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Note: In its subcontract with The Ryland Group, Inc (Contractor/Claimant), SelectBuild Illinos, LLC (Subcontractor/Debtor) was required to indemnify Contractor/Claimant in certain instances. The relevant provision stated:

“To the maximum extent permitted by law, Subcontractor [Subcontractor/Debtor] shall indemnify, hold harmless and defend [Contractor/Claimant]... from any and all claims, costs, losses, damages, fines, penalties, fees and other costs, including, but not limited to, attorneys' fees and dispute related costs (collectively, “Such Costs”), to the extent that Such Costs arise out of, are incidental to or result from (a) the performance of the Work ... and are attributable to bodily injury, personal injury, sickness, disease or death of any person, including any injury or death of an employee or owner of Subcontractor ... or (b) Subcontractor's or Subcontractor's Agents failure to comply with the Legal Requirements and (a) or (b) is caused by any act or omission of Subcontractor or anyone acting for, on behalf of or through or representing Subcontractor or Subcontractor's Agents.”

The contract also required Subcontractor/Debtor to purchase commercial general liability insurance and name Contractor/Claimant as one of the insured. The insurance policy stated:

“[T]hat the “Retained Limit” is $100,000 and the “Deductible Per Occurrence” is $1,900,000. An “occurrence” is “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”

“In the event you [Subcontractor/Debtor] are unable to pay the Deductible amount or any portion thereof, our obligation to pay damages to satisfy judgment or pay a settlement shall include the Deductible amount or any portion thereof. However, our obligation to pay damages under this policy shall not exceed the Limits of Insurance as set forth in the policy declarations, and shall not in any event include the ‘retained limit’ or any portion thereof.”

“Endorsement No. 8 to the ACE Policy provides that a contractor, such as Ryland, is an additional insured “with respect to liability for ‘bodily injury,’ ‘property damage’ or ‘personal and advertising injury’ caused, in whole or in part, by: 1. Your [Subcontractor/Debtor's] acts or omissions; or 2. The acts or omissions of those acting on your behalf; in the performance of your ongoing operations for the additional insured(s)....”

The Subcontractor/Debtor’s insurance policy was secured by two irrevocable standby letters of credit for the amount of USD 30,571,000 each in favor of Insurer. The deductible obligations for these standby LCs made “the [Subcontractor/Debtor] the party actually liable for payment of [Contractor/Claimant’s] claims under the Ace Policy.”

When Subcontractor/Debtor subsequently filed for protection under Chapter 11 of the U.S. Bankruptcy Code (reorganization), the bankruptcy court confirmed the reorganization plan. The plan provided that

“Prepetition Letters of Credit shall continue to collateralize all obligations under-insurance Policies and Agreements ... secured by such Prepetition Letters of Credit, whether such obligations exist as of the Effective Date or arise thereafter, and such Prepetition Letters of Credit and obligations shall survive the Effective Date unaffected and unaltered by the Plan.”

This confirmation included a discharge injunction, that is a permanent injunction against any entity that held any claims or debts against Subcontractor/Debtor.

Subsequently, Subcontractor/Debtor’s employees sued Contractor/Claimant for “carless and negligent acts and or omissions.” As per original contract between Contractor/Claimant and Subcontractor/Debtor, Contractor/Claimant made a claim on the insurance policy.

Concerned that this claim would trigger a drawing on the standbys, Subcontractor/Debtor moved in the bankruptcy action to enjoin the claim for indemnification on the grounds of the permanent injunction. Subcontractor/Debtor argued the claim against Insurer is truly a claim against Subcontractor/Debtor because the indemnification will cause Insurer to draw on the LC. United States Bankruptcy court, Carely, J, denied the Subcontractor/Debtor’s motion to enforce the permanent injunction against Contractor/Claimant.

The Subcontractor/Debtor argued a claim against Insurer was in fact a claim against Subcontractor/Debtor. The Judge stated that “[Subcontractor/Debtor] are trying to fuse [Contractor/Claimant’s] claim against [Insurer], and [Insurer's] claim against them, into one direct claim by [Contractor/Claimant] against [Subcontractor/Debtor]. However, these obligations are separate. That [Subcontractor/Debtor] may ultimately be responsible for the claim, or that [Insurer] may draw against the Letters of Credit to satisfy its claim against [Subcontractor/Debtor], does not change this. [Insurer's] liability to [Contractor/Claimant] is not dependent upon whether there exists a source of payment from [Subcontractor/Debtor], but upon [Contractor/Claimant’s] direct rights as an additional insured under the Policy.”

Comments: This case is significant because the Contractor is an additional insured and its rights are deemed independent of the rights of the Debtor/Applicant-insured (who will be liable to reimburse the insurer). The case is of interest as enlarging the independence principle in U.S. bankruptcy law for additional insured rights against an insurer of a bankrupt.

[SJD]

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of the ICC or Coastline Solutions.