Is insurance just a business or does it serve a greater public good? If it weren’t for insurance, a fire or earthquake could leave you homeless; a visit to the emergency room could wipe out your bank account; a workplace accident could leave you salary-less. But, on the other hand, picture that wily Geico lizard, and insurance seems more like any other business trying to make a buck.
Back in the 1940s, the courts and Congress grappled with whether insurance qualified as commerce. In U.S. v. South-Eastern Underwriters Ass’n, the United States District Court for the Northern District of Georgia held that insurance was not commerce and therefore was beyond the reach of Congress’ Commerce Clause power. On appeal, the Supreme Court reversed, holding that insurance was, indeed, a business, and a large one at that, with total assets exceeding “the value of all farm lands and buildings in the United States.” It probably didn’t help that South-Eastern Underwriters used a monopoly to fix premium rates and agent commissions, and used “coercion and intimidation” to force individuals to buy from it.
Congress disagreed with the South-Eastern Underwriters decision and passed the McCarran-Ferguson Act in 1945 out of a belief that “regulation . . . by the several States of the business of insurance is in the public interest.” Providing that “no Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance . . . unless such Act specifically relates to the business of insurance,” McCarran-Ferguson created a form of reverse preemption. In other words, unlike ordinary preemption, in which federal law automatically wins out over conflicting state law, when it comes to insurance regulation, state law trumps.
But when is a state law “for the purpose of regulating the business of insurance?” And when does a federal law “specifically relate to the business of insurance?” And is “the business of insurance” different from plain old “insurance?” With language like that, McCarran-Ferguson “ensured” a future of litigation.
Ames v. Lumbermens: Factual Background
In a recent adversary proceeding in Ames Department Stores, Inc.’s chapter 11 case, Lumbermens Mutual Casualty Company argued that McCarran-Ferguson should bump jurisdiction from federal bankruptcy court to state rehabilitation court. The adversary proceeding commenced in 2006 and originally involved two insurance companies, Lumbermens Mutual and Travelers Indemnity Company. Back in 2000, Ames was still offering its customers “bargains by the bagful” and providing workers’ compensation insurance for its employees under a policy with Travelers. Ames entered a surety bond agreement with Lumbermens to backstop Ames’ obligation to Travelers, under which, if Ames failed to pay Travelers for whatever reason, Lumbermens would pay Travelers on Ames’ behalf. Ames was required to reimburse Lumbermens for any such payments, but Ames’ employees could keep their workers’ comp coverage in the meantime.
During its chapter 11 case, Ames continued to operate and needed to provide its employees workers’ compensation. Apparently, Travelers did not buy the department store’s slogan to “believe in Ames,” so Ames took out two letters of credit from Wachovia Bank for the benefit of Travelers to backstop Ames’ obligations to Travelers for workers’ comp insurance. These letters of credit were fully cash collateralized.
Sure enough, in 2003, Ames missed some payments to Travelers. Lumbermens, in dire straits of its own, failed to make the backstop payments to Travelers. Rather than bothering with Ames, Travelers went straight after Lumbermens in a Connecticut state court action, which settled with Lumbermens depositing $8 million into a trust account for Travelers’ benefit. In exchange, Travelers promised that, in the future, if Ames failed to make its payments, Travelers would draw on the Wachovia letters of credit before drawing from the trust account. Lumbermens and Travelers did not seek approval of this arrangement from the bankruptcy court.
Ames commenced an adversary proceeding against both Travelers and Lumbermens in 2006, arguing, among other things, that Travelers should have first looked to Lumbermens and its $8 million trust account before looking to the letters of credit, which were collateralized by cash of the bankruptcy estate. After settling with Travelers in 2008, Ames amended its complaint to remove Travelers from the adversary proceeding and asserted claims against Lumbermens for failing to honor the surety bond agreement under state contract law and for violating the automatic stay under federal bankruptcy law because Lumbermens had modified Ames’ rights under the bond agreement without court approval. Additionally, the debtor moved for declaratory judgments (a) to release the $8 million held in trust to Ames’ bankruptcy estate and (b) that, if Ames failed to pay Travelers for its workers’ comp, Travelers would knock on Lumbermens’ door first before drawing on Wachovia’s letters of credit.
By 2012, Lumbermens’ own financial situation had gone from bad to worse, and it entered state rehabilitation proceedings in Illinois. The state rehabilitator challenged the bankruptcy court’s jurisdiction over the adversary proceeding, arguing for the issues to be addressed in Illinois state court as part of Lumbermens’ ongoing insolvency proceeding. The United States District Court for the Southern District of New York granted the rehabilitator’s motion to withdraw the reference and requested a report and recommendation on Lumbermens’ jurisdictional motion from Judge Gerber in the United States Bankruptcy Court for the Southern District of New York.
McCarran-Ferguson Discussion in Ames
Judge Gerber first worked his way through a detailed analysis of the usual jurisdiction round of suspects: 28 U.S.C. sections 1334, 157, core versus non-core matters, in rem versus in personam jurisdiction—if you have any room left after the holidays, the report and recommendation is a veritable smorgasborg of bankruptcy law procedure. Finding that it had authority to hear all the claims, the bankruptcy court continued on to determine whether McCarran-Ferguson applied.
Judge Gerber broke down the statute into three prongs for analyzing whether to apply reverse preemption. First, he considered whether the federal law at issue specifically relates to the business of insurance, and quickly concluded that the Bankruptcy Code does not. Therefore, he found, the “unless” clause at the end of the McCarran-Ferguson provision cited (“unless such Act specifically relates to the business of insurance”) did not apply.
The second prong concerns whether the state law at issue was “enacted for the purpose of regulating” insurance. Here, the parties disagreed about which state law was at issue. Citing the Supreme Court case U.S. Dept. of Treasury v. Fabe, Ames asserted that only the specific statute relegating jurisdiction to the Illinois state court was at issue. Judge Gerber agreed that the specific statute was the appropriate federal law to assess, but found that the jurisdictional provision had a regulatory purpose after all. He cited the Second Circuit decision Stephens v. American Intern. Ins. Co. for a broad reading of the second prong of the McCarran-Ferguson analysis. Accordingly, Judge Gerber reasoned, the purpose of the jurisdictional provision of the Illinois state law was to ensure orderly and predictable liquidations of insurance companies, and therefore, the state law at issue regulated the business of insurance.
In prong three, however, Judge Gerber came out on Ames’ side, finding that allowing the case to proceed in federal bankruptcy court would not “impair, invalidate, or supersede” Illinois state law. Judge Gerber cited the Supreme Court decision Humana v. Forsyth for the proposition that “[w]hen federal law does not directly conflict with state regulation, and when application of the federal law would not frustrate any declared state policy or interfere with a State’s administrative regime, McCarran-Ferguson does not preclude its application.” In other words, for a state law to win out over a federal law, the federal law has to really mess with state policy. Here, Judge Gerber found that bankruptcy court jurisdiction would not contravene Illinois law in any meaningful way, because any bankruptcy court judgment would remain subject to the priority scheme of the Illinois insurance action. Therefore, hearing the adversary proceeding in federal bankruptcy court would not impair, invalidate or supersede Illinois Insurance Law.
In Ames v. Lumbermens, the Southern District of New York indicated a reluctance to apply McCarren-Ferguson broadly. A party desiring to challenge bankruptcy court jurisdiction on McCarren-Ferguson grounds will need to find a way in which state law would be impaired. Pointing to a statute conferring jurisdiction to state court will not suffice. Rather, for reverse-preemption to apply, the Bankruptcy Code must interfere with state law or policy in a more fundamental way.