SCHRIER SHAYNE KOENIG SAMBERG & RYNE, P.C. Attorneys for: Kathleen McCarthy 825 East Gate Boulevard, Suite 320 Garden City, New York 11530 Tel: (516) 739-8000 Fax: (516) 739-8004 Richard E. Schrier, Esq. (RS-9985) Hearing Date: January 7, 2016 at 11:00 p.m. (E.T.) UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK In re: METRO AFFILLIATES, INC., et al. Debtors. : : : : : : : Chapter 11 Case No: 13-13591(SHL) REPLY MEMORANDUM IN REPLY TO THE OBJECTIONS FILED BY LIBERTY MUTUAL INSURANCE COMPANY AND THE LIQUIDATING TRUSTEE S OBJETION TO THE MOTION SUBMITTED BY KATHLEEN McCARTHY FOR AN ORDER REJECTING THE STIPULATION AND MEMORANDUM OF UNDERSTANDING BETWEEN THE LIQUIDATING TRUSTEE AND LIBERTY MUTUAL INSURANCE COMPANY REGARDING CLAIMS HANDLING MATTERS AND IN FURTHER SUPPORT OF McCARTHY S APPLICATION FOR CLARIFICATION OF THE PLAN CONFIRMATION ORDER Kathleen McCarthy ("McCarthy"), by and through her undersigned attorneys, hereby submits this reply memorandum of law in reply to the objections filed by Liberty Mutual Insurance Company ( Liberty ) and the Liquidating Trustee s ( Trustee ) objection to McCarthy s Motion, for entry of an order, rejecting the Stipulation and Memorandum of Understanding [ MOU ] [ECF No,. 1767] between the Liquidating Trustee and Liberty Mutual Insurance Company regarding claims handling matters and in further support of McCarthy s application for clarification of the Plan Confirmation Order [ECF No. 1372], and together with such other and further relief as the Court deems just and proper.
1. The Liquidating Trustee in its Objection to McCarthy s application for clarification argues that the Plan is unambiguous and does not require clarification [ECF No. 1730 at para. 10 et. seq.], however, Liberty, in its objection to McCarthy s application to reject the MOU at paragraph 16 specifically states that on February 12, 2015, in response to a motion by McCarthy seeking an order clarifying the Plan [ECF No. 1730], the Liquidating Trustee filed the MOU [ECF No. 1767]. 2. Respectfully to the Trustee, it is quite apparent that the Plan, while addressing the issue of lifting the automatic stay under 362 of the Bankruptcy Code for all personal injury claimants which the Trustee claims was for the sole and limited purpose of permitting such Holder to seek full recovery (emphasis added), if any as determined by an order or judgment by a court of competent jurisdiction or under a settlement or compromise of such Holder s Allowed Insured Claim on account of its Allowed Insured Claim, from the applicable and available insurance policies maintained by or for the benefit of any of the Debtors, in fact the Plan failed to address the status of the pre-filing security that was maintained by the Debtor in connection with the motor vehicle policy maintained for the hundreds of school buses owned and operated by the Debtors. That issue is the subject of virtually all of the pending personal injury cases that have filed notices of claims in this bankruptcy proceeding regarding accidents that occurred outside of New York City. 3. Both Liberty and the Trustee, realizing that, in fact there was an ambiguity in the Plan and there was likely going to be disputes as to the use and distribution of the $16,200,000.00 security fund drawn down by Liberty pursuant to the Cross-Collateralization Amendment & Agreement by and between Liberty Mutual Insurance Company and Atlantic Express
Transportation Corp. (the Cross-Collateralization Agreement ) [ECF No. 1731-2 (Exhibit B)], initially staked out their respective positions. 