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Matter of Liquidation of Integrity Ins. Co.

December 12, 1996

IN THE MATTER OF THE LIQUIDATION OF INTEGRITY INSURANCE COMPANY


On appeal from the Superior Court, Appellate Division, whose opinion is reported at The opinion of the Court was delivered by Garibaldi, J. Justices Stein and Coleman, and judge Long, temporarily assigned, join in Justice Garibaldi's opinion. Judge Shebell, temporarily assigned, filed a Concurring opinion. Justice Handler filed a Dissenting opinion in which Justice O'hern joins. Chief Justice Poritz and Justice Pollock did not participate.

The opinion of the court was delivered by: Garibaldi

(This syllabus is not part of the opinion of the Court. It has been prepared by the Office of the Clerk for the convenience of the reader. It has been neither reviewed nor approved by the Supreme Court. Please note that, in the interests of brevity, portions of any opinion may not have been summarized).

IMO the Liquidation of Integrity Insurance Company (A-2-96)

Argued January 29, 1996 -- Reargued September 24, 1996 -- Decided December 12, 1996

GARIBALDI, J., writing for a majority of the Court.

Integrity Insurance Company (Integrity or surety), became insolvent and filed for liquidation. The Commissioner of Insurance (Commissioner) was appointed the Liquidator. Integrity had previously issued surety bonds to Credit Lyonnais, guaranteeing the payment of the promissory notes of investors in certain limited partnerships. The promissory notes, which called for installment payments, were assigned to Credit Lyonnais as collateral for substantial loans that it made to the partnerships. The debtors had begun to default on their installment payments before Integrity filed for liquidation.

The relevant statute governing the liquidation of an insolvent insurer permits creditors to file claims that are due against the insurance company. Credit Lyonnais filed claims for the full amounts of the promissory notes even though not all of the unpaid installments on the notes were actually due and owing on the date the surety bonds terminated. That Credit Lyonnais may not file a claim with the Liquidator for post-termination losses is undisputed. Credit Lyonnais, however, claims that it faced an uninsurable risk at the time of Integrity's default and could not purchase alternative insurance. Therefore, it faced a loss in the full amount of the bond. The issue, then, is whether Credit Lyonnais is entitled to file a claim for the full amount of the surety bond because Integrity's liquidation led to damages equal to the whole value of the bond.

The Liquidator sought summary judgment denying all proofs of claim to the extent that they made claims for installment payments that were due after the date of liquidation. The trial court granted the motions, finding that Credit Lyonnais and other similarly-situated creditors were entitled to the return of unearned premiums only.

The Appellate Division reversed. It held that the claim of Credit Lyonnais was valid because under the terms of the bond, Integrity's obligation to pay the outstanding bond amount arose when it issued the bond. In addition, the Appellate Division held that the Liquidator was judicially estopped from challenging this interpretation. The Supreme Court granted Integrity's petition for certification.

HELD: Credit Lyonnais is entitled to file a claim for an amount equal to each bond's face value less the sum of payments already made by Integrity and the debtor and assets recoverable from the debtor.

1. The Legislature has enacted a statutory design to govern insolvent insurance companies, N.J.S.A. 17:30C-1 to -31. An order of liquidation effectively ends the insurer's business, and a court is required to set a specific date for the termination of all policies. After liquidation, any losses suffered by policyholders should be disallowed. Those with claims against the insurer can submit them and collect from the marshalled assets pursuant to N.J.S.A. 17:30C-20. The statute, however, does not provide much guidance concerning which claims should be allowed in liquidation, nor does it define the amount of any claim that may be filed due to the premature termination of an insurance policy. Those answers must be found in the common law.

(pp. 7-8)

2. The common-law rule is that where an insurance company is adJudged insolvent, the claims existing on behalf of its policyholders have been held to be in the nature of damages for a breach of contract. Contract damages are designed to put the injured in as good a position as he would have been if performance had been rendered as promised. (p. 8)

3. For most policyholders, damages should be the difference between the cost of a new policy and the present value of the premiums yet to be paid on the policy. If, however, the defaults of the debtors before the date of termination indicated such a likelihood of future default that replacement insurance was unavailable, then the Court should award the full amount of the policy. (pp. 9-12)

4. At the time Integrity was adJudged insolvent, the debtors had defaulted on several payments. Integrity has conceded below that, as a result of the debtors' prior failure to pay, the risk of default on the remaining payments was so great that Credit Lyonnais could not have obtained alternative insurance. Therefore, under breach-of-contract rules, Credit Lyonnais is entitled to file a claim for an amount equal to each bond's face value less payments already made by Integrity and the debtor and future amounts recoverable from the defaulting debtor. (pp. 12-13)

