Tort Claims Against a Discharged Debtor with Insurance
 
September 1, 1999
 
Noel Robert Boeke - Tampa

It happens all too often. A debtor files for bankruptcy protection, the deadline to file a proof of claim in bankruptcy passes, and the creditor has taken no action to recover from the bankruptcy estate. Is the creditor out of luck? Perhaps not, if the creditor has a claim for which the debtor maintained liability insurance.

Generally, to retain its claim against a bankrupt debtor, a creditor must file proof of its claim in the bankruptcy proceeding within a specified time. When a creditor fails to file notice of its claim, the Bankruptcy Code's permanent injunction prohibits the creditor from proceeding against a debtor post-bankruptcy.(--1) Specifically, section 524(a) of the Bankruptcy Code operates as a "discharge injunction" against any act to recover a pre-bankruptcy debt from a discharged debtor personally.

The discharge injunction was designed primarily to protect the debtor and the bankruptcy estate, by providing the debtor with a fresh start. The discharge injunction does not, however, prevent a creditor from taking action against someone else who might also be liable to the creditor. For example, section 524(e) of the Bankruptcy Code permits a creditor to seek recovery from "any other entity" who may be liable on behalf of the debtor.(--2) As such, a creditor may still pursue nondebtors, guarantors, sureties, and insurance companies post-bankruptcy, to the extent these entities are liable for pre-petition claims against a discharged debtor.

In Owaski v. Jet Florida Systems, Inc. (In re Jet Florida Systems, Inc.), the Eleventh Circuit held that a discharge injunction does not affect the liability of third-party insurers, nor does it prevent a claimant from establishing an insurer's liability by proceeding nominally against a discharged debtor.(--3) In fact, numerous courts have concluded that a discharge injunction does not bar suit by a tort claimant against a discharged debtor for the sole purpose of recovering insurance proceeds.(--4) These courts do, however, generally condition modification of the discharge injunction on the proviso that the discharged debtor will not be liable for any costs of the reinstated litigation.

Judge Paskay, Chief Bankruptcy Judge for the Middle District of Florida, recently considered these issues on a motion to modify the permanent injunction filed by Martin and Bessie Atabong (the Atabongs)(--5). Mr. Atabong was injured on an amusement ride at a carnival sponsored by W.G. Wade Shows, Inc. (Wade Shows) in Michigan. The Atabongs subsequently filed a personal injury lawsuit against Wade Shows in Michigan. When Wade Shows filed for bankruptcy protection in Florida, the Atabongs' Michigan action was automatically stayed by section 362 of the Bankruptcy Code.

While Wade Shows was in the midst of bankruptcy, the Atabongs faced three options. First, they could have filed a motion for relief from the automatic stay in bankruptcy court, seeking to continue their personal injury action solely to the extent of the debtor's insurance coverage. Second, the Atabongs could have liquidated their claim in bankruptcy court. Third, the Atabongs could have waited for Wade Shows to emerge from bankruptcy, and then reinstated their Michigan action against Wade Shows to the extent of available insurance proceeds(--6).

Having missed the court's deadlines for filing a claim or motion for relief from the stay, the Atabongs had no choice but to pursue the viable, but unfamiliar third option in order to continue the Michigan personal injury action. Thus, following the close of Wade Shows' bankruptcy case, the Atabongs sought bankruptcy court approval to reinstate their Michigan tort action against the discharged debtor, for the sole purpose of recovering insurance proceeds(--7). Judge Paskay granted the Atabongs' motion to modify the discharge injunction, holding that the discharge injunction does not preclude parties injured in a prepetition accident from proceeding against a debtor for the limited purpose of establishing the debtor's liability in order to recover insurance proceeds(--7). Judge Paskay reasoned that the fresh start policy of the Bankruptcy Code was not intended to furnish a shield to third parties, such as liability insurers, by which an insurance company could escape its obligations because its insured happened to receive a bankruptcy discharge(--8).

The law is clear - liability insurers, guarantors, or sureties do not generally share in a debtor's bankruptcy discharge, but remain financially liable to the debtor in accordance with their underlying contractual obligations. Convincing a state court judge to follow this law and reinstate a tort action against a discharged debtor may be difficult, however, without specific guidance from the bankruptcy court. In addition, seeking modification of a discharge injunction in bankruptcy court, in order to reinstate litigation to the extent of insurance proceeds, may be time-consuming and expensive, and may afford an insurer greater opportunity to appeal(--9). Furthermore, courts are generally more comfortable with motions for relief from the stay filed during bankruptcy than with motions to modify a discharge injunction. Accordingly, creditors with pre-bankruptcy claims that may be satisfied from a debtor's liability insurance should strive to file a motion for relief from the automatic stay during the bankruptcy case in order to continue litigation outside of bankruptcy to the extent of insurance proceeds. Nevertheless, should a potential tort creditor miss a deadline for filing a motion for relief in bankruptcy court, all hope is not lost. A tort claimant may generally continue a nominal lawsuit against a discharged debtor, for the sole purpose of establishing the debtor's liability, as prerequisite to recovery from the debtor's liability insurer.

________

(--1) 11 U.S.C. § 524(a) (1999). Section 524(a) is known as the "permanent injunction" or "discharge injunction."

(--2) 11 U.S.C. § 524(e) (1999).

(--3) 883 F.2d 970, 976 (11th Cir. 1989) (per curiam).

(--4) E.g., Green v. Welsh, 956 F.2d 30, 33 (2nd Cir. 1992); Houston v. Edgeworth (In re Edgeworth), 993 F.2d 51, 54 (5th Cir. 1993); Hawxhurst v. Pettibone Corporation, 40 F.3d 175 (7th Cir. 1994).

(--5) In re W.G. Wade Shows, Inc., 234 B.R. 185 (Bankr. M.D. Fla. 1999).

(--6) This third option of awaiting the conclusion of bankruptcy to reinstate a tort action is neither a preferred nor recommended alternative to filing a motion for relief from the automatic stay during the bankruptcy case because this procedure is unfamiliar to many courts, expensive and time-consuming. Creditors are far better off filing a motion for relief from the automatic stay during the bankruptcy, within any deadlines established by the court, in order to continue existing litigation.

(--7) In re W.G. Wade Shows, Inc., 234 B.R. 185, 186 (Bankr. M.D. Fla. 1999). Judge Paskay's order, of course, conditioned reinstatement of the Michigan tort action on the proviso that Wade Shows would not be liable for any costs of the litigation. Id.

(--8) Id. at 188.

(--9) In fact, the Insurer in the Wade Shows case has appealed Judge Paskay's decision cited above.