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Matter of Liquidation of Integrity Ins. Co.

May 12, 1995


On appeal from Superior Court of New Jersey, Chancery Division, Bergen County.

Approved for Publication May 12, 1995

Before Judges Dreier, Villanueva and Braithwaite. The opinion of the court was delivered by VILLANUEVA, J.A.D.

The opinion of the court was delivered by: VILLANUEVA


Claimant, Credit Lyonnais, the obligee bank under surety bonds issued by Integrity Insurance Company (Integrity), later declared insolvent, appeals without leave granted from an order of the Chancery Division declaring that the Liquidator of Integrity, because of Integrity's insolvency, properly disallowed so much of Credit Lyonnais' proofs of claim that sought indemnification for sums due under promissory notes guaranteed by Integrity's bonds upon which there were defaults by investors after the termination of Integrity's bonds.

Credit Lyonnais asserts that its damages should be measured by the equitable value of the bonds (net amount due) on the date of Integrity's insolvency because the insolvency constituted an anticipatory breach of the surety agreement. The Commissioner of Insurance of the State of New Jersey in his capacity as Liquidator of Integrity (Liquidator) cross-appeals, arguing that if this court reverses the trial court order and thus holds that Credit Lyonnais is entitled to coverage for post-termination defaults, we should also reverse that portion of the order declaring that Credit Lyonnais is entitled to the return of a portion of its premium. The three surety reinsurers seek to have the Chancery Division order affirmed.

During the years of 1984 and 1985, certain investors -- limited partners -- became indebted to limited partnerships, which indebtedness was evidenced by promissory notes (Notes). The Notes were assigned by the limited partnerships to appellant Credit Lyonnais as collateral for the loans it made to the partnerships; thus, the investors became obligated to make payments under the Notes directly to Credit Lyonnais. The Notes required the investors to make payments in accordance with a schedule set forth in each Note. The last scheduled payment under any of the Notes became due on November 30, 1989.

Integrity, a New Jersey stock insurance company that issued various types of insurance policies as well as surety bonds, issued to Credit Lyonnais many investor financial surety bonds (Bonds) to protect Credit Lyonnais against the risk of an investor defaulting on the loans made by it to the partnerships. In re Integrity Insurance Co., 251 N.J. Super. 501, 502, 598 A.2d 940 (Ch. Div. 1991). The Bonds provide that Integrity is "firmly bound" to Credit Lyonnais in the amount of the limit of liability of the Bonds, which is the total amount of the investors' indebtedness to Credit Lyonnais under the Notes. Each Bond also provides that the premium "shall be payable upon the execution and delivery of this Bond and shall be fully earned and non-refundable from that time." The Bonds are the subject of this appeal.

On March 24, 1987, the Chancery Division issued an Order of Liquidation (Liquidation Order) pursuant to which Integrity was adjudicated insolvent. This order, which was amended and supplemented by the court's March 25, 1987 order, provided that coverage under all of Integrity's policies, bonds and other contracts of insurance was terminated as of April 24, 1987.

The Liquidator was directed to give notice to all recorded policyholders and known claimants against Integrity and its insureds for (1) any known claims; (2) circumstances that could reasonably expect to give rise to future claims; and (3) unasserted claims in order to reserve the right to assert future claims against Integrity.

Pursuant to a supplementary order filed on July 8, 1987, upon receipt of a Proof of Claim (POC), the Liquidator was to issue a Notice of Determination (NOD) which either allowed or denied the POC. Rejected claimants were given sixty days to file an objection to the NOD. Once an objection was filed, the Liquidator could affirm or modify the prior NOD. If no objection was filed the NOD became the final judgment of the Superior Court.

Pursuant to the Liquidation Order, the Liquidator received an estimated 856 POCs for claims arising from the Bonds issued by Integrity. *fn2 The Liquidator denied coverage for all defaults by limited partners that occurred after the Bonds were deemed terminated by the Liquidation Order. The Liquidator also denied claims for the return of premiums on the ground that the Bonds provided that the premiums were fully earned upon the issuance of the Bonds.

On September 21, 1989, the Chancery Division Judge appointed a Special Master to hear objections to the NODs. In April 1990, the Liquidator filed a motion for summary judgment before the Special Master seeking an order (1) disallowing all POCs to the extent they sought a return of premiums; (2) disallowing all POCs to the extent they sought damages for defaults on bonded obligations where the default occurred after April 24, 1987; and (3) a declaratory judgment disallowing all POCs to the extent they sought to obtain payment from the estate notwithstanding that the lending institutions (obligees) released their claims against bonded principals or received an adverse adjudication thereof. The motion was supported by the surety reinsurers and was opposed by Credit Lyonnais as well as other entities.

