What’s the Insured Value of an Allowed Bankruptcy Claim? Pay-as-Allowed, Pay-as-Paid, and a Novel Variation

John E. Heintz and Kyle P. Brinkman

John E. HeintzBrinkman, Kyle P.Bankruptcy of the insured does not relieve an insurer of its obligations under its insurance policy, including to pay covered liability claims held by creditors of the bankruptcy estate. Generally, for a creditor to obtain a distribution from the estate, the creditor must file a timely “proof of claim” in the bankruptcy proceeding, and the claim must be “allowed” by the bankruptcy court. Because a debtor’s assets are typically insufficient to compensate all creditors for the full allowed value of their claims, creditors usually are paid only a fraction of the dollar value allowed. Disputes have, as a result, sometimes arisen between debtor insureds or their successors on the one hand, and their insurers on the other, over whether the insurer is obligated to pay the allowed value of an insured claim (“pay-as-allowed”), or instead only the fractional amount the creditor actually would receive from the estate if there were no insurance coverage (“pay-as-paid”).

To date, only a few court decisions have addressed this issue. The leading case adopting the “pay-as-allowed” approach is the Seventh Circuit’s 1991 decision applying Illinois law in UNR Industries, Inc. v. Continental Casualty Co. The policyholder UNR had petitioned for bankruptcy reorganization after becoming the target of thousands of asbestos-related claims. The bankruptcy court approved a plan that created a trust for the benefit of asbestos claimants, and which required UNR to transfer more than half of its stock to fund the trust. The asbestos claimants agreed that their claims would “be fully settled and satisfied” by the stock transfer. Following confirmation of the bankruptcy plan, UNR sued several of its insurers, including Continental Casualty Company (CNA), seeking a declaration that they were obligated to pay the full “allowed” value of the asbestos claims rather than the “paid” value that the asbestos claimants received from the trust. The Seventh Circuit agreed. The court reasoned that a contrary result threatened “to confer a windfall” on the insurer because, absent UNR’s bankruptcy, CNA would have been liable to pay the full amount of the asbestos claimants’ damages rather than the “arbitrarily discounted amount” received by the asbestos claimants. The court found support for its position in the CNA insurance policies, which included standard language that the bankruptcy of the insured does not relieve the insurer of its obligations. The UNR “pay-as-allowed” approach has been followed in the Northern District of Illinois’ 2011 decision in ARTRA 524(g) Asbestos Trust v. Fairmont Premier Insurance Co. and in the District of Maryland’s National Union Fire Insurance Co. v. Porter Hayden Co. decision in 2012.

Currently, the sole case adopting the “pay-as-paid” approach is the California Court of Appeals’ 2006 decision in Fuller-Austin Insulation Co. v. Highlands Insurance Co. Similar to UNR, Fuller-Austin involved a post-bankruptcy trust funded with the company’s stock and empowered to pay asbestos claims out of trust assets. The California court, however, rejected the UNR approach, resting its decision primarily on the ground that the “insurance policies indemnify Fuller-Austin for amounts it is ‘obligated to pay’ by law.” The court reasoned that the transfer of stock to the trust was not the amount Fuller-Austin was “obligated to pay”; instead, it said the legal obligation was the amount eventually paid by the trust to individual asbestos claimants. The Fuller-Austin approach reduces the insurer’s liability and therefore is the approach preferred by insurers.

A variation on the situation presented in UNR and Fuller-Austin arises when the debtor’s plan provides that claimants will be paid directly in stock of the reorganized company. In such circumstances, the Fuller-Austin court’s concern is not implicated because the entity to which the debtor becomes “legally obligated to pay” the allowed claim is the claimant, rather than an intermediary trust created to pay claimants. The “allowed” value is therefore even more clearly the appropriate measure of liability in such situations than it was in UNR. If the “pay-as-paid” approach were nevertheless adopted, however, a novel issue arises over how to calculate the “paid” value. Because the value of stock fluctuates relative to the value of currency, and therefore, the date on which such stock is valued will affect—potentially substantially—the insurer’s obligation under the policy. Although no available case decision has yet addressed the issue, insurers have argued that the stock must be valued either at its market rate when transferred to the holder of the allowed claim or at the amount ultimately received by the holder upon sale of the stock, if any. The latter of these should be rejected because it makes determining the insurance value of the claim impossible before the claimant sells the stock and, additionally, because it is dependent on fortuity or the whim of the claimant. Moreover, both approaches potentially result in varying insurance values for similar claims of creditors within the same class, as different creditors may receive distributions at different times and sell their stock at different times, all while the market value of the stock fluctuates. This result would appear to be inconsistent with the fundamental bankruptcy principle that similarly-situated creditors must be treated similarly. A single stock value applicable to all claims would appear to be both more practical and more consistent with bankruptcy principles. This single value typically is determined through the bankruptcy proceeding before confirmation in order to allocate shares among allowed claims and fund a disputed claim reserve.

Although the case law remains sparse, the proper insurance valuation for claims allowed in bankruptcy is an important issue for debtor insureds, their successors, their insurers, and the debtor’s creditors. These issues should therefore be taken into consideration with the advice of coverage counsel both before conclusion of the bankruptcy, when the debtor may have more options to address them proactively, and if a coverage dispute concerning an allowed bankruptcy claim arises after conclusion of the bankruptcy.