Opinion
01 Civ. 2966 (JGK)
January 25, 2002
OPINION AND ORDER
On January 25, 2001, the plaintiff-appellee Alan Cohen, as Chapter 11 Trustee ("Trustee") for the debtor County Seat Stores, Inc., brought an adversary proceeding (the "Coverage Proceeding" or the "Coverage Action") in the United States Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court") against the defendant-appellant National Union Fire Insurance Company of Pittsburgh, Pa. ("National Union") to determine the scope of an insurance policy (the "Policy" or the "DO Policy") that National Union had issued to County Seat. The Coverage Action seeks to establish that certain of County Seat's former directors and officers ("Directors and Officers") are covered for any damages that the Trustee might establish in a separate adversary proceeding (the "Underlying Action") brought in the Bankruptcy Court against the Directors and Officers. National Union moves pursuant to 11 U.S.C. § 157 (d) to withdraw the reference of the Coverage Action from the Bankruptcy Court.
I.
Most of the relevant facts in this case have been set forth in this Court's prior Order dated April 26, 2001, familiarity with which is assumed. The following facts are either undisputed or matters of public record, unless otherwise indicated.
The defendant-appellant National Union Fire Insurance Company of Pittsburgh, Pa. ("National Union") is an insurance company that issued an insurance policy (the "Policy" or "DO Policy") to the County Seat Stores, Inc. ("County Seat" or the "Company"). The DO Policy covers the period from September 25, 1998 to September 27, 1999 (the "Policy Period"), and provides two main types of coverage. See DO Policy at 1, attached as Attachment 2 to Ex. A to the Affidavit of Ronald H. Alenstein in Support of Defendant's Motion to Withdraw the Reference ("Alenstein Aff."). The first, entitled "Coverage A," is liability coverage for County Seat's directors and officers during the Policy Period and covers, in relevant part,
the Loss of each and every Director or Officer of the Company arising from a Claim first made against the Directors or Officers during the Policy Period or the Discovery Period (if applicable) . . . for any actual or alleged Wrongful Act in their respective capacities as Directors or Officers of the Company, except when and to the extent that the Company has indemnified the Directors or Officers.
DO Policy ¶ 1. The second, entitled "Coverage B" or "Corporate Liability Insurance," provides coverage for any:
Loss of the Company arising from a (i) Securities Claim made against the Company, or (ii) Claim first made against the Directors or Officers during the Policy Period or the Discovery Period (if applicable) . . . for any actual or alleged Wrongful Act, but in the case of (ii) above only when and to the extent that the Company has indemnified the Directors or Officers for such Loss pursuant to law, common or statutory, or contract, or the Charter or By-laws of the Company duly effective under such law which determines and defines such rights of indemnity.Id. The Policy provides for an aggregate cap of $25,000,000 in coverage.Id. at 1.
The DO Policy also contains a number of explicit exclusions. One such exclusion is central to the present case and is called the "Insured v. Insured Exclusion". This exclusion denies coverage for any "Loss in connection with a Claim made against an Insured . . . which is brought by any Insured or by the Company; or which is brought by any security holder of the Company, whether directly or derivatively, unless such security holder's Claim is instigated and continued totally independent of, and totally without the solicitation of, or assistance of, or active participation of, or intervention of, any Insured or the Company . . . ." DO Policy ¶ 4(i).
The procedural history in this case is complex and began on January 22, 1999, when County Seat and CSS Tradenames, Inc. filed a second voluntary petition for Chapter 11 relief with the Bankruptcy Court, during the Policy Period in question. The Bankruptcy Court appointed the plaintiff-appellee Alan Cohen as Trustee of the estate on March 12, 1999. The Trustee then brought an adversary proceeding (the "Underlying Action") before the Bankruptcy Court on September 20, 2000, naming certain of County Seat's former directors and officers, including Sam Forman, Brett Forman, and Paul Roth (the "Directors and Officers" or the "Intervenors") as defendants. This action, which seeks damages in excess of $100 million, alleges that the Directors and Officers caused County Seat's bankruptcy and liquidation by committing a number of acts in their official capacities that amounted to breaches of fiduciary duty, corporate waste and mismanagement, and fraudulent conveyance. Soon after the Underlying Action was filed, the Unsecured Creditors' Committee (the "Committee") joined the Underlying Action as a plaintiff.
The Directors and Officers then tendered the Underlying Action to National Union as a claim under the DO Policy. By letters dated September 28, 2000 and October 6, 2000, National Union denied coverage, citing the Insured v. Insured Exclusion and asserting that the exclusion applies because the claims raised in the Underlying Action allegedly belong to, and can only be asserted on behalf of, County Seat, which is both the "Company" and an "Insured" under the DO Policy. See Alenstein Aff. ¶¶ 5, 6. On January 5, 2001, National Union filed a Demand for Arbitration against the Directors and Officers with the American Arbitration Association ("Arbitration Action"), seeking a declaration that National Union's proposed interpretation of the Insured v. Insured Exclusion was correct. Id. ¶ 7.
