993 F. 2d 51 - Edgeworth v. Edgeworth

Christine Genson, the appellant's mother, died on June 7, 1989, while under the care of appellee Dr. Lewis Edgeworth. A month later, Edgeworth filed for protection under chapter 7 of the Bankruptcy Code. Appellants did not participate in the bankruptcy case1 but, after Edgeworth received a discharge, they sought and obtained bankruptcy court approval to file a medical malpractice claim in state court.2 Shortly afterward, Edgeworth persuaded the bankruptcy court to reverse itself--to enforce his discharge by enjoining the lawsuit pursuant to 11 U.S.C. § 524(a). The district court affirmed. The question before us is whether the appellants may pursue their lawsuit against Dr. Edgeworth in order to collect any judgment solely from the proceeds of his malpractice liability policy. We hold that they may do so, because 11 U.S.C. § 524(e) excludes the liability insurance carrier from the protection of bankruptcy discharge and the proceeds of the policy were not property of Edgeworth's estate.

As this case turns on the construction of sections 524 and 541 of the Bankruptcy Code, it presents questions of law that are reviewed de novo.3

A. A Discharge Under § 524 Does Not Preclude a Suit to Recover from an Insurer

The bankruptcy court and district court enjoined appellants from proceeding with their state court lawsuit against Dr. Edgeworth because they apparently believed that the malpractice claim was discharged under section 727 and 524. In general, section 524 protects a debtor from any subsequent action by a creditor whose claim has been discharged in a bankruptcy case. To ensure that a discharge will be completely effective, it operates as an injunction against enforcement of a judgment or the commencement or continuation of an action in other courts to collect or recover a debt as a personal liability of the debtor. 3 Collier on Bankruptcy p 524.01, at 524-4 (15th ed.). A discharge in bankruptcy does not extinguish the debt itself, but merely releases the debtor from personal liability for the debt. Section 524(e) specifies that the debt still exists and can be collected from any other entity that might be liable.4

In the liability insurance context, of course, a tort plaintiff must first establish the liability of the debtor before the insurer becomes contractually obligated to make any payment.5 The question, then, is whether section 524(a) acts to bar such liability-fixing suits even if a plaintiff has agreed to foreswear recovery from the debtor personally and to look only to the policy proceeds.

Most courts have held that the scope of a section 524(a) injunction does not affect the liability of liability insurers and does not prevent establishing their liability by proceeding against a discharged debtor.6 This interpretation is grounded in both textual and equitable foundations. Section 524(a)(2) enjoins only suits "to collect, recover or offset" a debt as the "personal liability of the debtor," a phrase that has been interpreted to exclude merely nominal liability. In re Fernstrom Storage and Van Co., supra note 6.

The foundation of this reading of § 524(a)(2) is that it makes no sense to allow an insurer to escape coverage for injuries caused by its insured merely because the insured receives a bankruptcy discharge. "The 'fresh-start' policy is not intended to provide a method by which an insurer can escape its obligations based simply on the financial misfortunes of the insured." Jet Florida, 883 F.2d at 975; see Green, 956 F.2d at 33. "Such a result would be fundamentally wrong." Lembke, 93 B.R. at 703.7

Finally, allowing commencement or continuation of such actions does not inequitably burden the debtor. Burden there is, in the sense that attending depositions and trial may take up Edgeworth's time. But this is not a burden alleviated by § 524 when the purpose of the suit is to establish Edgeworth's nominal liability in order to collect from his insurance policy.8 Edgeworth has not asserted that he will be required to pay the costs of his defense against appellants' suit or that the insurance company denied coverage or is defending under a reservation of rights. Such threats to Edgeworth's pocketbook might require a different result under § 524.9 Thus, as long as the costs of defense are borne by the insurer and there is no execution on judgment against the debtor personally, section 524(a) will not bar a suit against the discharged debtor as the nominal defendant.10

Edgeworth makes much of the fact that the appellants never filed a claim in the bankruptcy proceeding, and it is true that their failure to do so waived their ability to recover from Edgeworth personally. But, at least in a case like this where no question has been raised about the sufficiency of the liability insurance coverage, a plaintiff's failure to file in the bankruptcy proceeding should not impair the right to file suit against another party who may be liable on the debt. See Green, 956 F.2d at 35; Jet Florida, 883 F.2d at 974-75, and cases cited therein; In re White, 73 B.R. at 984; Mann, 58 B.R. at 958.

B. The Insurance Proceeds Were Not Property of the Estate

As part of his argument that Houston's claim is barred, Edgeworth also asserts that the insurance proceeds sought by Houston were part of the bankruptcy estate and may not now be recovered. Edgeworth does not argue that these "insurance proceeds" literally came into the estate and were distributed as part of his Chapter 7 liquidation. In fact, Edgeworth never explicitly tendered the insurance policy or any insurance proceeds into the bankruptcy estate.11 Instead, Edgeworth argues that the insurance proceeds were part of the estate as a matter of law and that his discharge acted to bar forever any prepetition claims against the insurance policy.

"Property of the estate," defined in 11 U.S.C. § 541(a), includes all legal or equitable interests of the debtor in property as of the commencement of the case. This definition is intended to be broadly construed,12 and courts are generally in agreement that an insurance policy will be considered property of the estate.13 Insurance policies are property of the estate because, regardless of who the insured is, the debtor retains certain contract rights under the policy itself.14 Any rights the debtor has against the insurer, whether contractual or otherwise, become property of the estate.15

Acknowledging that the debtor owns the policy, however, does not end the inquiry. "The question is not who owns the policies, but who owns the liability proceeds."16 In In re Louisiana World Exposition, Inc., for example, even though the policy was property of the estate, the proceeds of the liability policy were payable to the directors and officers of the corporation and were not part of the debtor's estate.17 Likening the circumstances before it to cases in which a purchaser of an insurance policy assigned its proceeds to other entities,18 the court noted that ownership of a policy "does not inexorably lead to ownership of the proceeds."19

The overriding question when determining whether insurance proceeds are property of the estate is whether the debtor would have a right to receive and keep those proceeds when the insurer paid on a claim. When a payment by the insurer cannot inure to the debtor's pecuniary benefit, then that payment should neither enhance nor decrease the bankruptcy estate.20 In other words, when the debtor has no legally cognizable claim to the insurance proceeds, those proceeds are not property of the estate.21

Examples of insurance policies whose proceeds are property of the estate include casualty, collision, life, and fire insurance22 policies in which the debtor is a beneficiary. Proceeds of such insurance policies, if made payable to the debtor rather than a third party such as a creditor, are property of the estate and may inure to all bankruptcy creditors. But under the typical liability policy, the debtor will not have a cognizable interest in the proceeds of the policy. Those proceeds will normally be payable only for the benefit of those harmed by the debtor under the terms of the insurance contract.

Although Dr. Edgeworth's liability policy was part of the Chapter 7 estate, the proceeds of that policy were not. Dr. Edgeworth has asserted no claim at all to the proceeds of his medical malpractice liability policy, and they could not be made available for distribution to the creditors other than victims of medical malpractice and their relatives. Moreover, no secondary impact has been alleged upon Edgeworth's estate, which might have occurred if, for instance, the policy limit was insufficient to cover appellants' claims or competing claims to proceeds. Consequently, in this case the insurance proceeds were not part of the estate as a matter of law, and section 524 does not bar appellants from pursuing their state court suit against Dr. Edgeworth so they can recover against policy proceeds.

For the foregoing reasons, the decisions of the bankruptcy and district courts are REVERSED.