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Delaware Bankruptcy Court Holds That Discharge Does Not Affect Additional Insured’s Rights to Pursue Indemnification Against Debtors’ Insurer

In re SelectBuild Illinios, LLC, Case No. 09-12085 (KJC), 2015 WL 3452542 (Bankr. D. Del. May 28, 2015)

The Delaware Bankruptcy Court recently denied a Motion to Enforce a Permanent Injunction against a contract counterparty, The Ryland Group, Inc. d/b/a Ryland Homes (“Ryland”), and held that Ryland could seek indemnification as an additional insured from the Reorganized Debtors’ insurer, ACE American Insurance Company (“ACE”).

By way of background, Ryland and debtor SelectBuild Illinois, LLC (“SelectBuild”) entered into a construction contract whereby SelectBuild would perform work as a subcontractor for Ryland.  The contract required SelectBuild to indemnify Ryland in certain circumstances and to maintain certain insurance, including naming Ryland as an additional insured for work performed for Ryland.  SelectBuild chose ACE as the insurer to meet this obligation.  Selectbuild’s obligations to ACE were secured by two irrevocable standby letters of credit.  During the construction project, three of the Debtors’ employees were injured at a Ryland construction site.  The employees filed various claims against SelectBuild and were paid in full in light of the high deductible on the Debtors’ workers’ compensation policy.

Thereafter, the Debtors filed for bankruptcy and a proof of claim bar date was established.  Ryland received notice of the bar date but did not file a proof of claim.   The Debtors later confirmed a plan, which included a full discharge and discharge injunction in favor of the Debtors.  The confirmed plan also included a provision that prepetition letters of credit shall continue to collateralize all obligations under insurance policies and agreements. Following full administration of the Debtors’ cases, a Final Decree was entered and the cases were closed.

While the Debtors’ bankruptcy cases were ongoing, the Debtors’ injured employees filed a state court action against Ryland.  As a result, Ryland sent letters to the Debtors and ACE to tender Ryland’s defense in the state court action in accordance with the indemnification language in the contract.  In response, the Debtors retained counsel to defend Ryland.

Later, the Reorganized Debtors filed a Motion to Reopen the Chapter 11 Case to enforce the discharge and plan injunction.  The Reorganized Debtors argued that the plan’s discharge injunction prevented Ryland from seeking indemnification as an additional insured with ACE.  First, the Reorganized Debtors contend that the indemnification claim is an attempt to collect on a prepetition claim for which no proof of claim was filed.  Second, the Reorganized Debtors argue that Ryland’s claim against ACE is actually a claim against the Debtors’ estates because the indemnification claim will trigger a claim by ACE against the Debtors for the $1.9 million deductible, which is secured by the letters of credit.  Finally, the Reorganized Debtors assert that because the amount of the deductible and limit of insurance per occurrence are the same, the Debtors are effectively self-insured, and the claim for indemnification is a way to work around the discharge injunction.

Ryland, on the other hand, asserts that the discharge injunction does not bar an indemnification claim because Ryland is an additional insured under the ACE policy, therefore holding independent rights against ACE.  Ryland also contends that even if the indemnification claim is against the Debtors, it is a post-petition claim that was not subject to the discharge because the injured employees did not file a complaint until after the bankruptcy was filed.

The Third Circuit Court of Appeals has addressed the issue of when an indemnification claim arose and most recently ruled that “a claim arises when an individual is exposed pre-confirmation to a product or other conduct giving rise to injury that underlies a ‘right to payment’ under the Code.”  Wright v. Owens Corning, 679 F.3d 101, 107 (3d Cir. 2012) (emphasis in original).  The Bankruptcy Court held that any indemnification claim would be a pre-petition, contingent claim, arising when the contract was signed.  Accordingly, the Court found that if Ryland wanted to make an indemnification claim against the Debtors, Ryland should have filed a proof of claim.

Ryland, however, sought indemnification from ACE, not the Debtors.  Numerous courts have held that the discharge injunction does not extend to third parties and does not extinguish the debt itself, just a debtor’s obligation for the debt.  Nevertheless, the Reorganized Debtors assert that Ryland’s claim will trigger the obligation to pay the $1.9 million deductible under the ACE policy, which is secured by the letters of credit.  The Court disagreed with the Reorganized Debtors and held that Ryland’s status as an additional insured created independent contractual rights between Ryland and ACE.  The fact that Ryland’s claims against ACE may ultimately be the Debtors’ responsibility or cause ACE to draw on the letters of credit did not persuade the Court.  Next, the Court found that the continued collateralization of the deductible obligations was a specific commitment made in the confirmed plan and did not bar Ryland’s right to assert an independent claim as an additional insured against ACE.  Finally, the Court was not moved by the Debtors’ reference to other parties in the case which were granted motions to extend the bar date upon the condition that those claimants agree to satisfy any deductible that the Debtors might be obligated to pay.  Because Ryland was not seeking to pursue a claim against the Debtors, the Court dismissed that argument.