The U.S. Bankruptcy Court for the Southern District of New York recently prohibited insurers from terminating debtors' insurance contracts based on so-called "cesser" clauses, which provided for the automatic termination of insurance coverage upon the commencement of proceedings under any bankruptcy or insolvency law. LaMonica v. N. of Eng. Protecting & Indem. Ass'n Ltd. (In re Probulk Inc.), 407 B.R. 56 (Bankr. S.D.N.Y. 2009).

Probulk involved the procedurally consolidated chapter 7 bankruptcy cases of 73 debtors, each of which owned, operated or managed one or more ocean-going reefers, dry bulk ships, tankers, containers or freezer vessels. Upon the filing of the debtors' bankruptcy cases, the two relevant insurers—the UK P&I Club and the North of England Protecting and Indemnity Association Limited (collectively, the "Clubs")—sought to cancel the debtors' outstanding insurance contracts.

In response, the Trustee commenced an adversary proceeding seeking a preliminary injunction against the Clubs to prevent them from terminating outstanding insurance or, to the extent necessary, to require the Clubs to restore coverage that existed prior to the filing of the debtors' bankruptcy petitions.

In their defense, the Clubs contended that the Trustee failed to establish two prongs necessary for a party to obtain a preliminary injunction: (1) irreparable injury if preliminary relief is not granted; and (2) a probability of success on the merits.

Cesser Clause

With respect to the second prong, probability of success on the merits, the Clubs pointed to a certain "cesser" clause contained in the relevant contracts. This clause provided that insurance coverage would automatically terminate in the event that a member of the Clubs (the insured debtors) commenced proceedings under any bankruptcy laws. The Clubs claimed that this clause resulted in termination of coverage as soon as the debtors' boards authorized a bankruptcy filing.

The court, however, warned that "[t]he Bankruptcy Code is not so easily evaded."

The court noted that "[t]here is no question that in the circumstances at bar [the debtors'] insurance rights constituted property of the debtors." In turn, the court looked to section 541(c)(1)(B) of the Bankruptcy Code, which provides, with exceptions inapplicable here, that an interest of the debtor in property becomes property of the estate:

. . . notwithstanding any provision in an agreement...or applicable nonbankruptcy law...that is conditioned on the insolvency or financial condition of the debtor, on the commencement of a case under this title, or on the appointment of or taking possession by a trustee in a case under this title or a custodian before such commencement, and that effects or gives an option to effect a forfeiture, modification, or termination of the debtor's interest in property.

11 U.S.C. § 541(c)(1)(B).

The court concluded there was "no question that the debtors' insurance rights continued notwithstanding the Clubs' attempt to deem them terminated as a consequence of the resolutions of the boards of directors of the debtors authorizing a bankruptcy filing...." The court again emphasized that section 541(c) explicitly applies "not withstanding any provision in ... applicable nonbankruptcy law." Thus, the court stated, "the fact that the provisions of the Clubs' contracts are authorized under U.K. law or that the contracts are governed by U.K. law is not determinative."

Furthermore, the court noted that any questions as to the scope of section 541(c)(1) in these cases were addressed by the provisions of 28 U.S.C. § 1334(e)(1), which give the district court, and by referral, the bankruptcy court, exclusive jurisdiction "of all the property, wherever located, of the debtor as of the commencement of such case, and of property of the estate." With no issue regarding subject matter jurisdiction, the court reasoned "[t]he fact that the debtors' world-wide insurance rights became property of the estate makes applicable § 362(a)(3) of the Bankruptcy Code, creating an automatic stay in bankruptcy ...."

As the court explained, the automatic stay "prevents a party to a contract from terminating the contract or taking action to deem the contract terminated after the bankruptcy case has commenced without seeking relief from the stay, and it is obviously applicable to insurance contracts."1

Based on the foregoing, the court found that the Trustee had demonstrated that he had "a clear probability of success on the merits in seeking a preliminary injunction against the Clubs' purported termination of the debtors' insurance" and that application of the "cesser" clause would constitute a violation of the automatic stay.

Irreparable Injury

The court disposed of the issue of irreparable injury swiftly, finding that the Trustee was relieved of having to prove irreparable injury in order to obtain a preliminary injunction. As the court explained, "[i]t has been held that a debtor need not prove irreparable injury if the requested injunction is necessary in order to preserve the jurisdiction of the Bankruptcy Court, especially if the automatic stay is at issue."

In any event, the court found that the record contained sufficient evidence that termination of insurance would create irreparable injury under the facts of this case: "Without insurance [the Trustee] would have to abandon the vessels, some of them in mid-voyage, resulting in the possibility of loss of cargo and loss of the vessels themselves. He has stated without contradiction that he has attempted unsuccessfully to obtain other insurance for the vessels."

Finally, the court dealt with the Clubs' contention that they simply were not subject to the personal jurisdiction of the bankruptcy court. The court rejected this argument, noting that the Clubs stood "mute" and provided no support for their contention.

The court concluded the Trustee had sufficiently established that the termination of the debtors' insurance because of their bankruptcy filings would have an immediate, substantial, direct and foreseeable impact on U.S. debtors, which sections 541(c)(1)(B) and 362(a) were designed to prevent. The court reasoned that termination of insurance would "subvert the interest of the United States in administering bankruptcy proceedings of domestic corporations in one forum."

Thus, the court held that the "Trustee of these domestic corporations in U.S. bankruptcy proceedings has therefore made out a prima facie case that personal jurisdiction exists over insurers that provided such corporations with world-wide P & I [maritime operations] cover."