On June 6, 2024, the Supreme Court issued its opinion in Truck Insurance Exchange v. Kaiser Gypsum Co., No. 22-1079,conferring broad standing to debtors’ pre-bankruptcy liability insurers to appear and be heard in Chapter 11 bankruptcy proceedings. The ruling eliminates the “insurance neutrality” doctrine that previously constrained the participation of insurers in Chapter 11, greatly expanding insurers’ capacity to influence the reorganization process.
Background: Insurer Standing in Chapter 11 Bankruptcy
A Chapter 11 bankruptcy functions principally through the Chapter 11 plan of reorganization that redefines the rights and obligations of the debtor and its creditors through a court-supervised voting process. Although only creditors and equity security holders are entitled to vote directly on a plan, other interested parties, called “parties in interest,” have standing under section 1109(b) of the Bankruptcy Code to voice legal objections to plan confirmation and to raise and be heard on any other issue in a Chapter 11 case. The term “party in interest” is not defined in the statute except by an open-ended, illustrative list of qualifying entities: “the debtor, the trustee, a creditors’ committee, an equity security holders’ committee, a creditor, an equity security holder, or any indenture trustee.” Pre-bankruptcy insurers of the debtor frequently seek recognition under this statute to advocate for their interests in connection with the Chapter 11 plan and the reorganization process.
Prior to the Supreme Court’s opinion in Kaiser, however, pre-bankruptcy insurers’ standing under section 1109(b) was circumscribed by the so-called “insurance neutrality” doctrine. Under this rule, insurers were not entitled to voice objections or otherwise appear to be heard in a Chapter 11 case unless the reorganization increased the insurer’s pre-petition obligations or impaired its pre-petition rights. Insurers consequently lacked standing to object to any so-called “insurance neutral” reorganization, in which insurers’ rights and obligations, including coverage defenses, were preserved.
The Supreme Court’s opinion in Truck Insurance Exchange v. Kaiser Gypsum Co. Inc., eliminates this rule and confers “party in interest” status on any insurer with a financial stake in the reorganization. This broad holding may have far-reaching consequences, particularly in circumstances where the debtor-insured faces significant litigation exposure and insurance is the primary, viable source of recovery for claimants and creditor co-defendants, which are often seeking coverage from the same insurers.
The Kaiser Gypsum Bankruptcy
In the Chapter 11 bankruptcy of Kaiser Gypsum Company (“Debtor”), the Debtor was facing significant asbestos related liability and sought to confirm an “insurance neutral” plan (“Plan”) to distribute insurance policy proceeds to tort claimants. The Plan reserved to its primary liability insurer, Truck Insurance Exchange (“Truck”),all contractual rights, defenses, and obligations under the operative policies as they existed before the bankruptcy, but required tort claimants covered by insurance to litigate their claims in state court, forcing Truck to defend and indemnify those claimants up to the applicable policy limits. Tort claims that were not covered by the Debtor’s insurance would be liquidated within the bankruptcy case, subject to the disclosure requirements applicable to asbestos liquidation trusts provided under section 524(g) of the bankruptcy code.
Truck objected to the Plan on the grounds that the disparate treatment of covered and uncovered claims was the result of collusion between tort claimants and the Debtor, unfairly deprived Truck of the section 524(g) disclosure requirements, and subjected Truck to the possibility of fraudulent and duplicative claims. The Debtor and its tort claimants opposed Truck’s objection on the grounds that the insurer lacked standing under section 1109(b). They argued that the Plan was “insurance neutral” because it preserved Truck’s contractual rights and obligations and restored Truck to its pre-bankruptcy position. The Bankruptcy Court for the Western District of North Carolina, the District Court and the Fourth Circuit all agreed, finding that Truck was obligated under the terms of its policies to defend covered claims in state court—consistent with its treatment under the Plan—and the Plan did not increase or affect Truck’s potential liability.
