In re WL Homes LLC, Case No. 09-10571 (Bankr. D. Del. May 16, 2012)

CASE SNAPSHOT

The debtor’s insurer sought to lift the automatic stay in order to setoff $2.2 million in return premiums against potential defense costs that the insurer expected to incur related to certain insurance claims made against the debtor. The court denied the motion, finding that the insurer had not established a right to setoff under either state law or the Bankruptcy Code.

FACTUAL BACKGROUND

WL Homes, a national homebuilder, purchased insurance policies from Zurich American Insurance Company, to provide protection against claims relating to construction defects. The policies required WL Homes to pay a certain amount of such claims, defined as "self insured retention." Zurich’s obligation to pay claims only kicked in after WL Homes paid the self insured retention; Zurich could elect to pay any portion of the self insured retention, but if any final judgment or settlement was less than the retention amount, Zurich would have no obligation to pay damages.

At the time WL Homes filed for bankruptcy in 2009, Zurich held $2.2 million in premium overpayments (called a return premium). Under the policy, WL Homes was entitled to the return premium, but Zurich had not relinquished it as of the time it sought relief from the automatic stay. Zurich’s motion for relief from the automatic stay sought the court’s permission to apply the return premium toward any amount it may elect to pay in defending claims against the debtor. The chapter 7 trustee objected to the motion.

COURT ANALYSIS

Section 553 provides that the Bankruptcy Code does not affect any right of setoff that a creditor had before the bankruptcy. Creditors seeking to exercise their setoff rights, however, must seek relief from the automatic stay and show that the setoff could be exercised under nonbankruptcy (state) law. The most common form of proof is that a mutual claim and debt arose prior to the debtor’s bankruptcy.

Zurich argued that it had a "contingent claim" against the debtor’s bankruptcy estate because it had not yet advanced, nor had it decided if it would advance, defense costs within the self insured retention. Zurich claimed California state law permitted a party to setoff a contingent claim. The court did not agree with Zurich’s argument and found contrary authority stating that a party’s setoff rights were only available with fixed claims.

The court also found that Zurich’s claim did not fit within the parameters of section 553(a), which requires that a mutual debt and claim "both must have arisen pre-petition." Case law has consistently held that, for setoff purposes, a claim arises when all transactions necessary for liability occur.

Zurich did not present any evidence that as of the petition date it had paid, or elected to pay, any amounts within the self insured retention. "If there is still an election yet to be made and money yet to be paid - both of which are decisions entirely within Zurich’s control post-petition - then not ‘all transactions necessary’ for a definite liability to accrue occurred as of the petition date." (Emphasis in original.) Thus, the court held that Zurich had not established a right to setoff, and denied Zurich’s motion to lift the automatic stay.

PRACTICAL CONSIDERATIONS

The court clearly held that, when showing "cause" pursuant to a motion for relief from the automatic stay in order to exercise one’s setoff rights, the movant must: (i) demonstrate its right to setoff under state law, and (ii) show that it meets the requirements set forth in section 553 of the Bankruptcy Code.