Monthly Archives: May 2014

Selection of Counsel Disputes Between Insureds and Insurance Company

Most businesses know that one of the first things it should do when it is sued, is to forward a copy of the petition or complaint to all potential insurers to put the insurance company on notice of the claim. The next question is who has the right to select counsel to represent the insured/company. Most insureds have “go to” lawyers or law firms, but those lawyers or firms are not always on an insurance company’s approved list. The proliferation of “captive” law firms, which are paid lower rates by insurance companies, is making the selection of counsel a more common dispute between the insured and the insurance company.

This dispute between insurer and insured can create tension because an insured is likely to prefer its own counsel to a likely unknown “captive” firm which solely takes cases assigned by the insurance company. Tension also arises if an insured has a high self-insured retention (SIR) and risks having to change counsel half-way through a complicated case. If, as discussed below, an insured decides to use its preferred firm over objection of the insurance company, it can risk not being reimbursed for legal fees incurred in the defense of the claim.

Once an insurance company accepts defense of a lawsuit, the policy usually gives the insurance company the right to conduct the defense of the case. Included in this right to conduct the defense is the right to choose counsel for the insured. However, Texas law has traditionally supported an insured’s right to select its own counsel, at the insurer’s expense, when there is a question of coverage based on the claims in the complaint or petition. A potential conflict of interest is a common occurrence which commences on the insurance company’s decision to send a reservation of rights letter to its insured. Obviously, there is a conflict of interest if a lawyer needs to prove certain facts in the defense of the lawsuit, but it is those same facts which may later defeat coverage in a subsequent coverage dispute. The lawyer is in a difficult position if his bills are paid by the insurer and the litigation plan is being directed by the insurer, yet the lawyer’s fiduciary duties run to its client, the insured.

While there is a certain line of Texas cases which stated that if an insurer offers a defense under a reservation of rights, then the insured is entitled to select its own counsel at the insurance company’s expense.  However, the Fifth Circuit recently clarified that this was not a per se rule. Further, in order for there to be a conflict of interest, the facts to be decided in the underlying liability lawsuit must be the same facts on which coverage depends. An example of such a conflict would occur if the policy excludes fraud. An insured may have reason to be concerned if the lawyer (paid for by the insurance company) directs the defense in a way that may allow for a finding of fraud – a result that would absolve the insurance company for liability for any judgment. In this example, the facts to be decided in the underlying suit (negligence) would be the same facts on which coverage depends. Fifth Circuit and Texas Supreme Court cases would allow an insured to select its own counsel, at the insurer’s expense, only if the conflict rose to this level.

The Court did emphasize that the lawyers hired by the insurance company must not diverge from their duties to the insured. However, these duties may not cure the concern of an insured who is questioning whether the lawyer is acting in its best interests rather than the interests of the insurance company. An insurer can select its own counsel but runs the risk of footing the bill if it is later decided that a true conflict did not exist.

 

Bankruptcy Court’s Equitable Powers Not Unlimited

Lest we forget, the U.S. Supreme Court recently reminds us that Bankruptcy Courts, unlike other federal courts, are courts of equity and law; however, while bankruptcy judges have a great deal of discretion to carry out the philosophy and purpose of the Bankruptcy Code, that power is constrained.

In Law v. Siegel, the Supreme Court examined whether a bankruptcy court exceeded its authority under section 105(a) of the Bankruptcy Code and its inherent powers by authorizing the chapter 7 trustee to “surcharge” the debtor’s homestead exemption to defray litigation costs incurred in an adversary proceeding brought against the debtor. Section 105(a) permits a bankruptcy court to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions” of the Bankruptcy Code.

The debtor listed his house as exempt and encumbered by two liens and, therefore, represented that there was no non-exempt value in the house and it was of no economic benefit to the bankruptcy estate. The trustee objected, alleging that one of the asserted liens was a sham, won, and, in doing so, incurred over $500,000 in legal fees. The trustee moved to surcharge the homestead exemption to pay these fees. The bankruptcy court permitted the surcharge and was affirmed on appeal. However, the Supreme Court was not so inclined to permit the surcharge.

