The United States District Court for the Southern District of Texas, applying federal law, has reversed a bankruptcy court's ruling that the proceeds of an E&O liability policy were property of a bankruptcy estate. In re Burr Wolff, LP, 2007 WL 2964835 (S.D. Tex. Oct. 10, 2007). The court held instead that the issue was not ripe for adjudication because a declaratory judgment action concerning the insurer's obligations under the policy was pending, and thus "no proceeds" were currently available.
A company that provided professional services related to the payment of property taxes purchased an E&O liability policy with coverage limits of $5 million. At the end of 2005, the company failed to pay taxes for certain of its clients and, estimating that it was contractually liable for more than $6 million, it made a claim under its E&O policy. The insurer denied coverage, and the company filed a declaratory judgment action in state court regarding the insurer's coverage obligations. The company later filed for bankruptcy under Chapter 7 of the Bankruptcy Code. One of the company's clients filed a proof of claim against the company's estate in the bankruptcy action and sought an order from the bankruptcy court: (1) lifting the automatic stay; and (2) ruling that the proceeds of the E&O policy were not part of the estate.
The district court held that the issue was not ripe for judicial determination because "the facts that underlie that determination are not known." In particular, the court observed that "whether there will even be insurance proceeds for the estate to claim is contingent upon the outcome of [the coverage] litigation pending in state court."
The court also observed that, even if coverage were not in dispute, the Fifth Circuit held in Houston v. Edgeworth, 993 F.2d 51 (5th Cir. 1993), that the proceeds of a policy are property of the estate only if "the debtor has a cognizable claim" to the proceeds, which would occur only where: (1) the debtor has a right to keep the proceeds; or (2) the proceeds "fail to fully satisfy all claims." In the instant case, the court concluded that determining the debtor's right to the proceeds was not yet ripe because it was not known whether the claims made against the company by its former clients would exceed the policy's limit.
The court added that it believed that any hardship imposed on the parties by refusing to address the issue "would be slight," and therefore there was no equitable reason to address the issue at the present juncture.