In bankruptcy actions where the debtor is planning to fund the reorganization with liability insurance proceeds, any related dispute with the debtor’s insurers over coverage can lead to complications regarding whether the bankruptcy court’s jurisdiction extends to the insurance coverage dispute.

The "Core" vs. "Non-Core" Issue

A bankruptcy court can deal only with matters involving rights directly arising out of the Bankruptcy Code, or with matters that are "related to" the bankruptcy proceeding. Normally, debtors will seek the bankruptcy court’s "core" jurisdiction over the insurance coverage dispute on the ground that jurisdiction exists because the outcome of the dispute will acutely impact the administration and property of the estate—the bankruptcy court’s central responsibility and duty. Conversely, many insurers (or others who oppose the extension of bankruptcy court jurisdiction over the coverage dispute) will argue that coverage cases are state law actions that do not trigger the bankruptcy court’s jurisdiction.

Courts have come to conflicting conclusions on this issue. If there is a common theme to the divergent results, it seems to be this: If the insurance coverage dispute involves insurance proceeds that could constitute the most significant asset of the bankruptcy estate, then the dispute should be considered within the bankruptcy court’s "core" jurisdiction and should be adjudicated by the bankruptcy court (unless and until a jury trial is needed). Under this set of circumstances, rather than ceding its control over the pivotal assets of the estate upon which a reorganization ultimately will be based, the bankruptcy court’s exercise of "core" jurisdiction over the coverage dispute allows the bankruptcy court to discharge its duty of administering the debtor’s bankruptcy estate.

Bankruptcy Court Jurisdiction

In Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982), the U.S. Supreme Court addressed whether a Bankruptcy Court could hear and adjudicate cases that were not based on rights created by the bankruptcy code, but were somehow "related to" the bankruptcy proceeding.

The Court held that Congress could not vest in a non-Article III court the power to adjudicate, render final judgment, and issue binding orders in traditional actions arising under state law without the consent of litigants and subject only to ordinary appellate review. In light of the Marathon decision, in 1984 Congress amended the jurisdiction of bankruptcy courts, creating "core" jurisdiction and "non-core" jurisdiction. "Core" proceedings include matters concerning the administration of the estate, the confirmation of an estate, and those affecting the liquidation of estate assets.

The bankruptcy court’s jurisdiction over "non-core proceedings" are those that are not considered "core" proceedings, but are otherwise related to a case under the Bankruptcy Code. The bankruptcy court’s jurisdiction over such proceedings is narrower than its jurisdiction over "core" proceedings. In "non-core" proceedings, the bankruptcy court’s jurisdiction is subject to mandatory and discretionary abstention provisions require a bankruptcy court to abstain from hearing a proceeding where:

• a timely motion is made for the bankruptcy court to abstain
• the proceeding in question is based upon a state law claim or state law cause of action
• the proceeding is related to a case under the Bankruptcy Code but does not arise under the Bankruptcy Code
• the proceeding could not have been commenced in a federal court absent jurisdiction under the "non-core" provisions of the Bankruptcy Code
• an identical action is commenced, and can be timely adjudicated, in a state forum of appropriate jurisdiction

Alternatively, a bankruptcy court may abstain from hearing any proceeding arising under the Bankruptcy Code or related to a case under the Code. A court should consider discretionary abstention when the party seeking abstention demonstrates the existence of most of the mandatory abstention circumstances. Bankruptcy courts are required to make a determination as to the "core" or "non-core" nature of a proceeding on a claim-by-claim basis. In the context of insurance coverage disputes – which usually are litigated as suits seeking declaratory relief based on the terms of a contract, the insurance policy—the jurisdictional analysis must focus on how the resolution of the dispute will impact rights or obligations that are created under, or are central to, the Bankruptcy Code.

There are three main procedural contexts in which a "core" versus "non-core" insurance dispute can arise. The first is where insurance coverage litigation existed between the debtor and an insurer prior to the debtor’s bankruptcy filing and was stayed upon the bankruptcy filing. In this context, the "core" versus "non-core" dispute will result when either the debtor or the insurer seeks relief to pursue the coverage action in a non-bankruptcy forum. The second situation is where an adversary insurance coverage proceeding is filed in the debtor’s bankruptcy proceeding, and either the debtor or (more frequently) the insurer seeks to withdraw the reference to the adversary proceeding from the bankruptcy court. The third situation involving "core" versus "non-core" issues is where the insurance policy provides coverage to the debtor and a non-debtor, such that the satisfaction of claims of either one (particularly the non-debtor) would result in a diminution of the assets available for the claims of the other. In this situation, litigation between the co-insureds may arise either as a stayed lawsuit for which relief from a stay is sought, or as an adversary proceeding for which one party seeks withdrawal from bankruptcy court.