Justice Scalia, writing for a unanimous Supreme Court, reinforced that “in exercising [its authority under section 105] and inherent powers, a bankruptcy court may not contravene specific statutory provisions.” In the context of exemptions, the Bankruptcy Code plainly states that exempt property “is not liable” for the payment of “any administrative expense” (see 11 U.S.C. § 522(k)). The Court held that the bankruptcy court’s surcharging the debtor’s exemption ran afoul of the prohibition stated in section 522(k), as the trustee’s attorney’s fees were “indubitably an administrative expense.” The Court also observed that the “carefully calibrated exceptions and limitations” to the exemption statute are further proof that the courts do not have discretion to disturb a debtor’s exemption based on other equitable considerations.

The decision acts as a reminder that a bankruptcy court’s discretionary authority to act is not unlimited, particularly when constitutes taking action which is prohibited by the Bankruptcy Code. In so holding, the Supreme Court, revisited its decision in Marrama v. Citizens Bank (2007). In Marrama, the Supreme Court held that a bankruptcy court had inherent equitable powers that did not depend on section 105(a) and rejected the argument that a bankruptcy court’s equitable powers were confined by specific provisions of the Bankruptcy Code. While Law does not directly overrule Marrama, it recharacterizes Marrama’s equity analysis, labeling it as mere “dictum” and holds that a bankruptcy court’s inherent non-section 105 equitable power are limited to those which it “may also possess” (emphasis supplied).

What lesson is learned from all of this? Bankruptcy court’s have neither the inherent nor statutory equitable power to contravene specific provisions of the Bankruptcy Code. Bankruptcy Courts, non-Article III courts, are once again reminded of their place and that section 105(a) is not a broad mandate of equitable authority for the purpose of seeking or providing relief that contravenes the letter of the Bankruptcy Code.

Responding to Preference Demand Letters- a Primer

A debtor’s bankruptcy is never a good thing (usually it means little or no payments on the debt will be forthcoming). Even greater insult to this injury is to receive a demand letter from a chapter 7 Trustee asking that you return funds paid to you by the account debtor in the days or months preceding the bankruptcy filing, which you have undoubtedly already used. This un-Godly process typically begins with the receipt of a letter from the chapter 7 Trustee or his law firm advising that their review of the debtor’s books and records indicate an avoidable transfer has taken place and the funds should be returned or litigation will ensue. The demands – or dare I say “shake-downs” – often include a proposal for settlement. Before you whip out your check book and return your “hard earned” – or at least hard fought/sought for – money, you should consult with a bankruptcy attorney to find out (a) if the transaction at issue actually qualifies as a preference transfer, (b) whether and to what extent applicable statutory defenses may be available, and (c) your possible negotiation strategy.

A. What is a Preference?

Preferential transfer law is a creature of Congress as part of the Bankruptcy Code’s attempt to level the playing field for all creditors by not allowing one creditor to be favored (receive more) than it would have received if it were to wait in line with all of the other creditors in the debtor’s bankruptcy case. Some States have assignment for benefit of creditor statutes that contain similar provisions, but none of these compare the avoiding punch of section 547 of the Bankruptcy Code.

Simply put, a preference is a payment (called a “transfer”) of some property (usually cash represented by a check but can also be real or other personal property) of the debtor (important factor – it must be the debtor’s property) to a creditor (that is you or your agent), for the purpose of paying a pre-existing debt (called an “antecedent” debt) within 90 days prior to the filing of the bankruptcy case (calculated by not including the filing date and adding backwards), at a time when the debtor was insolvent, and which payment enables you to receive more than you would receive if you had not received the payment and got paid with all of the other creditors in a chapter 7 liquidation. These are the elements of a preference transfer action. The chapter 7 Trustee has the burden to prove these elements. Insolvency is presumed to exist (i.e., you must prove otherwise, which can be expensive). Further, in the context of receiving a check or other payment instrument (which are the most common forms of payment on a debt) the transfer takes place when the instrument is honored by the bank on which it is drawn (i.e., cash the check quickly).

