On Feb. 23, Pennsylvania became the second state to recognize an "ordinary course of business" exception to preference actions brought under a state insolvency statute where the defense is not expressly set forth in the statute. In Joel S. Ario, Insurance Commissioner of the Commonwealth of Pennsylvania, in his Official Capacity as Liquidator of Reliance Insurance Company v. Ingram Micro Inc., the Pennsylvania Supreme Court was faced with the issue of whether an insurer's pre-liquidation payment for a covered loss to an insured can be clawed back as a preference under the Pennsylvania Insurance Department Act of 1921 (the 1921 Act).
In an opinion authored by Justice Debra Todd, the court concluded that a payment made by an insurer to an insured in the ordinary course of business does not constitute antecedent debt and, therefore, is not a preference under the applicable provisions of the 1921 Act.
Factual And Procedural Background
In 1999, Reliance Insurance Company issued certain Trade Credit Insurance Policies (the Policies) to several entities (the Policyholders). Pursuant to the Policies, Reliance insured the Policyholders for losses arising from the nonpayment by customers of the Policyholders for goods and services delivered by the Policyholders. In the year 2000, the Policyholders suffered losses that were covered by their respective Policies, and the Policyholders consequently filed claims with Reliance.
After reviewing the claims, Reliance determined that the losses constituted "covered losses" under the Policies. As a result, and in accordance with the terms of the Policies, Reliance and the Policyholders executed certification and release agreements. Once those agreements were delivered to Reliance, Reliance paid the Policyholders the amounts due under the Policies.
Less than one year later, on May 29, 2001, the Commonwealth Court granted the petition of M. Diane Koken, then-Pennsylvania insurance commissioner, to place Reliance in rehabilitation under Section 221.15 of Article V of the 1921 Act (Article V), 40 P.S. § 221.15. Thereafter, on Oct. 3, 2001, the Commonwealth Court granted the petition of the commissioner, as rehabilitator of Reliance, to place Reliance into liquidation under Section 221.20 of Article V.
In her capacity as liquidator of Reliance Insurance Company, Koken (the Liquidator) commenced preference actions against the Policyholders under Section 221.30 of Article V (the Preference Provision) seeking the return of the payments that had been made to the Policyholders by Reliance on account of the Policyholders' claims (the Policyholder Preference Actions).
On Oct. 7, 2004, each of the Policyholders filed a motion for summary judgment claiming, inter alia, that Reliance's payment to them was made in the ordinary course of business and, as such, was not recoverable as a preference. On Nov. 8, 2004, the Liquidator filed a cross motion for partial summary judgment.
On Jan. 26, 2006, President Judge James Gardner Colins of the Commonwealth Court issued a memorandum opinion and order granting summary judgment to the Policyholders. The Commonwealth Court held that the contested payments were not voidable preference payments under Article V. In the same order, Colins denied the Liquidator's motions for partial summary judgment.
On Feb. 9, 2006, the Liquidator filed an application for reconsideration of the Jan. 26, 2006, memorandum opinion and order. On April 11, 2006, the Policyholder Preference Actions were consolidated for purposes of briefing to and disposition by the state Supreme Court.
The Arguments On Appeal
On appeal, the Liquidator argued that the underlying transfers by Reliance to the Policyholders were preferential because all of the statutory requirements had been met: the payments were made to the insureds less than one year before Reliance was placed in rehabilitation; the payments were to creditors (i.e. the Policyholders); and the payments were on account of antecedent debts (i.e. the debts arose at the time the Policyholders suffered losses under their policies and filed proofs of loss with Reliance, all of which occurred months before Reliance paid the Policyholders).
The Policyholders argued, inter alia, that a payment made in the ordinary course of business is not a payment on account of an antecedent debt; and the debt was not antecedent because it did not arise until after the Policyholders executed a "Certification and Release" form, which was required under the Policies before payment could be made on the underlying claims, and because the payments were made substantially contemporaneously with the execution of the underlying Certification and Release form.
The Court's Analysis
The court's analysis focused in large part on the term "antecedent debt": in order to constitute a preferential payment under Article V, the payment must have been made on account of "antecedent debt." Like the federal Bankruptcy Code, the 1921 Act does not define this term.
Moreover, the Liquidator and the Policyholders ascribed very different meanings to the term, both of which the court found to be reasonable statutory interpretations. The Liquidator argued that, as a general matter, an antecedent debt is considered to be a debt when a policyholder first suffers an insured loss under its policy. More specifically, the Liquidator argued that the payments to the Policyholders were made months after the Policyholders suffered losses under their policies and submitted claims to Reliance for payment.
The Liquidator also argued that a preference action could not be defeated simply because the payments were made in the ordinary course of business, because there is no ordinary course exception written into the preference provisions of the 1921 Act.
The Policyholders did not dispute the general definition of "antecedent debt" as described by the Liquidator; instead, they argued that payments or transfers made in the ordinary course of business do not constitute antecedent debt. Based on the foregoing, and after finding that the term antecedent debt is not free from ambiguity, the court found it necessary to ascertain the Legislature's intent in drafting Article V of the 1921 Act.
In validating an ordinary course defense to preference claims, the court was persuaded by the fact that analogous federal bankruptcy law recognizes an ordinary course exception to preference actions, and that at least one other jurisdiction has read an ordinary course of business exception into its insurance insolvency statute.
As importantly, the court gave great weight to the impact a contrary decision would have on the Pennsylvania insurance market. The court stated: "An insurance consumer's selection of an insurer might very well turn on whether a policyholder's receipt of monies paid for a loss by an insurer may be recovered as a voidable preference."
The court concluded that insureds would simply not buy insurance from Pennsylvania-domiciled insurers should payments the insureds received for losses be subject to disgorgement. According to the court, its construction of the preference provisions of Article V of the 1921 Act "best upholds the interests of insureds, including policyholders of insurance, creditors, and the public, as well as the best interests of the Pennsylvania-domiciled insurers."
Interestingly, the court did not resolve the issue raised by the Policyholders that as "policyholders" of Reliance, they could not be "creditors" subject to the preference provisions of the 1921 Act. Instead, the court validated the "ordinary course" exception to Pennsylvania insurance insolvency preference actions, and concluded that Reliance's payments to the Policyholders constituted "ordinary course" payments in any event.
The decision in Ario v. Ingram Micro Inc. demonstrates that Pennsylvania courts, in interpreting certain insolvency provisions of the Pennsylvania Insurance Department Act, will look to parallel provisions of the Bankruptcy Code, as well as to the relatively better-developed body of common law that has matured under the federal statute.
The next test of the 1921 Act's preference provisions may come when a liquidator sues a policyholder to recover a payment outside of the insurer's ordinary course of business. In that event, the court will be called on to determine whether "policyholders," by definition, are "creditors" of the insurer subject to the preference provisions of the 1921 Act.
Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors' rights. He is a member of the American Bankruptcy Institute, the American Bar Association and its business law section, the Commercial Law League of America, the Pennsylvania Bar Association and the business law section of the Philadelphia Bar Association.
Sommer L. Ross practices in the area of business reorganization and financial restructuring. Admitted to practice in Delaware, Pennsylvania and New Jersey, Ross is a 2004 graduate of Rutgers University School of Law, where she was a member of the Rutgers Law Journal, and a graduate of the University of Delaware.
Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.