4. To analyze the MOU and how it impact the Plan and those individual personal injury claimants, the following undisputed facts are relevant: a. The liability insurance policy issued by liberty (policy number AS2-721-001153-051) provided for $1 million of coverage with a $500,000.00 self-insured deductible; b. With regard to claims up to $500,000.00, the debtor was wearing "two hats", that is the debtor was both the insured party and was the party responsible for payment of legal fees, costs and expenses of defending claims made as well as the obligation to pay claims up to the $500,000.00 deductible amount (that is, the Debtor was self-insured for the first $500,000.00 of the cost of each claim); c. Liberty, on the other hand, as it relates to the first $500,000.00, did not have any insurance responsibility, but rather was acting as the agent for the debtor when it hired attorneys to defend the claims and supervised the litigations on behalf of the debtor for which the debtor paid Liberty a fee via insurance premiums; d. However, once the initial $500,000.00 deductible was exhausted, Liberty began wearing it's "insurance hat", that is, it had the obligation to pay claims in excess of the deductible; e. With regard to the initial $500,000.00 self-insured deductible, Liberty as the agent for the insured (the debtor), had "...the right but not the duty to advance any part or all of the deductible amount..." (see the deductible endorsement of the liberty policy at ECF no. 1731-1 at page 18 of 131); f. Pursuant to the deductible endorsement of the Liberty policy, in the event Liberty elected to advance any part of the deductible amount for legal fees, litigation expenses or the payment of
claims, The debtor, wearing it's "self-insured hat", was required to promptly reimburse Liberty for all payments advanced since the payment of the litigation costs and claims were the "... Sole and exclusive liability..." of the debtor as the self-insurer and the "... exercise of "...Liberty's "right to advance such amounts shall not create any obligations or be construed as giving rise to any course of dealing nor shall the exercise of "...Liberty's... right to advance such amounts be construed as a waiver or an estoppel of"...liberty's... rights under the policy." (See paragraph 5 of the Deductible Endorsement attached hereto as Exhibit A ); g. To secure the debtors obligation to reimburse Liberty in the event it advanced any sums of money, the debtor established revocable and unconditional letters of credit in the total sum of $17,864,335 (see the Letter of Credit Security Agreement annexed hereto as Exhibit B to this memorandum); h. Additionally, to further secure Liberty in the event the debtor failed to replenish the money advanced by Liberty, in its role as agent for the debtor in connection with the self-insured portion of the policy, the parties entered into the Cross-Collateralization Agreement which provided that in the event Liberty was not reimbursed for monies that it had advanced, Liberty had the right to draw down the required amount from the letters of credit. Thereafter, in the event the debtor failed to replenish the security, pursuant to the Cross-Collateralization Agreement, liberty have the right but not the obligation to draw down the remaining security available (see the Cross- Collateralization Agreement annexed hereto as Exhibit C ). i. Prior to the filing of the bankruptcy petition by the debtor, the debtor failed to pay the outof-pocket sums advanced by Liberty and thereafter failed to replenish the collateral; j. After the debtor failed to replenish the collateral, Liberty exercised its right to draw down on the remaining collateral available (which was approximately $16,200,000);
5. Liberty, upon information and belief, took the position that: a. it had rightly drawn down on the remaining collateral; b. it had the right to utilize those funds to reimburse itself for all out-of-pocket expenses incurred in connection with the continuation of the defense of claims asserted against the debtor's; c. it could utilize those funds to make payments in satisfaction of a judgment or in regard to a settlement with the injured claimants up to a total sum of $500,000.00, after which Liberty would be responsible for paying those claims to the extent they exceeded $500,000.00; d. the fund that was drawn down was not the property of the debtors or the liquidating trust; and e. to the extent that any funds were left after the payment of litigation expenses and the satisfaction of all claims asserted against the debtor, only those remaining funds, if any, would be returned to the debtor s estate for distribution. 6. The trustee on the other hand, upon information and belief, took the position that: a. the fund drawn down by Liberty prior to the filing of the bankruptcy petition, is an asset that should be part the debtors estate; 7. However, after McCarthy made her application for an order clarifying the Confirmed Plan, the trustee stated at paragraph 14 of its Objection to the Cross-Motion of McCarthy for an order clarifying the confirmed plan [ECF No. 1730] that: "...14. Liberty maintains that the collateral is not a fund for distribution to claimants on account of insured claims it is not presently property of the debtors or the
