Sit On Rights & You Lose Insurance Benefits
When a fire loss occurs during the negotiation for the sale of real property the sale can be completed by the seller assigning its rights to recover from the insurer the benefits of the fire insurance. In In Re: JMC Memphis, LLC, JMC Memphis, LLC,…, United States Court of Appeals, Eleventh Circuit, — Fed.Appx. —-, 2016 WL 3923833 (07/21/2016) an appeal came to the Eleventh Circuit from the bankruptcy court’s order approving a settlement agreement as part of the Chapter 7 bankruptcy proceedings of debtor Geoffrey Edelsten. JMC Memphis, LLC (“JMC”) — a non-party to the settlement agreement — appealed the bankruptcy court’s order to the district court. The district court dismissed JMC’s appeal as equitably moot.
In August 2012, JMC entered into a contract to purchase an apartment complex (“Property”) from Investments Australia, LLC. The Property had been damaged badly by a number of fires, all but one of which occurred before JMC contracted to buy the Property. The last fire occurred, however, on 22 September 2012 after execution of the purchase contract but before closing. Following the 22 September fire, JMC and Investments Australia executed an amendment to the purchase agreement. In pertinent part, Investments Australia assigned to JMC its rights, title, and interest in insurance proceeds paid “in connection with the September 22, 2012 claim,” noting that JMC was “responsible for pursuing the claim, and retaining its own attorneys and/or adjusters.” In the event no insurance was recovered, Investments Australia agreed to pay JMC $85,000.
Investments Australia later filed a civil action against its insurer, International Hanover, Ltd. (“Hanover”), to recover on claims related to all fires on the Property. Hanover denied coverage, asserting several defenses.
In January 2014, Edelsten (a member of Investments Australia) filed for bankruptcy. As part of the bankruptcy proceedings, Edelsten and the other two members of Investments Australia (Levy and Mawardi) participated in mediation with Hanover to resolve the ongoing insurance dispute. The parties entered ultimately into a settlement agreement pursuant to which Hanover agreed to pay $750,000 to the bankruptcy trustee in exchange for a full release of all claims against Hanover under the insurance policy and an order barring future claims by any party against Hanover arising under the insurance policy.
The parties to the settlement moved the bankruptcy court to approve the settlement agreement and to issue a bar order. The bankruptcy court scheduled a non-evidentiary hearing on the motion. JMC appeared at the hearing and argued its objections to the settlement agreement. Briefly stated, JMC’s position is that it — and not the members of Investments Australia or the bankruptcy estate — is entitled to 100% of the insurance proceeds.
After considering JMC’s objections, the bankruptcy court approved the settlement agreement. The bankruptcy court, however, required the bankruptcy trustee to set aside $100,000 in escrow pending resolution of JMC’s claim. In doing so, the bankruptcy court found that JMC’s claim to the insurance proceeds was limited to proceeds connected to the 22 September fire. Moreover, in the light of the $85,000 valuation set forth in the amendment to the purchase agreement, the bankruptcy court reasoned that an escrow of $100,000 was sufficient to protect JMC’s interests.
JMC raised no contemporaneous objection to the bankruptcy court’s pronounced order and requested no stay of the bankruptcy court’s order. JMC appealed the bankruptcy court’s order to the district court. The district court dismissed JMC’s appeal as equitably moot.
Equitable mootness is a doctrine that permits courts sitting in bankruptcy appeals to dismiss challenges when effective relief would be impossible. The doctrine of equitable mootness reflects a court’s concern for striking the proper balance between the equitable considerations of finality and good faith reliance on a judgment and the competing interests that underlie the right of a party to seek review of a bankruptcy court order adversely affecting him. Central to a finding of mootness is a determination by an appellate court that it cannot grant effective judicial relief.
As an initial matter, the appellate court noted that JMC failed to exercise due diligence in protecting its own financial interests. Despite having been assigned all Investments Australia’s rights, title, and interest in the insurance proceeds arising from the 22 September fire (including expressly the responsibility to pursue a claim for coverage), JMC made no attempt to seek insurance coverage from Hanover. And nothing evidences that JMC participated in or contributed in any way to Investments Australia’s efforts to recover payment from Hanover during the lengthy civil litigation or during the ultimate settlement negotiations.
JMC’s failed to request a stay of execution of the settlement agreement from either the bankruptcy court or the district court. In the absence of a stay order (or even a formal objection from JMC), the settling parties relied on the finality of the bankruptcy court’s order and began consummation of the settlement agreement.
JMC contends that effective judicial relief is still available because the bankruptcy trustee currently holds over $435,000 (58%) of the insurance proceeds and because the district court could easily require Levy and Mawardi to disgorge their settlement funds. JMC also contends that because JMC seeks no recovery of the funds already disbursed to the mediator and to Investments Australia’s lawyer, unwinding the settlement agreement would affect the rights of no third parties.
JMC’s argument, however, ignores the full consequences of unwinding the settlement agreement. Perhaps most important, unwinding the settlement agreement would also mean unwinding Hanover’s agreement to provide $750,000 in insurance coverage. Unwinding that portion of the settlement agreement would thus require all disbursement recipients — including both third parties — as well as the bankruptcy estate to disgorge all settlement funds received. Without payment from Hanover pursuant to the terms of settlement agreement, no monetary relief would be available to JMC.
In addition, granting JMC relief — thus allowing JMC to assert its own claim against Hanover under the insurance policy — would require an unwinding of the bar order: a central component of the settlement negotiations.
To the extent JMC seeks only partial unwinding of the settlement agreement (leaving intact Hanover’s agreement to provide coverage for the fires), granting such relief would necessarily reform the settlement agreement to reflect an agreement that no party intended/contemplated. The settlement agreement was the result of lengthy and careful negotiations and reflected a global compromise among several parties with conflicting interests. It would be inappropriate at this stage — particularly in the light of JMC’s overall failure to exercise due diligence — for a court to unwind select portions of the settlement agreement to allow JMC to now pursue financial compensation.
People like JMC and its lawyers forget that the duty of good faith and fair dealing devolves on both the insured and the insurer to do nothing to deprive the other of the benefits of the contract of insurance. In this case, after others worked up a settlement of the multiple fire claims, JMC attempts to destroy the settlement properly and in good faith entered into by the parties and the insurance company, unwinding a settlement that had already been paid out was simply unfair and equitably moot.
Barry Zalma, Esq., CFE, practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 49 years in the insurance business. He now limits his practice to service as an insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes.
Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.
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