After oral argument, the Special Master recommended and ruled that claims for unearned premiums would be allowed; however, he did not decide each claim on the merits. He next granted that portion of the Liquidator's motion seeking a disallowance of all POCs to the extent they sought damages for defaults by limited partners under the Notes where the defaults occurred after April 24, 1987, and denied the corresponding cross-motions that were filed in opposition to this motion. Finally, the Special Master denied without prejudice the portion of the Liquidator's motion seeking a declaratory judgment disallowing all POCs to the extent they sought to obtain payment from the estate notwithstanding that the obligees released their claims against the bonded principals.

On or about September 24, 1991, The Liquidator, Credit Lyonnais and other claimants filed objections in the Chancery Division concerning different aspects of the Special Master's ruling. Credit Lyonnais requested that the court (1) reject that part of the Special Master's order disallowing certain POCs; (2) deny the Liquidator's summary judgment motion; and (3) allow Credit Lyonnais' POCs against Integrity's estate.

On October 6, 1992, the Chancery Division Judge first held that the Special Master properly concluded that Integrity's estate was not liable for post-termination defaults, reasoning that it is "well-established law in New Jersey that the entry [of] a liquidation order terminates coverage under the insurer's outstanding policies. See Mayer v. Attorney General, 32 N.J. Eq. 815 (E. & A. 1880); Gray v. Reynolds, 55 N.J. Eq. 501, 37 A. 461 (E. & A. 1887)." The court also determined that the Special Master properly found that Integrity's obligation under the Bonds arose whenever an investor failed to make a scheduled payment to a lender, and that this obligation was terminated as of April 24, 1987; "all claims for defaults on monthly payments after that date were correctly denied . . . for the reason that they were not mature and a valid existing obligation . . . ."

The court next held that all bond obligees were entitled to a return of unearned premiums. The court stated that with respect to the method of calculation, the question is whether a pro rata method (i.e. so much per year) should be applied, or whether a declining balance method should be applied, a method which realizes that the number of required payments lessened in each subsequent year. The court stated that it would determine the method of calculation at a later time.

The court also addressed the Liquidator's request for the court to determine the effect, if any, of a release or settlement upon an obligee's claim for an unearned premium, as well as on the bond. The court ruled that there is no connection between a financial surety bond claimant's right to unearned premium and a release or settlement between the bond claimant and the bond principals, and therefore ordered the Liquidator to allow all financial surety claims without regard to whether the claimant compromised obligations or settled. The court reasoned that the "value of the insurance policy was lost and whether . . . the bond was paid or not, is really irrelevant to that."

The court next discussed the issue as the effect of a settlement or a release on claims for defaults occurring after the cut-off date. The court recognized that Integrity had "gone forth for certain claimants" when Integrity had claims for its own payout and claims for uncollected portions of premium, and collected for the claimant as well as itself, and in some cases, just for itself. The Judge also recognized that this increased the monies available for distribution by reducing claims against the estate. Acknowledging that the fact pattern was different in each case, the court stated that there were many factors involved in resolving whether the issuance of a release by a claimant to one of the investor bondholders would defeat a claim. The court concluded that to the extent that the settlement was for the benefit of the estate it would not bar the claim except as adjusted by the benefit, and that if it was not for the benefit of the estate and an obligee was released, then the claim should fall. The court then listed the criteria to be considered in determining the effect, if any, of any release or settlement by an obligee, and indicated that the critical question was whether the settlement was fair. The Judge added that he knew settlements had been made and whether they were fair were fact-sensitive determinations that he would not make. The guidelines were for the Special Master to use in resolving these issues. Thus, the Judge denied the Liquidator's motion with regard to these matters.

On November 10, 1992, the Judge signed an order adopting the recommendation of the Special Master, which stated that similarly situated bond obligees were entitled to recover unearned premiums in accordance with N.J.S.A. 17:30C-26(c). The Special Master was also ordered to conduct a hearing to resolve the issue of calculation of unearned premiums. *fn3

On April 29, 1994, the Judge signed an order accepting the recommendation of the Special Master, which stated that the Liquidator's recommended allowance of the claims for unearned premium by the obligees of the ...

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