A lender files a UCC-1 in the debtor's home state with the goal of perfecting a security interest in all of the debtor's accounts, inventory and payment intangibles, including the debtor's rights to payment under its insurance policies. What happens when a fire or disaster strikes and the now-bankrupt debtor's largest asset is its business interruption insurance claim for its loss of income from the disaster? Docs a UCC-1 filing perfect the lender's security interest in a debtor's insurance coverage and claim proceeds, enabling the lender to enjoy a priority right to the insurance proceeds in bankruptcy?
In Wheeling & Lake Erie Railway Co. v. Keach (In re Montreal), 799 F.3d 1 (1st Cir. 2015), the First Circuit acknowledged that the lender's UCC-1 filing expressly listed accounts, rights to payment, and proceeds including insurance proceeds—but the Court still held that the lender had failed to perfect a security interest in the debtor's insurance coverage or claim proceeds.
Wheeling arose from the calamitous July 2013 tanker train derailment in Lac-Megantic, Quebec. The derailment and ensuing fire killed 47 people and destroyed much of the town. The debtor filed a Chapter II bankruptcy petition one month after the disaster. After a period of negotiation involving the debtor and the court appointed trustee, the debtor's insurance company agreed to pay S3.8 million in business interruption insurance proceeds for the loss of income to the debtor. A motion was brought to approve the settlement and the disposition of the insurance proceeds. Lender Wheeling objected. Wheeling claimed a priority interest in the insurance proceeds based on its UCC-1 filing and putative security interest in the insurance coverage and proceeds.
Wheeling argued that the insurance coverage, right to payment, and proceeds qualified as an "account" or a "payment intangible" and therefore its UCC-1 filing served to perfect Wheeling's security interest in the policy and proceeds. The First Circuit rejected this argument on several grounds. First and foremost, the Court observed that Section 1-109 of the Uniform Commercial Code (here, the Maine version) excludes from the reach of Article 9 "the transfer of an interest in or an assignment of a claim under a policy of insurance" except for certain health insurance receivables and assignments, and the proceeds of policies in which there was a perfected security interest. (The Article 9 insurance exclusion in Massachusetts is virtually identical.) Writing for the First Circuit, Judge Bruce M. Selya held that "the right to payment under an insurance policy . . . falls squarely within the heartland of this exclusion" and therefore the filing of a UCC-1 cannot and does not perfect a security interest in an insurance policy or claim proceeds.
The First Circuit's analysis appears sound on the facts of the Wheeling case, but the decision is a reminder of the sometimes controversial nature of the insurance exclusion in Article 9. See Verstein, "Bad Policy for Good Policies: Article 9s Insurance Exclusion," 17 Conn. Ins. Law J. 287 (suggesting modification of the insurance exclusion). As the law now stands, it is open to question whether lenders have any certain means, including being named on the policy as a loss payee, of securing an interest in an insurance policy.
Wheeling may have disappointed some lenders who had hoped based on MNC Commercial Corp. v. Rouse, 1992 U.S. Disc. Lexis 22166 (W.D.Mo. 1992) that the courts would liberally view all insurance proceeds, even insurance on lost profits, as the proceeds of income-producing collateral and within the scope of an Article 9 security interest created by the filing of a UCC-1.
But see CPC Acquisitions Lite, v. Helm, U.C.C. Rep. Serv.2d 669 (N.D.Ill. 2007) (negligent procurement insurance settlement involving damaged collateral considered proceeds, but not proceeds of settlement involving business interruption income losses).
How might the First Circuit rule in a case where the insurance proceeds arise from damage or destruction of inventory in which the lender had perfected its security interest under Article 9? Would the Court follow its strongly-worded decision in Wheeling and apply the statutory insurance exclusion? Or would it rule that because the underlying collateral was subject to an Article 9 security interest, the proceeds of the insurance policy are also subject to the Article 9 security interest? Something to think about before a secured party calls asking you about the strength of its claim to a debtor's insurance proceeds!
Originally published in ComCom Quarterly, December 2015
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