The Trustee responded on January 25, 2001, by commencing the present Adversary Proceeding (the "Coverage Proceeding" or "Coverage Action") against National Union before the Bankruptcy Court seeking a declaration that the DO Policy is property of the estate under 11 U.S.C. § 541, that the Insured v. Insured Exclusion does not apply to the claims raised in the Underlying Action, and that National Union violated the automatic stay provision in section 362 of the Bankruptcy Code by commencing the Arbitration Action without first seeking relief from the automatic stay that had come into effect when County Seat filed for reorganization. The Trustee and the Committee also filed a motion to enforce the automatic stay. On February 15, 2001, the Bankruptcy Court granted this motion. The Bankruptcy Court also, however, invited National Union to move for relief from the automatic stay so as to continue arbitrating the underlying coverage dispute. On March 13, 2001, the Trustee moved for Partial Summary Judgment with respect to the coverage dispute.
On March 22, 2001, the Bankruptcy Court entered a final order finding that the Arbitration Action violated the automatic stay. National Union then filed an appeal from that order.
On March 23, 2001, National Union moved before the Bankruptcy Court for a stay of the Coverage Action pending appeal. The Bankruptcy Court denied the motion. On April 4, 2001, National Union made a similar motion by Order to Show Cause before this Court. This Court denied the motion on April 26, 2001.
While National Union and the Trustee were disputing these matters, the Directors and Officers moved to intervene in the Coverage Action. The Bankruptcy Court granted this motion on March 30, 2001, and the Directors and Officers filed an Intervenors' Complaint with the Bankruptcy Court on April 6, 2001. On that same day, the Directors and Officers moved independently for Partial Summary Judgment with respect to the applicability of the Insured v. Insured Exclusion to the claims raised in the Underlying Action. The Bankruptcy Court scheduled oral argument on the two summary judgment motions for May 2, 2001.
On April 19, 2001, approximately two weeks before the oral argument, National Union filed a motion with the Bankruptcy Court to lift the automatic stay and allow arbitration of the coverage dispute. National Union simultaneously filed a motion with this Court to withdraw the reference of the Coverage Proceeding from the Bankruptcy Court, pursuant to 11 U.S.C. § 157 (d). This is the motion that is currently pending before this Court.
On October 10, 2001, this Court held a status conference with the parties and heard oral argument on National Union's appeal and motion to withdraw the reference. At the conference, the parties indicated that the Bankruptcy Court had not yet decided the motion to lift the stay and had directed the parties to try mediating their dispute in the intervening period. (See Tr. dated Oct. 10, 2001, at 3.) The parties also indicated that while they had been pursuing mediation for some time, they had reached an impasse just as they received notice from this Court scheduling oral argument. (Id.) However, the parties have recently advised the Court that they have agreed to withdraw the pending appeal and all motions before the Bankruptcy Court seeking to stay and/or compel arbitration of the underlying coverage dispute. The only matter pending before this Court is the motion to withdraw the reference of the Coverage Action. If the reference were withdrawn, the motions for summary judgment pending before the Bankruptcy Court on application of the Insured v. Insured Exclusion would be decided by this Court. The Bankruptcy Court has indicated that it is prepared to decide those motions.
II.
National Union moves for this Court to withdraw the reference of the Coverage Action, which was originally filed by the Trustee against National Union to determine the applicability of the Insured v. Insured Exclusion to the Underlying Action. The Directors and Officers opposed this motion in their briefs but indicated at oral argument and in subsequent correspondence that they no longer oppose the motion. The Trustee and the Unsecured Creditors Committee continue to oppose the motion.
Under 28 U.S.C. § 157 (d), a "district court may withdraw . . . any case or proceeding referred [to the bankruptcy court] on its own motion or on a timely motion of any party, for cause shown." The statute does not define the term "cause," but the Second Circuit Court of Appeals has identified a number of relevant factors, including: (i) whether the proceeding is core or non-core; (ii) judicial economy; (iii) uniformity of bankruptcy administration; (iv) economical use of debtors' and creditors' resources; (v) reduction of forum shopping; (vi) expediting the bankruptcy process; and (vii) the presence of a jury demand. See Orion Pictures Corp. v. Showtime Networks, Inc., 4 F.3d 1095, 1101 (2d Cir. 1993).
