Last month, the United States Court of Appeals in two separate circuits held that liability insurers have standing as parties in interest to appear and be heard in an insured's Chapter 11 case where the insurer might be liable to indemnify the claims of the insured's creditors. In In re Global Industrial Technologies, Inc., 2011 WL 1662792, --- F.3d --- (May 4, 2011) ("GIT"), an en banc panel of the Third Circuit held that "when a federal court gives its approval to a plan that allows a party to put its hands into other people's pockets, the ones with the pockets are entitled to be fully heard and to have their legitimate objections addressed. In short, they at least have bankruptcy standing."

GIT argued that its plan was "insurance neutral" and nothing in the plan or the confirmation order preclude insurers from asserting any rights or defenses under the policies, except those related to "anti-assignment provisions." The bankruptcy court agreed with GIT, denied the insurers standing to object to the plan or establishment of a trust for silica claims against the debtor, and confirmed the plan. The district court affirmed.

On further appeal, the Third Circuit adopted the Seventh Circuit's test for standing that "anyone who has a legally protected interest that could be affected by a bankruptcy proceeding" constitutes a party in interest, and rejected the "more exacting" requirement for standing imposed by the lower courts as "a misunderstanding of the Code." The plan increased the insurers' liability exposure because of "suspect circumstances surrounding the creation of the APG Silica Trust and the questionable provenance of the silica-related claims." The Third Circuit felt that "the integrity of the bankruptcy proceeding is called into question by nonfrivolous allegations of collusion between GIT and the asbestos claimants' counsel in negotiating the establishment of the APG Silica Trust and Silica Injunction." The Court concluded that the insurers' "incentive to pursue" the issue supported their claim to standing.

The Third Circuit explicitly did not reach whether the insurers could satisfy the more stringent standards for appellate standing, reversing solely on the lower courts' failure to grant the insurers bankruptcy court standing to be heard on their plan objections below. In a footnote, however, the Court admonished "that the implications of our decision in Congoleum [holding that insurers had appellate standing where the integrity of the bankruptcy system was at stake] be taken into account" in the event of a future appeal after remand.

The dissenting opinion noted that the insurers were not injured by plan confirmation because the plan preserved insurers' rights to contest coverage for claims paid by the silica trust. Moreover, granting the insurers standing, the dissent worried, would open the floodgates to self-serving challenges to plan confirmation in future cases imperiling the Bankruptcy Code's purpose to foster reorganizations. "[T]o say that an insurance company is worried that its risk for future indemnity obligations might be larger than it projected when it established the insurance policy is another way of describing the leitmotif of the insurance industry within its normal course of business."

On May 16, 2011, the Second Circuit reached a similar result in In re Heating Oil Partners, LP, 2011 WL 1837820. There, the Court concluded that a liability insurer had standing to bring a motion in bankruptcy court seeking an order declaring void a default judgment entered against the insured debtor. The judgment creditor argued that the insurer lacked standing as a third party to the bankruptcy proceedings to invoke the protections of the debtor's discharge injunction or the automatic stay. The Second Circuit reasoned that the judgment creditor sought to satisfy its judgment with the debtor's insurance coverage. The insurer's motion had a "direct impact" on whether the insurer would be required to pay indemnity. Thus, "[w]ithout a doubt," the insurer's "personal stake" made the insurer a party in interest pursuant to Section 1109(b).

Taken together, these two circuit level decisions create a dramatic trend away from the approach adopted by many lower courts to insurer standing in Chapter 11 cases. These decisions will give insurers new ammunition in pursuing their stake in an insured's bankruptcy, not just in important jurisdictions bound by these rulings such as the District of Delaware and the Southern District of New York, but also around the country. Additionally, debtors and their creditors seeking to make use of insurance proceeds to pay claims will need to reevaluate their approach and inclusion of insurers in the bargaining process.