"Core" Coverage Disputes

Several courts have found that insurance coverage disputes qualify as "core" proceedings, especially where the insurance proceeds are the "linchpin" of the reorganization, and the resolution of the coverage dispute will have a significant impact on the administration of the estate.

Courts also have found that coverage disputes should be considered to be within the bankruptcy court’s "core" jurisdiction when the results of such determinations are central to the possible success or failure of any reorganization.

This rationale is grounded on two considerations. First, the phrase "property of the estate" is one that is created and defined by the Bankruptcy Code. A dispute over whether insurance policies or proceeds constitute property of the estate can thus be characterized as one that is unique to a bankruptcy proceeding, and one that arises under the Bankruptcy Code itself. Second, where a policy at issue is asserted to be the only asset available to fund a reorganization or liquidation, or is asserted to be the single-most important asset of the estate, the impact of the dispute on the administration of the estate is great.

In this context, the resolution of the insurance dispute will determine, in large part, whether the debtor can emerge from bankruptcy and, perhaps more importantly, will resolve the claims of the debtor’s creditors. Without exercising "core" jurisdiction over this type of case, the bankruptcy court would be in the position of potentially frustrating its central duty—supervising and facilitating the reorganization of the debtor’s estate.

In Celotex Corp. v. AIU Ins. Co. (In re Celotex), 152 B.R. 667 (Bankr. M.D. Fla. 1993), the debtor was a former manufacturer that filed for Chapter 11 protection in the wake of an overwhelming number of asbestos-related personal injury suits. After filing for bankruptcy, Celotex filed an adversary complaint for declaratory relief against its liability insurers for a declaration of the insurers’ obligation to provide coverage for the debtor’s asbestos-related liabilities. The insurers contested the bankruptcy court’s jurisdiction on the ground that the claim was a state-law, "non-core" claim over which the bankruptcy court had limited jurisdiction.

The bankruptcy court held that the claim was a "core" claim within the bankruptcy court’s jurisdiction, relying on a rebuttable presumption of "core" jurisdiction because the proceeding pertained to the determination of whether the insurance policies at issue were property of the estate.

Key to the Celotex court’s analysis was its characterization of the coverage case as one involving a determination of property of the estate, rather than as a simple state law contract suit. The court identified an important "nexus" between the coverage dispute and the reorganization proceeding: The debtor’s determination to pursue its insurers for coverage was driven by the desire to maximize the size of the estate, ultimately for the satisfaction of creditors, rather than to collect damages for its own direct benefit (as would be the case in an ordinary state court contract action).

In In re Prudential Lines, Inc., 170 B.R. 222 (S.D.N.Y. 1994), the debtor’s plan of reorganization established a trust to pay asbestos claims asserted against the debtor. The trustee of the asbestos trust filed an adversary action against the debtor’s liability insurance carriers following the establishment of the trust, seeking declaratory relief that would resolve the trust’s rights to insurance coverage provided by the carriers’ policies.

As in Celotex, the Prudential Lines insurers objected to the bankruptcy court’s jurisdiction over the coverage dispute, arguing that the dispute was a "non-core" matter and could not be adjudicated by the bankruptcy court. The bankruptcy court found that the proceeding was "core," and the district court affirmed. As in Celotex, the district court determined that the characterization of the coverage dispute was not controlled by the general notion that insurance coverage actions are governed by state law. The district court noted that the trustee’s adversary action was not a "traditional breach of contract" claim, insofar as it sought to determine whether the policies and their proceeds were assets of the estate.

This rationale was adopted in In re Reliance Group Holdings, Inc., 273 B.R. 374 (Bankr. E.D. Pa. 2002), where the court noted that, even though an insurance coverage dispute may rest upon the interpretation of state law, "a determination of what is property of the estate and concurrently, of what is available for distribution to creditors of that estate, is precisely the type of proceeding over which the bankruptcy court has exclusive [i.e. "core"] jurisdiction."

The Prudential court identified a second key factor supporting the bankruptcy court’s exercise of "core" jurisdiction over an insurance coverage dispute: the resolution of the insurance dispute was key to the debtor’s reorganization process. In Prudential, more than 7,000 claims had been asserted against the debtor’s asbestos trust which potentially were covered by the insurance policies. The policies contained "pay-first" provisions which, the insurers claimed, required the debtor or the trust to pay the individual claims before any insurance proceeds had to be paid. The court recognized that the trust (and the debtor) lacked the capability to follow these procedures, and was alarmed by the possibility that the trust would fail without the proceeds – the largest pool of assets available to fund the trust. Since the trustee’s adversary action would have a profound impact on the reorganization process and be determinative of the success of the reorganization, the dispute was within the bankruptcy court’s "core" jurisdiction.