The threshold inquiry is whether a claim is core or non-core because that determination can affect the remainder of the analysis. See id. For example, non-core proceedings are subject to de novo review, see 28 U.S.C. § 157 (c)(1), and, hence, withdrawing the reference for these matters may be an efficient procedure to avoid unneeded duplication of judicial effort. Id. These considerations are generally absent in the case of core proceedings, which Bankruptcy Courts can adjudicate to final binding judgment, and which often involve matters within a bankruptcy court's particular expertise.
A.
The core/non-core distinction derives from Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982), which held that the 1978 Bankruptcy Act violated Article III of the United States Constitution because it vested bankruptcy judges, who lack the Article III protections of life tenure and protections against salary diminution, with the power to adjudicate legal disputes that had little to do with core bankruptcy functions. The four-member plurality emphasized that "the restructuring of debtor-creditor relations, which is at the core of the federal bankruptcy power, must be distinguished from the adjudication of state-created private rights, such as the right to recover contract damages . . . ." Id. at 71. In response to Marathon, Congress enacted 28 U.S.C. § 157, which classifies matters as either "core proceedings" or "non-core proceedings," see Orion, 4 F.3d at 1100-01, and provides a nonexclusive list of proceedings that are "core proceedings." See 28 U.S.C. § 157 (b)(2). In this Circuit, the Court of Appeals has held that the bankruptcy courts' core jurisdiction should be construed as "close to or congruent with the constitutional limits" set forth in Marathon, and that Marathon is to be construed narrowly. In re United States Lines, Inc., 197 F.3d 631, 636-37 (2d Cir. 1999); see also Resolution Trust Corp. v. Best Products Co. (In re Best Products Co.), 68 F.3d 26, 31 (2d Cir. 1995) (noting that the sponsors of the 1984 Bankruptcy Code revisions "repeatedly said that 95 percent of the proceedings brought before bankruptcy judges would be core proceedings"). The mere fact that a claim is based on state law will not by itself render it non-core. See 28 U.S.C. § 157 (b)(3)
Whether a contract proceeding is a core proceeding depends on: (1) whether the contract is antecedent to the reorganization petition and (2) the degree to which the proceeding is independent of the reorganization. The latter inquiry depends, in turn, on "the nature of the proceeding."United States Lines, 197 F.3d at 637. A proceeding can be core by virtue of its nature if the type of proceeding is "uniquely affected by the bankruptcy proceedings" or if the proceeding "directly affect[s] a core bankruptcy function," such as administering the orderly and equitable distribution of the estate's assets. Id. at 637.
This case involves a post-petition cause of action brought on the basis of a pre-petition insurance contract that covers the debtor and its former Directors and Officers for claims raised against them arising out of actions by the Directors and Officers. The Underlying Action alleges claims for fraudulent and preferential transfers, and for money damages resulting from alleged breaches of the fiduciary duties of the Officers and Directors. This case is thus very similar to United States Lines, 197 F.3d at 631, in which the Court of Appeals had to decide the core or non-core status of an action for declaratory judgment seeking to determine a debtor's coverage under a pre-petition insurance policy for claims raised by a number of personal injury victims, some of which claims accrued post-petition. As the Court of Appeals noted, the fact that the parties executed the policy pre-petition weighed against its core status. See id. at 638. Moreover, the Court noted that in Orion, where the insurance proceeds subject to dispute would only "augment the assets of the estate for general distribution," the Court had found this effect on the administration of the estate to be insufficient to render the proceeding core. Id.
However, the Court of Appeals also noted that in the bankruptcy context, where a debtor is faced with substantial liability claims within the coverage of an indemnity policy, "resolving disputes relating to major insurance contracts are bound to have a significant impact on the administration of the estate." Id. The Court noted that the insurance proceeds in question were "almost entirely earmarked for paying the personal injury claimants" and represented "the only source of cash available to that group of creditors." Id. Finally, the Court found that the bankruptcy court would have great difficulty trying to distribute the assets of the estate in an equitable manner without first knowing whether these particular creditors would be entitled to indemnification under the policy. The Court concluded that the action was core by virtue of its nature because it might "directly affect the bankruptcy court's core administrative function of asset allocation among creditors . . . ." Id. at 639.
National Union argues that United States Lines is distinguishable from the present case because it involved a policy with a "pay-first provision," under which the debtor was required to pay any personal injury claims out of its own funds before the insurer's indemnification obligations were triggered under the policy, thereby leading to some difficulties in paying such claims and uncertainty with respect to reimbursement. However, what was critical in United States Lines was not that the policy contained a pay-first provision but rather that the bankruptcy court could not easily proceed with its core function of effecting an equitable reorganization without deciding the coverage dispute in the case. See id. at 639.
