Article

Topics: Insolvency; Proceeds

Prior History: In re Irving Tanning Co., No. 10-11757-LHK, 2012 Bankr. LEXIS 3960 (Bankr. D. Me. Aug. 28, 2012) [USA], noted in 2013 ANNUAL REVIEW OF INTERNATIONAL BANKING LAW & PRACTICE at 417.

Note: Six related companies, all engaged in the tanning, manufacture, and sale of leather, filed various petitions for relief under Chapter 11 of the U.S. Bankruptcy Code. The Debtors were Prime Tanning Company, Inc., a holding company and the parent of the remaining Debtors, Irving Tanning Company, Cudahy Tanning Company, Inc., Prime Tanning Co., Inc., Prime Tanning Corp., and Wismo Chemical Corp. (collectively, "Debtors"). Among them, the Debtors had operations in Maine, New Hampshire, Wisconsin, and Missouri.

In the course of operating their respective businesses, three of the Debtors maintained selfinsurance programs for workers' compensation claims in Maine, New Hampshire, and Missouri. Under those states' statutes, if an employer wishes to self-insure, it must secure its obligations to pay compensation claims in one or more ways identified in the statutes. To secure its obligations under the Maine statute, one Debtor obtained a standby letter of credit issued by Wells Fargo in the amount of USD 718,000.00. When that Debtor terminated its self-insurance program, the Maine Superintendent of Insurance ("Superintendent", or together with Acstar Insurance Company, "Beneficiaries") consented but maintained the letter of credit until all claims were paid. Beneficiary eventually drew on the letter of credit and all proceeds were paid to the Maine Treasurer to be held in trust for future worker's compensation claimants.

The same Debtor also maintained a selfinsurance program in New Hampshire. To ensure the availability of funds to satisfy its workers' compensation obligations in New Hampshire, Debtor posted a USD 100,000.00 surety bond issued by Acstar Insurance Company ("Acstar" or together with the Main Superintendent of Insurance, "Beneficiaries") for the benefit of the State of New Hampshire Department of Labor. Debtor agreed to indemnify Acstar for amounts it might be required to pay, and it secured that obligation by providing Acstar with a standby letter of credit issued by Wells Fargo in the amount of USD 551,250.00. Acstar eventually drew on the letter of credit and at the time of the decision, it held the proceeds.

A second Debtor maintained a self-insurance program for workers' compensation in Missouri. In accordance with Missouri statutes, Debtor posted a USD 535,000.00 surety bond issued by Acstar for the benefit of the Missouri Department of Labor and Industrial Relations. Debtor agreed to indemnify Acstar for the amounts it might be required to pay, and it secured that obligation by providing Acstar with a standby letter of credit issued by Wells Fargo in the amount of USD 551,250.00. Acstar eventually drew on the letter of credit and at the time of the decision, it held the proceeds.

Another Debtor operating in Maine was required to post security as well. However, in the case of that Debtor, the funds were paid into a trust. The funds paid into that trust were maintained in the trust as of the date of the decision.

At issue in the case was Debtors' attempt to have approved a joint liquidating plan, which contained provisions addressing the letter of credit proceeds and the trust funds. Specifically, the proposed plan required the letter of credit proceeds and the trust funds to be turned over to Debtors. Debtors would then be required to place a portion of the transferred funds in an escrow account to satisfy all outstanding workers' compensation claims. Any remaining claims would be paid out of that account on a pro rata basis, and the plan would have established a bar date and injunction to prevent holders of claims from seeking satisfaction of their claims from any other source of funds or from any of the other entities potentially responsible for satisfying such claims. Finally, the excess of the letter of credit proceeds and trust funds that was not placed into the escrow account would be distributed to Debtors' creditors in a manner described in the plan.

Beneficiaries, among others, objected to the confirmation of the plan, opposing both its proposed use of the letter of credit proceeds and trust funds, and its injunction against the satisfaction of workers' compensation claims outside of the escrow account. The objecting entities argued that the plan contravened state workers' compensation laws governing the payment of claims. They also argued that Debtors' only interest in the letter of credit proceeds or the trust funds was limited to a "chose in action" to recover any surplus that may remain after all actual and potential workers' compensation claims had been satisfied under state law. In short, Beneficiaries argued that the letter of credit proceeds and the trust funds were not property of the Debtors' bankrupt estates and could not be appropriated for use in the plan.

The Bankruptcy Court for the District of Maine, Kornreich, J., agreed with the Beneficiaries that Debtors did not have a property interest in the letter of credit proceeds or the trust funds. It also agreed that Debtors' sole interest was a "chose in action" to recover excess funds in accordance with state law. The Bankruptcy Court rejected the plan, also citing other grounds not related to the letter of credit issues. On appeal and as to the letter of credit proceeds, the U.S. Bankruptcy Appellate Panel for the First Circuit in an opinion by Bailey, J., affirmed.

Debtors argued that they held contingent interests in the letter of credit proceeds and that those interests are property of their bankruptcy estates, and even if their interests are mere "choses in action", even those limited interests are property of the Debtors' bankrupt estates. Debtors conceded during the appeal that such interests as they did have were unmatured and contingent and that they had no present right to dispose of the letter of credit proceeds. They also conceded that unless the Bankruptcy Code preempted Beneficiaries' state law rights to the letter of credit proceeds, Debtors may not presently reach and distribute the letter of credit proceeds and the plan may not be confirmed.

The appellate decision, therefore, turned on whether the Bankruptcy Code preempted Beneficiaries' state law rights to the letter of credit proceeds. The Appellate Panel agreed that Section 1123 of the Bankruptcy Code preempts any nonbankruptcy law that, but for the preemption, would prevent a proponent of a Chapter 11 plan from employing such adequate means of implementation as the proponent incorporates into its plan.

The court also held, though, that the scope of preemption under that section was not unlimited. It interpreted three limitations applicable to Debtors' attempt to reach the letter of credit proceeds. First, a liquidating plan need only liquidate and distribute assets of the Debtors' estates-a plan need not enhance the assets by augmenting the Debtors' assets at the expense of third parties. Debtors' plan sought to do just that. Second, the court noted that workers' compensation laws are health and safety laws, not mere economic regulations, and as such, those statutes could not be preempted by Section 1123 at all. Third, if the court were to interpret Section 1123 to preempt state law, it would undoubtedly transgress the state law rights of the Beneficiaries.

As a result, the court held that the Bankruptcy Code did not preempt Beneficiaries' state law rights in the letter of credit proceeds, and because the proposed plan violated applicable non-bankruptcy law, it could not be confirmed. Beneficiaries were permitted to maintain the letter of credit proceeds and use those to satisfy workers' compensation claims that were pending or were to be filed.

[JAM/pt]

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