A lender files a UCC-1 in the debtor's home state with the goal
of perfecting a security interest in all of the debtor's accounts,
inventory and payment intangibles, including the debtor's rights to
payment under its insurance policies. What happens when a fire or
disaster strikes and the now-bankrupt debtor's largest asset is its
business interruption insurance claim for its loss of income from
the disaster? Does a UCC-1 filing perfect the lender's security
interest in a debtor's insurance coverage and claim proceeds,
enabling the lender to enjoy a priority right to the insurance
proceeds in bankruptcy?
In Wheeling & Lake Erie Railway Co. v. Keach (In re
Montreal), 799 F.3d 1 (1st Cir. 2015), the First Circuit
acknowledged that the lender's UCC-1 filing expressly listed
accounts, rights to payment, and proceeds including insurance
proceeds - but the court still held that the lender had failed to
perfect a security interest in the debtor's insurance coverage or
claim proceeds.
Wheeling arose from the calamitous July 2013 tanker
train derailment in Lac-Megantic, Quebec. The derailment and
ensuing fire killed 47 people and destroyed much of the town. The
debtor filed a Chapter 11 bankruptcy petition one month after the
disaster. After a period of negotiation involving the debtor and
the court-appointed trustee, the debtor's insurance company agreed
to pay $3.8 million in business interruption insurance proceeds for
the loss of income to the debtor. A motion was brought to approve
the settlement and the disposition of the insurance proceeds.
Lender Wheeling objected. Wheeling claimed a priority interest in
the insurance proceeds based on its UCC-1 filing and putative
security interest in the insurance coverage and proceeds.
Wheeling argued that the insurance coverage, right to payment,
and proceeds qualified as an "account" or a "payment intangible"
and therefore its UCC-1 filing served to perfect Wheeling's
security interest in the policy and proceeds. The First Circuit
rejected this argument on several grounds. First and foremost, the
Court observed that Section 1-109 of the Uniform Commercial Code
(here, the Maine version) excludes from the reach of Article 9 "the
transfer of an interest in or an assignment of a claim under a
policy of insurance" except for certain health insurance
receivables and assignments, and the proceeds of policies in which
there was a perfected security interest. (The Article 9 insurance
exclusion in Massachusetts is virtually identical.) Writing for the
First Circuit, Judge Bruce M. Selya held that "the right to payment
under an insurance policy . . . falls squarely within the heartland
of this exclusion" and therefore the filing of a UCC-1 cannot and
does not perfect a security interest in an insurance policy or
claim proceeds.
The First Circuit's analysis appears sound on the facts of the
Wheeling case, but the decision is a reminder of the
sometimes controversial nature of the insurance exclusion in
Article 9. See Verstein, "Bad Policy for Good Policies: Article 9's
Insurance Exclusion," 17 Conn. Ins. Law J. 287 (suggesting
modification of the insurance exclusion). As the law now stands, it
is open to question whether lenders have any certain means,
including being named on the policy as a loss payee, of securing an
interest in an insurance policy.
Wheeling may have disappointed some lenders who had
hoped based on MNC Commercial Corp. v. Rouse, 1992 U.S.
Dist. Lexis 22166 (W.D.Mo. 1992) that the courts would liberally
view all insurance proceeds, even insurance on lost profits, as the
proceeds of income-producing collateral and within the scope of an
Article 9 security interest created by the filing of a UCC-1. But
see CPC Acquisitions Inc. v. Helm, U.C.C. Rep. Serv.2d 669
(N.D.Ill. 2007) (negligent procurement insurance settlement
involving damaged collateral considered proceeds, but not proceeds
of settlement involving business interruption income losses).
How might the First Circuit rule in a case where the insurance
proceeds arise from damage or destruction of inventory in which the
lender had perfected its security interest under Article 9? Would
the Court follow its strongly-worded decision in Wheeling
and apply the statutory insurance exclusion? Or would it rule that
because the underlying collateral was subject to an Article 9
security interest, the proceeds of the insurance policy are also
subject to the Article 9 security interest? Something to think
about before a secured party calls asking you about the strength of
its claim to a debtor's insurance proceeds!
This article appeared in the December 2015 edition
of the ComCom Quarterly, the newsletter of the Complex Commercial
Litigation Section. For more articles like these on business
litigation, bankruptcy, and intellectual property topics, check out
the Quarterly at http://is.gd/lFJCJw.