liquidating trust subject to the distribution mechanisms of the plan. Rather, the collateral is held by liberty in accordance with the terms and conditions of the insurance collateral agreements as security for the performance of the debtor s financial obligations under the insurance policy, subject to being returned or refunded to the liquidating trust, to the extent not used to satisfy obligations of the debtors to Liberty. The liquidating trustee, after reviewing the policy and the applicable agreements between Liberty and the debtors regarding the collateral, does not dispute the foregoing characterization by Liberty regarding the nature of the collateral ". 8. That admission by the Trustee gave Liberty the "green light" to utilize the funds to reimburse itself (Liberty) for all the costs and expenses related to the defense of the claims asserted by the injured claimants. However, the trustee's admission came at a price But not at a price that affected Liberty. 9. The price was that Liberty would join the Trustee in taking the position that Liberty only had to pay claims in motor vehicle cases up to the minimum amount of insurance required to be maintained in the state in which the motor vehicle accident occurred and that the remaining funds would be returned to the estate for distribution to the unsecured creditors (See the MOU (ECF No 1767) at paragraph 4). 10. Both Liberty and the trustee have argued that: a. the MOU is consistent with the terms of the Plan and is merely "administrative"; b. Liberty is only responsible for the payment of any claims that exceed $500,000.00; c. Liberty is still subject to the deductible endorsement that reads at paragraph 5: "... We have the right but not the duty to advance any part or all of the deductible amount " (See Exhibit A: annexed hereto).
d. That as a result, Liberty is not obligated to use the funds that were draw down to pay any of the claims asserted by the injured claimants; 11. However, it is likely that Liberty and the Trustee are aware of the public policy that liability insurance is a contract of indemnity and Liberty, having already drawn down the security that was designed to be utilized by the self-insured debtor for the payment of injured parties claims, found that in a handful of states, when a claim is made, the courts have ruled, as a matter of public policy, that an injured party should be entitled to recover at least the statutory minimum required by that state s financial responsibility law. 12. The defect in the foregoing theory is that in New York, the courts have ruled that the insurance coverage becomes irrevocable as to a third-party at the time of the occurrence. Therefore, when a third-party brings an action, he or she is entitled to receive the full amount of the insurance coverage, not just the mandatory minimum amount. See: Allstate Ins. Co. v. Sullam, 349 N.Y.S.2d 550 (Sup. Ct. 1973). 13. Both the trustee and Liberty have argued that McCarthy is seeking to obtain an advantage over other unsecured creditors since the debtor was de facto "uninsured" for the first $500,000 of loss. They have further alleged that McCarthy is essentially arguing that the Liberty policy should be a "drop-down policy in which event Liberty, as the insurer for claims in excess of $500,000.00, would be responsible for claims less than the stated policy obligations. Both the trustee and Liberty have cited cases for the proposition that an excess insurer is not responsible for liability below the limits contained in the excess policy. 14. However, the facts of this case are vastly different from the facts in those cases cited by the trustee and Liberty regarding the theory of "drop-down insurance".