B. What Defenses Are Available to a Preference Demand/Action?

There are generally only 2 ways to attack a preference allegation. First, ask whether the Trustee can establish all of the elements of a preference transfer? Second, ask whether you can assert one of the statutory defenses set out in section 547(c) of the Bankruptcy Code. Common law defenses – like estoppel, waiver, off set, and good faith – do not apply. The preference amount must exceed $600 (if the debtor’s debts are primarily consumer debts) or $5,850 (if the debtor’s debts are primarily non-consumer debts). Also, if the demand involves a money judgment for less than $1,175, consumer debt of less than $17,575, or a non-insider/non-consumer debt of less than $11,725, any action will have to be filed in the district court for the district in which you reside.

The two most common defenses that you might have to a preference are (1) new value and (b) ordinary course of business. The new value defense is similar to set off except that it applies only to prospective services rendered or good supplied. The other defense, ordinary course of business, involves transfers to you in payment of a debt which are in the ordinary course of yours and the debtor’s financial business or recognized in your industry. A trustee might not want to pursue an action or would be willing to settle cheaply if you can readily establish either or both of these defenses from examining the kinds of payments that had been received in the past. If these defenses are available you want to make this known up front to the trustee. Many cases have been settled quickly when the creditor could provide documentation that would support these defense.

C. Should I (or How Should I) Respond to a Preference Demand Letter?

First, remain calm. It is just a letter. A stronger reaction might be justified if you were served with an actual lawsuit. Second, resist the temptation to throw the demand letter in your “circular file” (i.e., your trash can). Ignoring a demand letter may only serve to embolden the Trustee and eliminate a later opportunity to resolve the matter. As noted above, you may have certain valuable, sustainable defenses that you want to flesh out and/or as to which you require additional information. Often the source of the Trustee’s information, which led to the issuance of the demand, is incorrect and/or based on limited data. An initial response may be necessary to gather information to establish whether the Trustee can prove the elements of a preference and/or to support a defense. This also will provide a breathing period to get your arms around what is happening and whether you will be able to mount a good defense and/or enable you to begin the settlement negotiation process. Further, most demands contain relatively small discounts for up-front payments, so unless the offer is just “too good to refuse” you are better off delaying the process while you evaluate the Trustee’s evidence and applicable defenses. Bottom line: you want to respond verbally or in writing to all demands.

D. What Information is Needed to Determine Defenses?

You will likely be the source of information to enable your attorney to respond to a preference demand letter. Before contacting counsel, you may want to gather the payment history involving the debtor for at least the year preceding the bankruptcy filing. This information typically will include:

• Copies of all correspondence, contracts, credit applications, telephone logs, emails, and the like involving the debtor;
• A copy of all invoices, showing invoice date, terms and amount of each invoice;
• A copy of all payments received from the debtor identifying the method of payment (EFT, check, cashier’s check, money order, cash) and the date the payment was posted to your bank account;
• The number of days elapsed between date of invoice and date of payment was received; and
• All persons involved with the debtor’s account, so they can advise as the business terms between the parties and how payments were made, applied and any unique issues involving the debtor.

This information will prove valuable to your counsel in assessing your risk and exposure to avoidance of alleged preference payments.

E. Do I Need an Attorney? Are Attorney’s Fees Recoverable?

If successful, a trustee is not ordinarily entitled to recover attorney’s fees in prosecuting a preference action (they will be paid from the “estate”), but interest will continue to accrue on the amounts at issue. Also, you will not be able to recover fees and expenses paid to your attorney in defending against a preference demand or lawsuit. However, while it may not be very appealing to hire an attorney to help you get through this process, kind of like adding salt to the wound, the reality is that there are risks going it alone and having an attorney represent you can actually save time and money, particularly if a settlement is in prospect. In bankruptcy, like many other areas of the law, it really does help to walk-the-walk and talk-the-talk. Also, most attorneys will set fee rates based on amounts in dispute and will be willing to work with you on terms of engagement given the particular circumstances involved.