Courts have ruled in several similar cases that coverage disputes between a debtor and its insurers are "core" proceedings. The Second Circuit made such a determination in In re United States Lines, Inc., 197 F.3d 631 (2d Cir. 1999), which involved an asbestos injury trust, established in the debtor’s reorganization process, that sued the debtor’s liability insurers for a declaration of the trust’s right to immediate payment on certain indemnity policies. The policies’ proceeds were the only source available to fund the trust. Although the insurers objected to the bankruptcy court’s jurisdiction, the bankruptcy court determined that the proceeding was a "core" matter and could be adjudicated by the bankruptcy court. On appeal, the district court reversed, but the Court of Appeals affirmed the bankruptcy court’s initial ruling. The Second Circuit distinguished the situation where the insurance proceeds were the single-most important asset of the estate to fund the trust from the situation where insurance proceeds might only "augment" the size of the estate. In the latter situation, "core" jurisdiction would not be supported because the dispute would not have the requisite impact on the administration of the estate.

Courts have agreed with and adopted the implicit recognition that where an insurance coverage action pertains to the largest, most important asset of the estate, the bankruptcy court should have "core" jurisdiction over the dispute. In In re County Seat Stores, Inc., No. 01 CIV. 2966 (JGK), 2002 WL 141875 (S.D.N.Y. Jan. 31, 2002), the debtor’s Chapter 11 trustee brought a coverage adversary proceeding against a carrier who issued a director and officer liability policy ("D&O Policy") to the debtor, seeking a declaration of its rights to coverage under the D&O Policy and seeking to have the D&O Policy declared property of the estate.

In finding the action to be a "core" matter, the court noted that the case would determine whether the debtor would later be vulnerable to indemnification claims of its directors and officers if they were sued for their official acts, which would potentially deplete the estate’s assets otherwise available to other creditors, and also noted that without a determination of rights under the insurance policy (which the court identified as perhaps "the most important asset of the estate"), establishing an allocation of assets among creditors would be frustrated.

In In re Northwestern Institute of Psychiatry, Inc. v. Travelers Indemnity Co., 272 B.R. 104 (E.D. Pa. 2001), the court found that a debtor’s suit against its flood insurance carrier, concerning a policy that was issued after the debtor’s bankruptcy filing, constituted a "core" proceeding. The importance of the insurance asset to the estate was based on the impact it would have on the distributions to other creditors if the debtor itself were forced to pay for flood-related damages, which the debtor asserted to be covered by the insurance policy.

"Non-Core" Coverage Disputes

Not all courts have accepted rationales supporting the characterization of insurance coverage disputes as "core" proceedings. Some courts, adhering to a narrow reading of the Marathon decision and the Bankruptcy Code, have held that the bankruptcy court’s jurisdiction encompasses only those actions that literally are created by the Bankruptcy Code.

In In re United States Brass Corporation, 110 F.3d 1261 (7th Cir. 1997), the debtor’s liability insurers brought six actions for declaratory relief seeking to establish that their policies did not provide coverage to the liabilities incurred by the debtor in its purchase of a defective product line. The civil actions were filed prior to the debtor’s bankruptcy filing in state court; the debtor sought to have them removed to federal court, and then transferred to its bankruptcy proceeding. The insurers contested the bankruptcy court’s jurisdiction over the coverage actions and argued that the bankruptcy court should abstain from hearing the case.

The bankruptcy court granted the insurers’ request to abstain and both the district court and the Court of Appeals affirmed. The Court of Appeals noted that "core" proceedings were only those that "arise under the Bankruptcy Code in the strong sense that the Code itself is the source of the claimant’s right or remedy, rather than just the procedural vehicle for the assertion of a right conferred by some other body of law, normally state law." The coverage action, the court said, was not one created by the Bankruptcy Code, but rather by state law. The fact that the actions, in the aggregate, involved approximately $500 million in coverage was irrelevant to the "core" analysis.

The United States Brass court’s rationale was adopted in Travelers Indemnity Co. v. The Babcock & Wilcox Co., No. CIV.A.01-3387, 2002 WL 100625 (E.D. La. Jan. 23, 2002), involving an adversary action filed in the debtor’s bankruptcy proceeding by a liability insurer against the debtor, regarding coverage of the debtor’s asbestos-related liabilities. As in United States Brass, the Babcock & Wilcox court accepted the description of the coverage action as simply a state law contract action, and found that as such, the coverage action could not be a core proceeding.

