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A recent case decided by the United States Court of Appeals for the Eleventh Circuit demonstrates the continuing uncertain relationship between proceeds of whole life insurance policy and bankruptcy estates. As long as courts continue to decide these issues by applying analyses which are fact specific to the insurance policy involved, the door will remain open for creative - and mischievous - litigation strategies.
In Ford Motor Credit Company v Stevens, 130 F 3d 1027, a Trustee was permitted to recover from a secured creditor an alleged overpayment as a loss payee under an insurance policy. The creditor was secured by a pick-up truck. When the truck was destroyed in an accident after bankruptcy, the creditor collected the full amount of remaining debt directly from the insurer. The creditor's claim under the policy was calculated at the higher interest rate under the original loan agreement (13.5%), rather than at the lower interest rate provided in the bankruptcy plan (12%).
Both parties agreed that the truck and the insurance policy itself were "property of the estate" The creditor argued, however, that because it was a loss payee, the policy proceeds are not property of the estate. Accordingly, it was entitled to recover from the insurer the full amount of its debt reflecting the original contract interest rate.
The Court held that even though the insurance policy is property of the estate, the policy proceeds are not necessarily so. It recognized that sometimes a creditor or beneficiary other than the debtor may be entitled to the proceeds of an insurance policy that is property of the estate. But, the Court stated that to determine the parties respective rights to policy proceeds, it must consider the "nature and type of the insurance policy involved, and its relationship to the property of the bankruptcy estate" Where the debtor has an interest in the policy proceeds, they are considered property of the estate and must be distributed according to the confirmed bankruptcy plan.
Since the policy in Sevens was intended to cover both the debtor owner as well as the creditor in the event of destruction of the truck, the policy proceeds acts as a substitute for the creditor's collateral. The Court reasoned that the creditor's interest in the policy proceeds flowing from the destruction of the collateral is only as great as its interest was defined at the time of the confirmation of the bankruptcy plan as the remaining principal owed with an interest rate of 12%. Since the creditor was bound by the term of the bankruptcy plan it was, therefore, limited to recovering from the policy proceeds the amount of its allowed claim as determined by the bankruptcy plan. Because the policy proceeds were a substitute for the original collateral, the creditor was not recover more than the amount of its secured claim as allowed under the bankruptcy plan and, accordingly, was required to turn over the excess to the Trustee.
By focusing on the "nature and type of insurance policy involved, and its relationship to the property of the bankruptcy estate; courts apply a fact specific analysis of each insurance policy on a case-by-case basis. This allows insurers, debtor-insured's and creditor-claimants to assert various rights in policy proceeds in the context of bankruptcy cases.
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