15. In the case at bar, unlike the facts in each of the cited "drop-down" cases, there is a fund that was available for the payment of claims up to the amount of the excess insurance. Liberty had the right to draw down the entire fund or to elect not to draw down any portion of the fund. Had Liberty elected not to draw down the fund, the fund would still be in the debtor s estate and the injured claimants would admittedly be unsecured creditors for the first $500,000 of damages incurred. Had that occurred and had McCarthy been arguing that Liberty should pay all losses from the first dollar, those facts would be consistent with the "drop down" cases cited by the trustee and Liberty which prohibit the injured party from seeking payment from excess policies for damages incurred below the excess policy limits. 16. But those are not the facts that we are faced within this action. Rather, Liberty did in fact elect to draw down the fund, which it had the right to do. Now both Liberty and the Trustee agree that Liberty properly exercised its right to draw down the remaining $16.2 million and that the fund that was drawn down is now NOT part of the debtor s estate. 17. In light of the foregoing, the issue that requires clarification and the reason for the request for an order rejecting the MOU is that a determination is required to be made as to the role of Liberty based upon the fact that it exercised its right to draw down the entire fund. 18. More specifically, in the self-insured model, Atlantic was both the insured party and the insurer. Therefore when a claim is made for personal injuries as a result of Atlantic's negligence, any payment that was made to any personal injury claimant, was made by Atlantic wearing its "insurance company hat". As set forth above, Liberty was merely acting as Atlantic's agent in hiring attorneys and paying claimants, since Atlantic, as a self-insured party, was paying all cost related to the personal injury claim.
19. Liberty, now having possession of the funds that were to be utilized for the payment of claims made and expenses occurred in connection with those claims, now stands in the shoes of Atlantic and has assumed Atlantics obligation to defend and pay claims up to the $16.2 million it drew down from the security fund. 20. New York State Insurance Department Opinion number 08-07 15 on the issue of assumption reinsurance and novation is instructive given the present factual circumstances. In pertinent parts, the opinion reads as follows: "Assumption reinsurance" is defined in dictionary of insurance terms (3rd ed. 1995) as a "form of insurance where the buyer (reinsurer) assumes the entire obligation of the cedent company effected through the transfer of the policies from the cedent to the books of the reinsurer" Thus, in Assumption reinsurance, the reinsurer assumes all of the functions formally handled by the original underwriting insurer, including but not limited to claims handling and payment, premium acceptance and return, and policy amendment, issuance, and cancellation. Assumption reinsurance is also commonly referred to as a "novation", a general contract term defined by Black's Law dictionary (8th Ed. 2004) as "[t]he act of substituting for an old obligation a new one that either replaces an existing obligation with a new obligation or replaces an original party with a new party."... New York law requires four elements to prove a novation: "(1) A previously valid obligation; (2) agreement of all parties to a new contract; (3) extinguishment of the old contract; and (4). A valid new contract." See: Israel v Chabra, 418 F. Supp. 2d 509 (S.D.N.Y. 2006); Healey v Healey, 190 A.D.2d 965 (3rd Dept, 1993); Chipouras & Ass. V 212 Realty Corp., 156 A.D.2d 549 (2nd Dept. 1989). As stated by the New York Court of Appeals
the state s highest court in Griggs v Day, 136 N.Y. 152, 160 (1852): " it usually, if not always, takes three parties to make a novation, and they must all concur upon sufficient consideration in making a new contract to take the place of another contract, and in substituting a new debtor in the place of another debtor. Novation is thus briefly to find: a transaction whereby a debtor is discharged from his liability to his original creditor by contracting a new obligation in favor of a new creditor by the order of the original creditor."... "... New York, law requires an insured's consent to effectuate a transfer of his insurance contract to another insurer that is assuming all the rights, responsibilities and functions of the original underwriting insurer however, such consent need not be formally provided, it may be inferred from the circumstances. See: Schloss Brothers v Bennet, 260 N.Y. 243 (1932); Kinsella v Merchants Nat. Bank & Trust of Syracuse, 34 A.D.2d 730 (4th Dept. 1970)..." 