Article

Note: To provide collateral for insurance policies, including workers' compensation policies, STran Holdings, Inc., Service Transport, Inc., and Dixie Trucking, Inc. (Debtors) entered into a Collateral Agreement with Protective Insurance Co. (Beneficiary), providing it with standby letters of credit totaling US$3,500,000 and additional cash collateral. Subsequently, one week prior to the date Debtors filed for bankruptcy under Chapter 11 (reorganization), Beneficiary drew on the LCs. Following Debtors' bankruptcy petition, Beneficiary used both the LC proceeds and a cash deposit from Debtors to pay US$2,039,494 to third parties, holding the remaining US$1,553,648 in an estimated insurance reserve.

Debtors then filed an adversary proceeding in their bankruptcy proceeding against Beneficiary seeking the turnover of estate property under Bankruptcy Code §542, alleging a violation of the automatic stay of Bankruptcy Code §362, unauthorized post-petition transfers under Bankruptcy Code §549, breach of contract, and breach of fiduciary duty and moved for partial summary judgment motion against Beneficiary with respect to the turnover of estate property, violation of the automatic stay, and unauthorized post-petition transfers. The United States Bankruptcy Court for the District of Delaware, Carey, J., granted Debtor's motion with respect to any excess LC proceeds and the deposit, concluding that they are property of the Estate pursuant to Bankruptcy Code §541. However, the court denied the remainder of the motion with respect to the LC proceeds paid to Beneficiary in advance of the bankruptcy filing, concluding that because the LC proceeds were not either paid with or secured by Debtors' property, they were not property of the Estate. It noted that the issue of whether there are excess proceeds remained to be determined based on the underlying contracts between the insurer and the debtor.

Debtors had asserted that the independence principle did not apply to the proceeds of an LC that had been drawn on prior to the filing of the bankruptcy petition. The bankruptcy court rejected that argument, citing the "well-established" principle that neither an LC nor its proceeds (as opposed to the collateral posted with the issuer) are the property of the Estate. "When the issuers of the letters of credit paid the LOC Proceeds to [Beneficiary], they did not use the Debtors' property, but their own property to make payments to third parties... Because the letter of credit proceeds were not paid with or secured by the Debtors' property, the fact that the proceeds were paid prior to the bankruptcy filing does not transform those entire proceeds into property of the estate."

Debtors also had argued that excess proceeds in the possession of the beneficiary were the property of the Estate, citing, Two Trees v. Builders Transport, Inc (In re Builders Transport, Inc.), 471 F.3d 1178, 1186 (11th Cir. 2006). Accordingly, the Judge granted Debtors' summary judgment motion with respect to entitlement to the excess proceeds. However, the Judge noted that the entitlement to these proceeds depended on the terms of the agreements between the parties and various factual determinations regarding the amounts disbursed or permitted to be held in reserve. Accordingly, Debtors' motion for summary judgment was denied in that respect.

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