In the present case, the Trustee and the Directors and Officers allege that the DO Policy covers the Directors and Officers for the claims brought against them in the Underlying Action. The resolution of that dispute will determine whether the debtor will be subject to the indemnification claims of the Directors and Officers, potentially reducing the estate for other creditors, or whether the insurance proceeds will fund such indemnification expenses. The insurance proceeds available to pay any liability of the Directors and Officers in the Underlying Action, up to $25 million, may also be the most important asset of the estate. It would also be difficult for the Trustee to decide questions relating to the distribution of assets among creditors without a decision in the Coverage Action. For example, the Directors and Officers have sought to be paid for the substantial costs of defending the Underlying Action, to which they may or may not be entitled, and for which National Union may or may not be liable under the Policy. Any attempt to distribute funds from the estate in advance of a resolution of the Coverage Action could lead to inequitable distributions later. Hence, the Bankruptcy Court would have great difficulty administering an orderly and equitable distribution of the estate's assets without determining whether this asset was in fact available.
In sum, in this case, United States Lines controls and the Coverage Action is core because it threatens to affect a core bankruptcy function in a direct manner.
A number of courts have also found that post-petition disputes on pre-petition insurance contracts are core as a matter of law. See, e.g., Hirsch v. London Steamship Owners' Mutual Life Ins. Co. (In re Seatrain Lines, Inc.), 198 B.R. 45, 51 (S.D.N.Y. 1996) (Sotomayor, J.); In re Century Brass Products, Inc., Misc. Civ. No. 2:91-79X, 1992 WL 22191, at *2-3 (D. Conn. Jan. 7, 1992) (Cabranes, J.); Valley Forge Plaza Assocs. v. Fireman's Fund Ins. Cos., 107 B.R. 514, 518 (E.D. Pa. 1989) (L. Pollack, J.); see also United States Lines, 197 F.3d at 641-43 (Newman, J. concurring). However, it is currently unsettled in this Circuit whether such actions are core as a general rule. See, e.g., United States Lines, 197 F.3d at 641. It is unnecessary to decide this issue here because the claim is core under United States Lines, for the reasons discussed above.
B.
The fact that a claim is core does not necessarily decide the withdrawal analysis. See Hirsch v. London Steamship Owners' Mutual Life Ins. Co. (In re Seatrain Lines, Inc.), 198 B.R. 45, 53 (S.D.N.Y. 1996). However, it does strongly suggest that there is no cause to withdraw the reference, see id., and the other factors identified by the Court of Appeals in Orion also support denying the motion to withdraw.With regard to judicial economy, the Bankruptcy Court has been involved in the current coverage disputes ever since the Trustee brought the Coverage Action in January 2001. The Bankruptcy Court has already decided a number of motions pertaining to this dispute and is now well versed in both the procedural history and the facts of this case. The Bankruptcy Court is also adjudicating the Underlying Action and has had summary judgment motions pending from the Trustee and the Directors and Officers related specifically to the coverage disputes in this case since March 22, 2001 and April 6, 2001, respectively. Indeed, the Bankruptcy Court has indicated to the parties that it is prepared to decide the motions but is awaiting a decision from this Court on the motion to withdraw the reference. It would be an inefficient use of judicial resources to withdraw this proceeding from the Bankruptcy Court at this point and lose the advantage of its views on this dispute.
The dispute in question also concerns interpretation of the "Insured v. Insured Exclusion." Although this is primarily a state law question of contract interpretation, its answer will depend in part on whether the Trustee is better viewed as representing the Company or its creditors in the Underlying Action. Whether the Exclusion applies may also depend in part on the role that other parties, such as the Unsecured Creditors' Committee, are playing in the Underlying Action and on the claims that have been raised in it. These are questions that involve the expertise of the Bankruptcy Court. In these circumstances, judicial economy would be better served by allowing the Bankruptcy Court to decide the coverage dispute along with the other proceedings.
Moreover, any adjudication by this Court of the scope of the Insured v. Insured Exclusion to the claims raised in the Underlying Action could interfere with the Bankruptcy Court's attempt to administer a unified and equitable plan for reorganization. Allowing the Bankruptcy Court to adjudicate the Coverage Action will, by contrast, help ensure uniformity in the various proceedings among all the parties and help prevent inconsistent judgments. Adjudication of these matters in a single forum will also make litigation of the underlying disputes more economical for both the debtor and its creditors. These efficiencies are particularly important in the bankruptcy context because County Seat's creditors have been forced to enforce their rights in a context of scarce and diminishing assets.
These factors alone would be sufficient to decide against withdrawing the reference of the Coverage Action in this case, even if this proceeding were non-core. The fact that these proceedings are core nevertheless provides additional support for this conclusion. See In re Orion, 4 F.3d at 1101.
In sum, there is no cause to withdraw the reference in this case.
III.
The Court has considered all the other arguments raised by the parties and finds them to be either moot or without merit. National Union's motion to withdraw the reference of the Coverage Proceeding is denied.
SO ORDERED.