A recent decision by the Bankruptcy Court for the Southern District of New York in the In re Frontier Insurance Group cases examines the limitations on the deference bankruptcy courts are required to afford to state insurance laws and proceedings. The Frontier Insurance decision is the latest development in a lengthy dispute over the ownership of real property between a reorganized debtor emerged from bankruptcy and the New York State liquidator of the debtor’s wholly-owned insurance subsidiary.

Case Background

Between 1993 and 1997, the debtor, its insurance subsidiary and a county development authority entered into a series of installment sale agreements whereby legal title to certain real property (referred to as the Rock Hill Property) was conveyed to the development authority until February 2014, in exchange for certain tax benefits. At the conclusion of the prescribed time period, the development authority was required to re-convey the Rock Hill Property to the entity originally owning such property. [Spoiler alert: there is a dispute between the reorganized debtor and the insurance subsidiary as to which of them is entitled to the return of the property.]

The development authority held the property for a long time, and a lot can (and did) happen while it held the property. Both the debtor and its insurance subsidiary encountered financial difficulties. The insurance subsidiary became the subject of a rehabilitation proceeding under New York Insurance Law before the Albany County Supreme Court, and the debtor filed for bankruptcy relief under chapter 11 of the Bankruptcy Code.

In its bankruptcy case, the debtor listed the Rock Hill Property as property of the estate on its schedules and, when its plan of reorganization became effective, that estate property vested in the reorganized debtor – or so the reorganized debtor has alleged. Soon after the plan’s effective date, the debtor’s chapter 11 case was closed.

As to the insurance subsidiary, in late 2012, the Albany County Supreme Court converted its rehabilitation proceeding into a liquidation proceeding. After the conversion, a statutorily-appointed liquidator was tasked with liquidating the insurance subsidiary’s business and, to that end, began preparing to sell the Rock Hill Property. The reorganized debtor filed a claim in the liquidation proceeding asserting that it, not the insurance subsidiary, owned the Rock Hill Property. The liquidator disagreed and a dispute soon arose between the reorganized debtor and the liquidator, each claiming a reversionary interest in the property.

On February 24, 2014, the liquidator petitioned the Albany County Supreme Court to resolve the reorganized debtor’s claim in the liquidator’s favor and convey the Rock Hill Property to the liquidator. Before the proceedings could progress, however, the reorganized debtor removed the action to the United States District Court for the Northern District of New York and asserted counterclaims against the liquidator for title of the Rock Hill Property. The liquidator responded by filing a motion to remand the action to the Albany County Supreme Court. The reorganized debtor countered again, seeking to reopen its bankruptcy case for the bankruptcy court to resolve the issue. The bankruptcy court granted the reorganized debtor’s request, and on June 11, 2014, the action was transferred to the bankruptcy court along with the liquidator’s motion to dismiss and remand.

Bankruptcy Court Analysis

Parties’ Arguments. The reorganized debtor initially sought to reopen its chapter 11 case to move the bankruptcy court to enforce the provisions of its confirmed plan of reorganization, which the reorganized debtor contended vested in it the reversionary interests in the Rock Hill Property. With this contention in mind, the reorganized debtor responded to the liquidator’s motion to dismiss and remand in the reopened chapter 11 case by alleging that the liquidator’s attempt to claim ownership of, and sell the Rock Hill Property was a collateral attack on the bankruptcy court’s confirmation order. The liquidator, on the other hand, painted a very different picture, arguing that the bankruptcy court was either precluded by the McCarran-Ferguson Act from hearing the case, or, in the alternative, should abstain.

Court’s Analysis. In considering the liquidator’s preclusion argument, the bankruptcy court found that it was not barred by the McCarran-Ferguson Act from deciding the issues before it. Under the McCarran-Ferguson Act, federal law, including the Bankruptcy Code, will be reverse preempted by state insurance law if: (i) the federal statute does not specifically relate to insurance; (ii) the state law at issue was enacted to regulate the business of insurance; and (iii) federal statute at issue would invalidate, impair, or supersede the state law. See In re MF Global Holdings Ltd., 469 B.R. 177, 194 n.17 (Bankr. S.D.N.Y. 2012). While it conceded the first two elements, the bankruptcy court ultimately concluded that its adherence to the Bankruptcy Code – i.e., interpreting the plan and its confirmation order – would not “invalidate,” “supersede” or “impair” the state court liquidation proceeding or law, even if the insurance subsidiary’s estate would be reduced by such a determination.

Expanding on this reasoning, the bankruptcy court similarly disregarded the liquidator’s various abstention arguments. The court explained that it would not be inappropriately venturing into an area of state statutory regulation by exercising jurisdiction over this case. Rather, the bankruptcy court re-emphasized that it would only be interpreting its own confirmation order, and not issuing a determination with respect to the actual ownership of the real property. Specifically, the bankruptcy court stated that its sole responsibility was to determine whether the real property did, in fact, vest in the reorganized debtor under the confirmed plan, and, as such, whether res judicata attached or the insurance subsidiary was enjoined from bringing claims against the reorganized debtor.

The bankruptcy court held that a potential reduction in the assets available to an insolvent insurer resulting from a bankruptcy court’s interpretation of its own order does not, on its own, constitute an impairment of a state court liquidation proceeding that requires abstention. Accordingly, given the fact that the overall process by which New York’s regulation of insurers would remain intact, the bankruptcy court found the liquidator’s arguments insufficient to warrant abstention or the dismissal and remand of the case.

Takeaway

The McCarran-Ferguson Act generally preserves the authority of the states to regulate insurance. Therefore, federal law cannot invalidate, supersede or impair state law. Whether an action in federal court would result in an improper novation of state law is typically a matter left to the federal court’s discretion. In this instance, the bankruptcy court asserted that it was simply interpreting its own order, not venturing into an area of state statutory regulation, and was thus not precluded or under any obligation to abstain from considering this matter.