Insurance companies are not immune to a bankruptcy dunning letter and should never ignore the preference demand issued by the trustee.
Preference letters are sent to all unsecured creditors in order to provide them with each fair and equal treatment. Reclamation of such payments is intended to redistribute and disperse the bankruptcy estate’s assets equitably among all of the unsecured creditors.
After a party files for bankruptcy and the creditor – in this case, the insurance company – files its proof of claim with the proper court, the creditor is thereafter confronted by a demand letter from the bankruptcy trustee seeking repayment of all monies received from your customer within the 90 days prior to the filing of the bankruptcy petition.
This period is commonly known as the “preference period.” The Bankruptcy Code presumes that a debtor is insolvent during the 90-day period before the bankruptcy petition is filed. Therefore, all payments and transfers made to creditors by the debtor during that period are suspect.
In a written premium, the insurance company “earns” portions of the premium based on the amount of time the insurance policy has been in effect. Earned premiums are essentially pro-rated earnings of the premium. Generally, an earned premium is non-returnable to the insured, and it thereafter belongs to the insurer.
To illustrate, if a $2,000 policy has a two-year lifespan, and no claim has been filed one year into the policy, the insurance company will have an earned premium amount of $1,000.
An insurance company – just like any party that enters into an agreement with another – risks its insureds filing for bankruptcy.
When the insured does file, the insurance company may not cancel the policy for non-payment of pre-petition premiums.
In fact, any action taken by the insurer within 90 days prior to the filing of the bankruptcy petition may be deemed ineffective and subject to the automatic stay imposed by the bankruptcy filing. Furthermore, the insurance company may receive a dunning letter for premiums it previously earned.
For this reason, it is important to be vigilant as to whether an insured is in financial distress and raises the possibility of filing for bankruptcy, because once the 90-day pre-petition period begins, the earned premium faces potential preferential claim treatment.
There are ways to deal with a situation in which the insurer receives a dunning letter received on earned premiums. To begin, as indicated above, do not ignore the preference demand issued by the trustee. This will cause nothing but more stress and work down the road. Instead, take action.
Since a preference action allows the trustee to recover funds the debtor paid to a creditor in a transaction entered into prior to the commencement of the bankruptcy case, the insurance company should investigate whether the trustee is able to meet all of the necessary elements.
If not, then the trustee may set aside the transfer of debtor’s property.
The elements to establish a preference claim are as follows:
- There was a transfer;
- The debtor has an interest in the property transferred;
- That was to or for the benefit of a creditor;
- For or on account of an antecedent debt owed by the debtor before such transfer was made;
- Made while the debtor was insolvent;
- Made – (A) on or within 90 days before the date the petition was filed; or (B) if the creditor was an insider, on or within one year before the date the petition was filed; and
- That enabled the creditor to receive more than the creditor would have received if – (A) the case were a case under Chapter 7 of the Bankruptcy Code; (B) the transfer had not been made; and (C) the creditor received payment of such debt to the extent provided by the provisions of Chapter 7.
To recover a preference, the bankruptcy trustee must establish each and every element. In the event all of the elements cannot be proven, a preference has not been established and no recovery can be made.
However, if all of the elements are established, the insurance company, with the proper preparation, has a defense that can be raised to eliminate any liability.
To lay the seeds for this defense in advance, when entering into the agreement with the insured, ensure the agreement defines “events of default” and what the insurance company may do under such circumstances, including the ability to draw down on the insured’s collateral.
Debtors in bankruptcy matters are often required to maintain collateral to secure their obligations to the insurance company under such an agreement. This is especially important in a Chapter 11 bankruptcy proceeding as the debtor will need insurance to be able to reorganize.
If this is done in advance of the insured filing for bankruptcy (or rather, 90 days prior to the insured’s filing for bankruptcy), the insurance company has a strong defense to eliminate liability.
Therefore, the insurance company should then be able to retain the earned premiums.