21. In the case at bar, as set forth above, Atlantic was wearing two hats, that of the insured and that of the self-insurer. In the contract of insurance with Liberty, Liberty was not responsible for the debt that was incurred by an injured party for less than $500,000.00, the selfinsured deductible assumed by Atlantic. However, the policy of insurance in conjunction with the Cross-Collateralization Agreement had a written provision that permitted Liberty to assume Atlantic's role vis-a-vis the injured claimant in the event Atlantic failed to replenish the collateral that secured Atlantic's obligations. 22. Under the definition of "novation" as defined in Black's Law dictionary, upon the drawdown of the security fund, Liberty replaced Atlantic in its capacity as the obligated party to pay for the obligation of the insured (Atlantic). The consent by Atlantic wearing it's insured's
hat as well as wearing it's hat as the insurer is contained in the Cross-Collateralization Agreement when it gave the right to Liberty to draw down on the collateral upon a failure of Atlantic to replenish the security fund. Liberty's consent to the novation can be inferred by the act of drawing down the security fund of $16.2 million. There is no question that liberty was not damaged in the sum of $16.2 million for which it would be entitled to be reimbursed nor was it owed $16.2 million for a pay premiums. Rather, the only basis upon which liberty was permitted to draw down the $16.2 million was for the purposes of paying the cost for the defense of the claims brought against Atlantic as the insured and for the payment of damages incurred weather calculated via a judgment or settlement. 23. By reason of the foregoing, it is clear that: a. There existed a valid obligation by Atlantic wearing it's insurers "hat" to pay for the defense costs related to personal injury claims brought against Atlantic as the insured as well as paying for losses up to $500,000 per claim; b. The Cross-Collateralization Agreement was an agreement by Atlantic as the insured, Atlantic as the insurer and liberty as the third-party that should Atlantic fail to replenish the security, Liberty had the right to extinguish Atlantic's obligation to pay for litigation defense costs as well as losses up to $500,000 and assume that obligation by drawing down on the remaining fund available for use and paying those costs; c. When Liberty elected to exercise its right to draw down on the remaining $16.2 million security fund, it extinguished Atlantic's obligation to utilize those funds to pay the pending injury claims; and d. By operation of the actions of default by Atlantic in failing to replenish the fund and Liberty, in drawing down the remaining fund of $16.2 million, Liberty now
stands in the shoes of Atlantic in its capacity as a self-insurer up to the costs and payment of claims of $16.2 Million, thus creating a valid new contract. 24. By reason of the foregoing facts and law, and in the interest of justice and fairness to all parties, it is respectfully requested that this Court issue an order declaring the MOU a nullity, and of no force and effect and further issue an order that Liberty be required to first liquidate each claim and account for reasonable legal fees and expenses of Debtor in connection with the defense of properly filed personal injury and Workers Compensation claims and only when all claims have been fully liquidated and all costs of defense paid, should the remainder be remitted to the Liquidating Trustee for distribution to the unsecured creditors. WHEREFORE, Movant respectfully requests that this Court enter an order rejecting the Stipulation and Memorandum of Understanding between the Liquidating Trustee and Liberty Mutual Insurance Company regarding claims handling matters together with such other and further relief as the Court deems just and proper. Dated: Garden City, New York December 28, 2015 Yours, etc., SCHRIER SHAYNE KOENIG SAMBERG & RYNE, P.C. /s/richard E. Schrier By: Richard E. Schrier, Esq. (RS-9985) 825 East Gate Boulevard, Suite 320 Garden City, New York 11530 Tel: (516) 739-8000 Fax: (516) 739-8004 Attorneys for: Kathleen McCarthy
TO: Farrell Fritz, P.C. Attn: Patrick Collins Attn: Ted A. Berkowitz Attn: Veronique A. Urban 1320 RXR Plaza Uniondale, New York 11556 Tel: (516) 227-0700 Akin Gump Straus Hauer & Feld LLP Attn: Lisa Beckerman, Esq. One Bryant Park New York, New York 10036 Tel: (212) 872-1000 United States Trustee Office of the United States Trustee U.S. Federal Office Building 201 Varick Street, Room 1006 New York, NY 10004 Tel: (212) 510-0500