Vitek, Inc., Matter of, 92-2731

• Decision Date: 25 April 1995
• Docket Number: No. 92-2731,92-2731
• Citation: 51 F.3d 530
• Parties: Bankr. L. Rep. P 76,485 In the Matter of VITEK, INC., Debtor. Charles HOMSY and Ann Homsy, Appellees, v. Ben B. FLOYD, Trustee, Appellant.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 530

51 F.3d 530

Bankr. L. Rep. P 76,485

In the Matter of VITEK, INC., Debtor Charles HOMSY and Ann Homsy, Appellees, v. Ben B. FLOYD, Trustee, Appellant.

No. 92-2731.

United States Court of Appeals Fifth Circuit.

April 25, 1995.

Randall A. Rios, Keavin D. McDonald, Bonham, Carrington & Fox, Houston, TX, for appellant.

Linda Marshall, Baltimore, MD, for appellees.

Appeal from the United States District Court for the Southern District of Texas.

Before VAN GRAAFEILAND ^*, SMITH and WIENER, Circuit Judges.

WIENER, Circuit Judge:

Vitek, Inc. (Vitek) and Plaintiffs-Appellees Charles and Ann Homsy (the Homsys), as directors and officers of Vitek, were sued by over 400 plaintiffs, who claimed to have been injured by allegedly defective prostheses manufactured by Vitek. As a result, Vitek filed for bankruptcy protection under Chapter 7. During the ensuing bankruptcy proceedings, Defendant-Appellant Ben B. Floyd (Floyd), the trustee of Vitek's bankruptcy estate (the Estate), petitioned the bankruptcy court for authority to compromise with Vitek's liability insurance carriers. These compromises (the Settlements) provided that Vitek's liability insurance carriers would be protected from third-party suits by injunctive orders of the bankruptcy court in exchange for paying the remainder of the limits of the liability policies (the Policies) to the Estate for the benefit of creditors. The bankruptcy court approved the Settlements, issuing an injunctive order that protected Vitek's insurance carriers from third-party liability.

The Homsys objected, arguing that the Settlements left them exposed to suits while denying them defense and liability coverage under the Policies, despite their being coinsureds with Vitek under the Policies. The bankruptcy court rejected this argument, finding that the Homsys had no property interests in the Policies. The Homsys appealed to the district court, which reversed, holding that the Homsys had independent property rights in the proceeds of the Policies (the Proceeds). The district court remanded the case to the bankruptcy court with orders to extend the protection of its injunctive order to cover the Homsys. Floyd timely appealed to this court, arguing that Vitek's Policies (and the Proceeds) are property of the Estate, and that his authority as trustee to enter into settlements with Vitek's insurance carriers should not be conditioned on extension of the bankruptcy court's injunctive order to cover the Homsys. For the reasons set forth below, we reverse the ruling of the district court; and we modify the original order of the bankruptcy court and reinstate that order as modified.

I FACTS AND PROCEEDINGS

Between 1974 and 1980 Vitek marketed temporomandibular joint (TMJ) implants for persons suffering from TMJ disorders. ¹ Alleged defects in some models of these implants resulted in the filing of numerous lawsuits in many jurisdictions. Essentially every suit contained allegations that the implants were defective or that Vitek failed adequately to warn consumers of possible dangers attending the use of those implants, or both. At the time that the events underlying these lawsuits were occurring, the Homsys were officers, directors, and principal shareholders of Vitek.

Vitek filed a voluntary petition for relief under Chapter 7 of the United States Bankruptcy Code, and within days Floyd was appointed acting Chapter 7 Trustee of Vitek's bankruptcy estate. At the time that Vitek filed for bankruptcy approximately 426 lawsuits were still pending against it. Many of these suits also named one or both of the Homsys as defendants.

The Estate's remaining assets consisted primarily of liability insurance policies purchased by Vitek, a named insured on each of the Policies. The Homsys were listed either as coinsureds or as additional named insureds under each of the Policies, being covered thereunder as officers, directors, or stockholders of Vitek. Significantly, the Parties to the instant litigation have stipulated that the Homsys are coinsureds in all Policies. Under the terms of the Policies, the insurers must both indemnify and defend Vitek and the additional insureds (here, the Homsys) until the policy limits are exhausted.

As Trustee for the Estate, Floyd contacted counsel for plaintiffs in most of these suits, encouraging formation of a confederation, eventually called the Plaintiffs' Steering Committee. Floyd also initiated discussions with representatives of Vitek's several insurance carriers in an effort to obtain and distribute the Proceeds.

