Creditors Committee’s Request to Sue Diocese Insurers Denied

Recently, a bankruptcy judge denied a request by a creditors’ committee to sue the insurers of the Roman Catholic Diocese of Rockville Centre (the “Debtor”).

The judge found that the Official Committee of Unsecured Creditors’ (the “Committee’s”) request to proceed with the action was baseless since no settlement had been reached and the Committee’s entire argument was based on hypothetical future events that may or may not happen.

The Debtor declared bankruptcy nearly three years ago to address Child Victims Act claims commenced against the Diocese. On October 1, 2020, the Debtor initiated an adversary proceeding against insurers (“Insurers”) seeking a declaratory judgment regarding the availability of coverage for sexual abuse claims. The Committee then filed a motion to intervene in this action, which the bankruptcy court granted.

Shortly after, the Court entered an order that appointed a mediator to help the Debtor, Committee, and Insurers develop a plan of reorganization. Since then, the Debtor and Insurers have been attempting to reach a consensual plan of reorganization.

In August 2023, the Committee filed a motion requesting that the Court enter an order granting the Committee leave, standing, and authority to “commence and prosecute” an action on behalf of the Debtor.

The Committee’s overarching concerns are that the Debtor will reach a settlement with insurers without the consent of the Committee, which would enable the Debtor to proceed with a Plan of Reorganization and emerge from Chapter 11  over the objection of  and without the support of the Committee. The Committee asserts that engaging in these settlement discussions without Committee involvement is deceptive and violates the New York General Business Law Section 349 and the New York Insurance Law Section 2601.[1]

The Committee argued that it satisfied the three-part test required to obtain derivative standing to pursue a cause of action on behalf of the Debtor’s estate.

The three-part test requires the Committee to show (1) a demand was made to the debtor to pursue the claim (2) the claim is colorable and (3) the debtor unjustifiably failed to prosecute the claim that is likely to benefit the reorganized estate.  The Committee contended that it satisfied the three-part test.

Regarding the first prong, the Committee made a Demand.  In its Demand, the Committee expressed its concerns regarding a settlement between the Debtor and Insurers without the consent of the Committee and demanded that the Debtor either provide assurances that it would not enter a settlement without Committee consent or bring a cause of action against the Insurers under Section 349 and Section 2601.  The Debtor declined both to provide assurances that it would not settle without Committee consent and refused to bring the cause of action against the Insurers.

For the second prong requiring a colorable claim, the Committee noted that Section 2601 prohibits making knowing misrepresentations to insurance claimants and failing to try to equitably and in good faith settle insurance claims.  The Committee argued that the Insurers violated this provision by engaging or threatening to engage in settlement discussions with the Debtor without Committee involvement and without assurances that the Debtor would not enter into a settlement without Committee consent.  Second, the Committee noted that the above behavior is separately actionable under Section 349. The Committee argued that settlement discussions are deceptive because entering or threatening to enter into a tentative settlement with a bankruptcy policyholder that has “no chance of acceptance by tort claimants or the court” is misleading to the Debtor’s estate, the survivors and the public. Also, that deceptive practices satisfy the three prongs under Section 349, which requires the deceptive practices in question to be consumer-oriented, materially misleading and cause the Debtor injury.

The Committee asserted that this “deceptive” conduct has been practiced in other Diocesan bankruptcy cases such as In re Diocese of Rochester and In re Diocese of Camden where there have been significant attempts at reaching a settlement agreement with Diocesan Insurers without participation by the Creditors Committee representing the victims in those cases.

As expected, the Debtor and the Insurers objected.  The Debtor asserted its authority “and even the duty” to settle the insurance coverage action, liquidate such assets for the benefit of creditors and that such a liquidation would be in the best interest of the bankruptcy estate.

The Debtor also asserted that any such settlement would be subject to Court approval at which the Committee could then object.  The Debtor also contended that, although it had spoken to all relevant parties about settling, thus far no settlement offer beneficial to the estate had been made, so that the Debtor had no reason to believe it would be accepted.  The Debtor argued that the process in which the Committee seeks to engage is “wasteful of estate resources” as the Debtor had only engaged in settlement discussions and that no settlement has been reached.

Insurers similarly argued that the Committee’s arguments failed because it relied on a hypothetical settlement with the Debtor which may never occur.  The Insurers argued that the basis for the causes of action against them were unripe since they were based on alleged future statutory violations arising from a hypothetical settlement with the Debtor which indisputably had not yet occurred.

The Insurers also suggested that the motion undermined the parties’ efforts to mediate a consensual resolution since the derivative claims constituted an improper collateral attack on the Court’s mediation order which specifically stated that nothing that occurred during the Court’s mediation creates a basis for liability.

Judge Glenn disagreed with the Committee’s position and denied its motion.

The Court determined that the Committee failed to plead a colorable claim because their claim is based on “contingent future events.”  Judge Glenn found that the claim is entirely speculative because it relied on the Debtor’s settlement discussions with Insurers and, to date, no settlement has been reached.

The Court also found that the Committee’s demand brings no benefit to the estate and when looking at the cost-benefit analysis, the litigation costs associated with pursuing the claims outweigh any benefits to the bankruptcy estate.  The Court agreed that victim-compensation negotiations between insurance companies and policyholders do not constitute consumer-oriented deceptive conduct and that the chain of events that the Committee alleged may cause injury are indeed both remote and speculative and hence do not give rise to actionable claims under the respective statute.

The Court also found that although the Committee had made the demand, it did not show that the claims to be brought by the Committee would benefit the bankruptcy estate.

Even though the Committee was denied standing to prosecute claims on behalf of the Debtor’s estate against Insurers, should a settlement ultimately be reached between the Debtor and the Insurers, the Committee will have its day in court to object when the settlement is presented to the Bankruptcy Court for approval.

[1] New York General Business Law Section 349 prohibits “Deceptive acts or practices in the conduct of any business, trade or commerce or in the furnishing of any service in [New York].”

New York Insurance Law Section 2601 among other things prohibits insurers from knowingly misrepresenting to claimants “pertinent facts or policy provisions relating to coverages at issue” and “not attempting in good faith to effectuate prompt, fair and equitable settlements of claims . . ..”