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Going After The Insurance When A Defendant Goes Bankrupt

The automatic stay associated with a bankruptcy filing is a powerful tool for defendants and will bring any litigation to a screeching halt.  But while the automatic stay presents an obstacle for continuing litigation in almost any case, there is strong grounds to obtain relief from the stay where a plaintiff’s claim is covered by defendant’s insurance.

United States Bankruptcy Code section 362 automatically imposes a stay on all actions against a debtor who files for bankruptcy.  This means that any and all lawsuits against the person or entity filing, even those that are unrelated to the bankruptcy, are put on hold.  The stay is immediately effective whether or not a creditor, such as a plaintiff in a personal injury case, receives notice of the stay and regardless of whether the court makes an order entering it.

However, Bankruptcy Code Section 362 also provides a means to escape the automatic stay.  Section 362(d)(1) provides that on the request of a party and after notice and a hearing, the court shall grant relief from the stay for “cause, including the lack of adequate protection of an interest in property of such party in interest.”  Although the grounds for relief from a bankruptcy stay for cause includes lack of adequate protection of an interest in property, relief from a stay  is not limited to that reason.

Indeed, “cause” for relief from a bankruptcy litigation stay is not defined in the Bankruptcy Code and is handled on a case by case basis.  (In re Fernstrom Storage and Van Co. (7th Cir. 1991) 938 F.2d 731, 735 (C.A 7 1991).)  The moving party is only required to make an initial showing that he is entitled to relief from the stay, the burden then moves to the debtor to overcome that showing.  (In re Sonnax Industries, Inc. (2nd Cir. 1990) 907 F.2d 1280, 1285.)

When determining if cause exists for relief from a bankruptcy stay, courts look at a number of factors:

  1. Whether relief would result in partial or complete resolution of the issues;
  2. The lack of any connection with or interference with the bankruptcy case;
  3. Whether other proceeding involved the Debtor as a fiduciary;
  4. Whether the Debtor has applicable insurance coverage and said insurer has assumed full responsibility for defending it;
  5. Whether the action primarily involves third parties;
  6. Whether litigation in another forum would prejudice the interests of other creditors;
  7. Whether the Movant’s success in the other proceeding would result in a judicial lien available by the Debtor;
  8. The interests of judicial economy and the expeditious and economical resolution of the litigation;
  9. Whether the parties are ready for trial in the other proceeding;
  10. Th impact of the stay on the parties and the balance of harm.

(In re New York Medical Group, P.C. (S.D.N.Y. 2001) 265 B.R. 408, 413.)

However, in weighing these factors, courts only consider those that are relevant to the circumstances of the case at hand and factors are not weighed evenly.   (In re Mezzeo (2nd Cir. 1999) 167 F.3d 139, 143.)  Thus, a moving party need not show a majority of these factors, nor even a majority relevant factors favor lifting the stay.

When the automatic stay is applied to litigation in which debtor has insurance covering the claim, several of these factors weigh strongly in favor of granting the movant relief from the stay, most obviously that the debtor has insurance and the insurer has assumed full coverage. However, other factors associated with the existence of insurance are also likely to weigh in favor of lifting the stay, such as the interests of judicial economy, the lack of prejudice to creditors due to the potential recovery being paid by insurance, and the lack of connection to or interference with the bankruptcy.

Indeed, the core policy behind a bankruptcy stay was to prevent prejudicial dissipation of the debtor’s assets.  When a judgment is or would be entirely covered by insurance from an insurance carrier, there is no possibility of prejudicial dissipation of debtor assets.  (See In re Bock Laundry Mach. Co. (N.D. OH 1984) 37 B.R. 557, 566 (“where…the pending action is neither connected with nor interfering with the bankruptcy proceeding, the automatic stay in no way fosters Code policy”).)

Where a defendant goes bankrupt during litigation, but insurance exists covering the plaintiff’s claims, there is a strong basis to obtain relief from the bankruptcy stay, and continue the litigation for the insurance proceeds.

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