Several months later Floyd filed a number of motions with the bankruptcy court seeking authority to compromise with most of Vitek's insurance carriers. Under the terms of these agreements the carriers would be required to remit all remaining Proceeds, up to the limits of their respective policies, in full satisfaction of the carriers' obligations. In return, the carriers would be protected by the injunctive order of the bankruptcy court from incurring additional liability and defense costs. The Homsys objected to these settlements, arguing that as coinsureds they were being deprived of their rights under the Policies: The Homsys were to be enjoined from suing the carriers, but they would not themselves be protected from third-party suits.

The bankruptcy court approved the Settlements, concluding that (1) the Estate was the sole owner of the Policies and the Proceeds, (2) the Settlements were in the best interest of all relevant parties, and (3) the Homsys' interests were adequately protected by their unsecured claims against the Estate. The district court disagreed, concluding that the bankruptcy court erred when it ruled that the Homsys had no independent property interests in the Proceeds. The district court did not mention corresponding interests in the Policies themselves.

Finding that the Proceeds were owned "by both the Homsys and Vitek because they are coinsureds," the district court concluded that the Homsys' portion of the Proceeds could not be regarded as property of the Estate. Therefore, reasoned the court, the bankruptcy court lacked authority to shield the insurance carriers from liability to the Homsys. The district court also concluded that granting the Homsys an unsecured claim against the Estate did not adequately protect their interests. Despite its determination that the Homsys' interest in the proceeds were not estate property, the district court in remanding the case to the bankruptcy court directed that court to extend its injunction to cover the Homsys. ² Floyd timely appealed.

II ANALYSIS

This case involves the interfacing of federal bankruptcy law with state insurance law. The central issue here is, when one of two or more coinsureds declares bankruptcy and seeks protection under Chapter 7, ³ what part of the proceeds of a liability policy that covers the non-bankrupt coinsureds should enrich the estate of the coinsured debtor? The district court attempted to answer this fundamental question by reference to insurance law. Relying on the notion--purportedly grounded in state insurance law--that "[a]n insurance company cannot prefer one of its insureds over another," ⁴ the district court reversed the bankruptcy court. In so doing, the court concluded that the Homsys had property interests in the Proceeds even though Vitek was the sole owner of the Policies, and that the bankruptcy court could not therefore effect a settlement that excluded the Homsys from any share of the Proceeds. We consider the bankruptcy and insurance aspects of this case in turn.

A. Bankruptcy Aspects

The district court correctly noted that under Sec. 541(a)(1) of the Bankruptcy Code, a bankruptcy estate includes "all legal or equitable interests of the debtor in property as of the commencement of [a bankruptcy] case." ⁵ Interpreting this provision, the Supreme Court has declared that "[t]he scope of ... [Sec. 541(a)(1) ] is broad. It includes all kinds of property, including tangible or intangible property, causes of action ... and all other forms of property currently specified in section 70a of the Bankruptcy Act." ⁶ The language of Sec. 541(a)(1) is unquestionably broad enough to cover a debtor's interest in liability insurance. ⁷ Indeed, an overwhelming majority of courts have concluded that liability insurance policies fall within Sec. 541(a)(1)'s definition of estate property. ⁸ This consensus is understandable: "[a] products liability policy ... is a valuable property of a debtor, particularly if the debtor is confronted with substantial liability claims." ⁹ Often, as in this case, liability policies constitute "the most important asset of ... [the debtor's] estate." ¹⁰ As one court put it, "language, authority, and reason all indicate that ... liability insurance polic[ies] are 'property of the estate.' " ¹¹

In In re Louisiana World Exposition, ¹² however, we distinguished titular ownership of a policy from total ownership of the proceeds of that policy, holding that the proceeds of Directors and Officers (D&O) liability insurance policies were not part of a corporation's bankruptcy estate even though the policies were purchased and owned by the corporation. ¹³ The policies at issue in that case provided liability coverage only for the corporate debtor's directors and officers and for the obligation of the corporation to indemnify those directors and officers. ¹⁴ Thus, under the D & O policies, the insurance companies' obligations flowed only to the corporate debtor's directors and officers, who were the only insureds under the policies. ¹⁵ The policies did not afford the debtor corporation any direct coverage for liability to third-party claimants. ¹⁶ In that narrow factual context, we concluded that the debtor corporation's ownership of the policies was not enough to render the proceeds of those policies property of the corporation's bankruptcy estate. Consequently, despite the debtor's legal ownership of the...