Other courts similarly have disposed of the "core" question on the basis that, because insurance coverage actions arise as a matter of state law, they can only be "non-core" proceedings. Rather than characterizing the coverage suits on the basis of the impact they would have on the debtor’s reorganization, these courts focused on the derivation of the rights upon which the suits were based—state insurance law—and minimized the potential effect upon the administration of the estate.

Some courts also disagree with the premise that an insurance coverage dispute is a "core" proceeding because the dispute has an effect on the determination of property of the estate. In In re Lawrence Group, Inc., 285 B.R. 784 (N.D.N.Y. 2002), a Chapter 11 debtor brought an adversary proceeding to recover for an alleged breach of contract and breach of the covenant of good faith and fair dealing by its insurer, which had issued to the debtor (prior to its bankruptcy filing) a policy covering losses from acts of employee dishonesty. The insurer contested the bankruptcy court’s jurisdiction over the suit, and filed a motion to withdraw the reference of the suit from the bankruptcy court.

In granting the motion, the district court found that the suit constituted a "non-core" proceeding that could not be adjudicated by the bankruptcy court. First, the court noted that "[t]he fact that the contract was executed pre-petition and that the dispute…could arise outside of bankruptcy proceedings weighs against its core status." Second, the court indicated that simply asserting that an action "involves property of the estate" was not enough to bring it within the court’s "core" jurisdiction.

The Lawrence Group court also observed that the impact of the outcome of this adversary action on the administration of the debtor’s estate was relatively small—falling short of the magnitude required to characterize the action as a "core" proceeding. Given this context, the court recognized that the bankruptcy court’s core administrative function would not be frustrated by allowing this case to proceed outside the bankruptcy proceeding, and thus held the case to be a "non-core" proceeding.

Conclusion

Not all coverage disputes are created equal—therefore, bankruptcy courts cannot treat all coverage disputes equally under Marathon and the Bankruptcy Code.

Indisputably, the authority of bankruptcy courts is limited to matters that are central to a debtor’s bankruptcy proceeding. Cases involving claims arising under state insurance law that pose an insignificant impact upon the administration of the debtor’s estate do not meet the jurisdictional standard demanded by Marathon and statutory law. Such cases would not thwart the bankruptcy court in its duty to administer a resolution of the claims asserted by creditors against the debtor.

The United States Brass court observed that "core" proceedings should be limited to those that are created by the Bankruptcy Code. The primary right or remedy created by Chapter 11 of the Bankruptcy Code is the right to an orderly reorganization during a period of protection from creditors. Where the very possibility of reorganization is substantially—if not solely—dependent upon the outcome of an insurance coverage action, such as where insurance assets are the single-most important asset (or the only asset) of the estate available to fund the claims of creditors, it follows that the right to an orderly reorganization is inextricably tied to the coverage dispute.

Although "core" may be a term of art under the Bankruptcy Code and not a metaphor, it nevertheless must connote something about the broader concept of the administration of a bankruptcy proceeding. In cases where the insurance assets significantly predominate all others or stand alone to constitute the bankruptcy estate, coverage disputes may not only be said to "impact the size" of the estate, but in effect to "be" the estate. To limit the bankruptcy court’s power to adjudicate disputes in that context would, in practical terms, largely eliminate the need for bankruptcy courts in those types of bankruptcies.

The scope of the bankruptcy court’s duties must be determined by what assets the debtor possesses to satisfy the claims of its creditors. As such, the principles codified in the Bankruptcy Code should be read to preserve the power of the bankruptcy court to adjudicate insurance coverage claims that involve assets which are central to the administration of the estate and which will determine the efficacy of the debtor’s reorganization. In reality, these types of claims differ in kind from most other state-law, contract-based claims, because the federal statutory rights to bankruptcy protection and reorganization are reliant on matters pertaining to the property of the estate—in these cases, the insurance policies and proceeds.

Thus, the Bankruptcy Code can be read to support the exercise of bankruptcy court power in situations where insurance policies and proceeds are so irreplaceable to the administration of the estate. Case law supports this conclusion, as well as the premise that the Bankruptcy Code should not be given a minimalist reading that would render bankruptcy courts powerless to administer bankruptcy proceedings in cases involving assets that are subject to litigation governed by non-bankruptcy law. This may not occur in every bankruptcy, or even in every bankruptcy involving an insurance dispute. However, to maximize the effectiveness of federal bankruptcy policy within the bounds of the constitutional rules of judicial authority, bankruptcy courts should be permitted to exercise "core" jurisdiction over insurance coverage disputes when resolving those disputes are central to the bankruptcy process.