROL A. DOYLE, Bankruptcy Judge.

Automotive Professionals, Inc. ("API") filed a petition under chapter 11 of the Bankruptcy Code. The State of Illinois filed a motion to dismiss API's case based on five grounds: (i) API is ineligible for bankruptcy relief because it is a domestic insurance company; (ii) API's officers lacked authority to file the bankruptcy petition because a state court appointed the Illinois Director of Insurance ("Director") as conservator of API's assets before it filed its bankruptcy petition; (iii) API has no assets to administer in bankruptcy because of a prepetition assignment for the benefit of creditors; (iv) sovereign immunity protects the Director from having to turn over API's assets; and (v) the automatic stay does not apply to an action filed by the Director in state court to liquidate API under the rehabilitation and liquidation provisions of the Illinois Insurance Code.

None of the State's arguments has merit. First, API is not a "domestic insurance company" and therefore is eligible to be a debtor under the Bankruptcy Code. Second, API's directors could authorize the filing of the bankruptcy petition despite the order of conservation issued by the state court. Third, the assignment for the benefit of API's creditors does not deprive API of assets to administer in this case. Fourth, sovereign immunity does not prevent the court from requiring the Director to turn over API's assets. Finally, the police and regulatory power exception to the automatic stay does not apply to liquidation or rehabilitation actions in state court. The State's motion to dismiss will therefore be denied.

I. Background and Facts

The following facts are undisputed. API is an Illinois corporation based in Schaumburg, Illinois. It sells vehicle service contracts to owners of vehicles. The purchaser pays API a fixed amount `and API agrees to pay for the cost of certain vehicle repairs for a fixed period of time after the expiration of the original manufacturer's warranty. API's vehicle service contracts are sold through automobile dealerships.

API has outstanding vehicle service contracts with approximately 325,000 consumers in 49 states, including approximately 16,250 consumers in Illinois. API has been registered with the Illinois Director of Insurance as an authorized service contract provider under the Illinois Service Contract Act ("Act"), 215 ILCS 152/1 et seq. (2006), since at least 2002. Each year the State has approved API's contract forms.

Most states have their own version of the Act, usually based at least to some degree on the Service Contracts Model Act. These laws generally require a service contract provider to demonstrate its financial ability to perform the contracts either through insurance, reserves or some other means. API's vehicle service contracts are backed by a combination of funds on deposit in various reserve accounts and insurance policies. The amount and type of insurance coverage or other financial backing for each of API's vehicle service contracts is based on the law of the state in which the vehicle service contract is sold.

If a company selling service contracts in Illinois satisfies the financial requirements of the Act through an insurance policy, the policy must provide "first dollar coverage" — meaning that it covers any liability that the service contract provider has under the service contract with the customer. All of API's vehicle service contracts sold in Illinois are backed by first dollar insurance coverage issued by Marathon Financial Insurance Co., Inc. ("Marathon"), Allstate Insurance Company or Travelers Insurance Company, Marathon also provides less comprehensive coverage for many of API's vehicle service contracts sold in states that do not require first dollar coverage.

For the last three years, API has operated at a cash deficit. There is now a cash shortfall of approximately $9 million in the reserve accounts relating to some of the vehicle service contracts. API's situation is complicated by provisions of the Marathon insurance policies that apply to vehicle service contracts sold in states that do not require first dollar coverage. Marathon contends that its coverage does not attach to cover claims until all funds placed in API's reserve accounts in the aggregate have been paid out for repair costs. Marathon may also assert that it has no obligation to pay on the non-first dollar policies for other reasons.

In the fall of 2006, API's management determined that it could not fix its financial problems and that it should wind down its operations. API executed an assignment of its assets for the benefit of creditors on February 15, 2007. The assignee is Michael Kayman. API's assets were transferred to the API Creditors Trust administered by Mr. Kayman for the purpose of liquidating the assets and paying out the proceeds to creditors.