The Supreme Court Vitiates the “Insurance Neutrality” Doctrine
In a dramatic reversal, the Supreme Court unanimously reversed the Fourth Circuit’s decision, finding that Truck’s financial liability for the claims at issue gave it standing to object to the Plan. Focusing on the text and history of section 1109(b), the Court concluded that Truck fell within the definition of “party in interest” in the Debtor’s Chapter 11 case because it had a financial interest in the reorganization. The common thread uniting the entities illustratively enumerated under section 1109(b) (including the debtor, creditors, and the trustee), the Court opined, was that each “may be directly affected by the reorganization because they have a financial interest in the estate’s assets . . . or represent parties that do.” Id. at 7. The Court further reasoned that the history of section 1109(b) reflected Congressional intent to prevent undue restriction on who may be a party in interest to ensure that dominant interests cannot control the restructuring process. On that basis, the Court concluded that insurers with financial responsibility for bankruptcy claims constitute “parties in interest” because they have an actual financial interest in the outcome of the reorganization like the other entities enumerated in section 1109(b).
The Court acknowledged that its holding contradicted the “insurance neutrality” doctrine applied broadly in the lower courts, but the Court rejected that rule as “conceptually wrong” and without “practical sense.” Id. at 13. The Court found that it was improper for courts to focus on the actual impact of a particular plan on a particular insurer because it “conflates the merits of an objection with the threshold party in interest inquiry.” Id. The proper focus, the Court confirmed, was whether the reorganization process, including processes unrelated to plan confirmation, might conceivably impact a party’s financial interest. Even though the Plan proposed by Kaiser did not alter Truck’s pre-bankruptcy rights and obligations, the Court concluded that Truck’s financial interests were impacted by the transformation of covered liabilities into bankruptcy claims. Finally, the Court dismissed concerns, often voiced in support of the neutrality doctrine, about allowing a flood of peripheral parties to derail the reorganization process. The Court acknowledged that there may be difficult cases requiring courts to evaluate whether truly peripheral parties have sufficiently direct interests, but, insurers “such as Truck with financial responsibility for claims are not peripheral parties.” Id. at 15.
Takeaways
The implications of the Supreme Court’s ruling in Kaiser are potentially far reaching. Although not explicitly acknowledged by the Court, insurers will likely contend that Kaiser confers blanket standing on all debtors’ pre-bankruptcy liability insurers and all debtors’ creditors’ insurers across all proceedings in Chapter 11. This is because liability insurers are, by nature, responsible for covered claims against the insured party, and because a debtor often owes obligations to creditors for claims that are covered both by the debtor and by the creditor’s insurers, both of which may be responsible for bankruptcy claims. The Kaiser decision leaves the door open for insurers to argue this responsibility in itself constitutes a financial stake in the counterparty’s reorganization sufficient to confer section 1109(b) standing. Further, the Court’s focus on the “conceivable” rather than the “actual” impact of a bankruptcy proceeding in defining a “party in interest” greatly, and perhaps limitlessly, expands an insurer’s rights to participate in the reorganization process.
Even so, several important limitations remain. The right to appear and be heard under section 1109(b) does not give either debtors’ pre-bankruptcy insurers or the creditors’ insurers the right to vote on a Chapter 11 plan. Further, the Supreme Court’s holding in Kaiser did not address Article III standing. Article III standing, including the “injury in fact” requirement, may independently limit insurers’ participation in a reorganization when their interests are adequately protected. Finally, the Kaiser holding is limited to the statutory conferral of standing in a Chapter 11 case under section 1109(b); it does not directly apply to bankruptcy proceedings under other Chapters, including liquidation proceedings under Chapter 7.
Limitations aside, insureds entering bankruptcy, their co-insureds, and their creditors should expect an uptick in insurer participation in the reorganization process, particularly in mass-tort cases where insurance policies constitute the primary assets for distribution. Depending on the amount of coverage at issue and notwithstanding the insurer’s fundamental duty to place the interests of its insured ahead of its own, a debtor’s insurer may have financial incentives to influence the reorganization process; Kaiser’s abrogation of the “insurance neutrality” rule significantly expands the ability to do so. Further, the broad holding in Kaiser potentially captures non-debtor insurers (e.g., those of debtor’s tort co-defendants), who also hold a direct financial interest in the reorganization. These insurers also may have financial incentives to oppose settlements between creditors and the debtor’s insurers, despite their contractual coverage obligations, potentially triggering a new flood of bad-faith insurance litigation.
In light of the changes wrought by Kaiser, debtors and creditors should more carefully consider coverage issues arising from the reorganization process and should work with coverage counsel to maximize the value of insurance assets in bankruptcy.
