Claiming Insurance Proceeds: Watch for State Law Twists and Turns

Park Restoration, LLC v. Erie Insurance Exchange (In re Trustees of Conneaut Lake Park, Inc.), 855 F.3d 519 (3rd Cir. 2017) –

When the debtor’s property was destroyed by fire, the insurance company applied the insurance proceeds first to delinquent property taxes based on a state statute. The company that managed and insured the property objected on several grounds. The bankruptcy court ruled that the proceeds were properly applied to the delinquent taxes, and the management company (not the debtor) was entitled to the balance. The district court agreed that the management company was entitled to the insurance proceeds, but concluded no portion of the proceeds should be applied to the delinquent taxes. The tax authorities appealed to the Third Circuit.

The debtor owned an historic venue known as the Beach Club, which was operated by a management company under a management agreement. The management company insured the property for $611,000. When the property was destroyed by fire, the debtor-owner submitted a claim. As required by state law, the insurance company required the debtor to obtain a certificate from the local municipal treasurer regarding whether any taxes were owed.

The certificate showed delinquent property taxes of ~$478,000 dating back over 15 years. This covered a period starting long before the management company began operating the Beach Club, and related to taxes owed on an entire 55.33 acre parcel, not just the one acre parcel where the Beach Club was located.

Pursuant to the state statute, the insurance company notified the management company that it would transfer $478,000 to the local tax authorities. After the management company objected, the insurance company interplead the proceeds in state court. The action was transferred to the bankruptcy court after the owner filed bankruptcy.

The management company argued that the state statute applied only where the fee owner of the property was the insured and where the taxes were the responsibility of the owner. It contended that any other interpretation would be a violation of the takings clauses of the federal and state constitutions. On the other hand the debtor contended that the management company was not entitled to any portion of the proceeds and sought to recover the balance after the taxes were paid.

As noted above, both the district and bankruptcy courts agreed that as between the debtor and the management company, the management company was entitled to the insurance proceeds. However, the district court determined that the state statute addressing delinquent taxes was ambiguous since the statute used “named insured” and “insured property owner” interchangeably. Turning to legislative intent to resolve the ambiguity, the district court concluded that the property tax section applied only to insureds who were property owners. Since the management company was not the property owner and was not responsible for the taxes, the district court reversed the bankruptcy court and held that the proceeds should not be applied to delinquent taxes.

On appeal the Third Circuit agreed with the tax authorities and reversed the district court based on the plain language of the statute. Although there were no state supreme court decisions on point, the Third Circuit relied on state rules of statutory interpretation. In its view the statute was “relatively straight forward”:

  1. The statute prohibited “[pay]ing a claim of a named insured for fire damage to a structure located within the municipality,” unless the insurance company received an appropriate certificate from the local treasurer.
  2. A certificate will show either the tax delinquency (including amount) or that no taxes were owed. Here, the certificate showed a 55.33 acre tax parcel with a tax delinquency of ~$478,000.
  3. Under the statute, upon receipt of the certificate the insurance company was required to “transfer to the treasurer an amount from the insurance proceeds necessary to pay the taxes.”

The Third Circuit noted that the statute did not say that the named insured had to be the “owner,” nor did it require that the entity be liable for taxes. The tax claim is basically an in rem claim levied against the insured property. So, the claim attached to the insurance proceeds. The Third Circuit was not impressed by the district court’s argument that the applicable section is open to different interpretations based on the interchangeable use of “named insured” and “insured property owner” throughout the entire statute. The particular section in question used only “named insured.”

The management company’s arguments based on public policy and equity suffered a similar fate. The words of the statute were clear. End of story. In addition, the court noted that public policy arguments could be made to support either position.

With respect to the argument that the debtor would receive a windfall since the proceeds would be used to satisfy delinquent taxes owed on other parcels, the court felt that the record on appeal did not allow it to make a judgment on the issue. It commented that the management company could seek an accounting or other equitable relief at a later time.

The management company’s argument that allowing the tax authorities to be paid from its insurance proceeds amounted to a “gratuitous confiscation” of its property without just compensation in violation of state and federal constitutional takings clauses also did not make any headway. After discussing the basics of unconstitutional takings, the court noted that to assert a takings claim a party must have a “legally cognizable property interest.” The management company had no cognizable interest in the entirety of the insurance proceeds since the policy itself stated that (1) the insurance company would pay the management company “unless some other person is named in the policy or is legally entitled to receive payment,” and (2) the policy conformed with state law. Thus, the court concluded that the statute was incorporated in the insurance policy, and the management company’s rights were subject to the tax authority claims.

Accordingly, the court determined that the insurance proceeds should first be applied to delinquent property taxes (although the amount of the taxes could still be challenged), and the balance should be paid to the management company.

This case highlights the key point that bankruptcy courts typically look to state law to define property rights, and state law can be far from uniform.

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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