On March 2, 2007, Michael McRaith, the Illinois Director of Insurance, filed a complaint against API and the API Creditors' Trust in the Circuit Court of Cook County. He obtained an Order of Conservation and Injunctive Relief ("Order of Conservation"), effectively freezing Kayman's activities as API's assignee. The complaint was brought in part under the Act. On April 4, 2007, McRaith filed a Complaint for Rehabilitation in state court seeking to "rehabilitate, wind down and terminate" the business and affairs of API under the rehabilitation and liquidation provisions of the Illinois Insurance Code. There has been no adjudication of any issues in connection with this second complaint.

API filed its bankruptcy petition in May 2007. The State filed its motion arguing that the case should be dismissed and the Director should be permitted to liquidate API under the rehabilitation and liquidation provisions of the Illinois Insurance Code.

II. Eligibility for Relief Under the Bankruptcy Code

The primary issue raised in the. State's motion is whether API is eligible to be a debtor under the Bankruptcy Code. The State argues that API is a "domestic insurance company" and therefore not eligible to be a debtor under § 109(b)(2) and (d) of the Bankruptcy Code, 11 U.S.C. § 109(b)(2) and (d). Section 109(b) provides that "[a] person may be a debtor under chapter 7 of this title only if such person is not — ... (2) a domestic insurance company...." Section 109(d) provides that "[o]nly ... a person that maybe a debtor under chapter 7 of this title ... may be a debtor under chapter 11 of this title." Thus, if API is a domestic insurance company, it may not be a debtor under either chapter 7 or chapter 11 of the Bankruptcy Code.

As a preliminary matter, the State argues that the court does not have subject matter jurisdiction over bankruptcy cases involving domestic insurance companies. However, the question is not one of jurisdiction — the court has subject matter jurisdiction over all cases filed under the Bankruptcy Code. See Promenade Nat'l Bank v. Phillips (Matter of Phillips), 844 F.2d 230, 236 n. 2 (5th Cir.1988). Instead, eligibility for relief under the Bankruptcy Code is a question of substantive bankruptcy law. See id.

Congress did not define "domestic insurance company" in the Bankruptcy Code. To fill this gap, the Seventh Circuit adopted the "state classification" test to determine whether a debtor is a domestic insurance company. Matter of Estate of Medcare HMO, 998 F.2d 436, 442 (7th Cir.1993); Matter of Cash Currency Exchange, Inc. (Cash Currency Exchange, Inc. v. Shine), 762 F.2d 542, 548 (7th Cir. 1985). Under this test, the court must determine (1) whether a debtor is considered a domestic insurance company under the law of the state in which it is incorporated, and if not, (2) whether the debtor is the "substantial equivalent" of an insurance company under state law. Id. at 444. The court must then consider whether the state classification is consistent with the purposes of the Bankruptcy Code. Id. at 442. Thus, the first question to be decided is whether Illinois law treats API as an insurance company.

The Act provides an exemption from compliance with the Illinois Insurance Code for service contract providers who comply with the Act. The State argues that API is not exempt from the Insurance Code because it has not complied with the Act. It also asserts that API is the substantial equivalent of insurance company. API contends that it is not an insurance "company because the Act completely exempts service contract providers from insurance regulation whether or not they comply with it, and because API has complied with the Act in any event

For the reasons discussed below, the court concludes that the Act provides an exemption to service contract providers who comply with the financial and registration requirements of the Act. API has complied with those provisions and is therefore exempt from compliance with and is not subject to any provision of the Illinois Insurance Code. It therefore is not classified as an insurance company under Illinois law for purposes of the state classification test.

A. Illinois Service Contract Act

The Act provides that service contract providers complying with the Act are not subject to and need not comply with any provision of the Illinois Insurance Code. It sets forth a statutory framework under which a service contract provider can do business in Illinois and not be treated as an insurance company. Section 5 of the Act states that "`service contract provider' means a person who is contractually obligated to the service contract holder under the terms of the service contract." It then specifically states that "[a] service...