5. From the record it cannot be determined whether some of the debtors may have assets capable of covering all or a portion of the outstanding loans. It would be inequitable to permit Credit Lyonnais to pursue recovery from the surety for the face value of the bonds without first seeking payment under the promissory notes. On remand, Credit Lyonnais must quantify its loss by providing evidence of the amount of recovery available under the promissory notes. (pp. 14-16)

Judgment of the Appellate Division is AFFIRMED and the matter is REMANDED for further proceedings consistent with this opinion.

JUDGE SHEBELL, Concurring, is of the view that at the time of Integrity's liquidation, the outstanding balance due on the notes was an absolute obligation of the surety because of the default of the debtors. The majority shifts the burden to Credit Lyonnais to prove that it cannot obtain payment under the notes, notwithstanding the fact that the very purpose of obtaining the bonds was to avoid this burden. Integrity's obligation to pay the outstanding balance due under the notes clearly flows from its contractual liability under the surety agreements.

JUSTICE HANDLER, Dissenting, in which JUSTICE O'HERN joins, is of the view that the relevant statute, the language of the promissory notes, and hornbook concepts of suretyship allow creditors like Credit Lyonnais to file claims only for promissory notes that are due and owing. The terms and provisions of the suretyship contracts also indicate that Integrity's obligation was secondary and limited only to the amounts actually due and owing under the principal obligations. The majority's analysis, which is based on a measure of contract damages, is flawed. Contract principles allow recovery only for claims that already exist, namely, claims that are currently due and owing. Moreover, by allowing Credit Lyonnais to recover in contract for amounts that were not due and owing on the date of the termination of the bonds, the majority greatly prejudices the legitimate contractual claims of other creditors whose claims were due and owing on the termination date.

JUSTICES STEIN and COLEMAN, and JUDGE LONG, temporarily assigned, join in JUSTICE GARIBALDI'S opinion. JUDGE SHEBELL, temporarily assigned, filed a Concurring opinion. JUSTICE HANDLER filed a Dissenting opinion in which JUSTICE O'HERN joins. CHIEF JUSTICE PORITZ and JUSTICE POLLOCK did not participate.

The opinion of the Court was delivered by

GARIBALDI, J.

Integrity Insurance Company (Integrity or surety), a New Jersey insurance company, became insolvent and filed for liquidation. The Commissioner of Insurance (Commissioner) was appointed the Liquidator. Integrity had previously issued surety bonds to Credit Lyonnais, guaranteeing the payment of the promissory notes of investors in certain partnerships. The promissory notes, which called for installment payments, were assigned to Credit Lyonnais as collateral for substantial loans that it made to the partnerships. Before Integrity was liquidated, the debtors had begun to default on their installment payments.

The relevant statute governing the liquidation of an insolvent insurer permits creditors to file claims that are due against the insurance company. Credit Lyonnais filed claims for the full amounts of the promissory notes even though not all of the unpaid installments on the notes were actually due and owing on the date the surety bonds terminated. That Credit Lyonnais may not file a claim with the Liquidator for post-termination losses is undisputed. Credit Lyonnais, however, claims that it faced an uninsurable risk at the time of Integrity's default and could not purchase alternative insurance with its returned premium. Therefore, it faced a loss in the full amount of the bond. The issue, then, is whether under basic principles of contract law Credit Lyonnais is entitled to file a claim for the full amount of the surety bond because Integrity's liquidation, a breach of contract, led to damages equal to the whole value of the bond.

I

In 1984 and 1985, seven different groups of investors each created their own limited partnership in California. Some investors were limited partners in more than one partnership. Those partnerships were created as tax shelters for the investors.

The investors signed promissory notes obligating them to make installment payments to the limited partnerships running through November 1989. According to the terms of the promissory notes, if an investor defaulted on an installment payment, the limited partnership maintained the right to demand immediate payment of the entire note.

All seven partnerships obtained loans from Credit Lyonnais, a multinational bank. The partnerships assigned the promissory notes to Credit Lyonnais as collateral for the loans. As part of those assignments, Credit Lyonnais became entitled to receive the installment payments directly from the investors. Credit Lyonnais sought surety bonds from Integrity to cover the risk of default on the part of the investors and partnerhips.

Integrity issued surety bonds to Credit Lyonnais that obligated Integrity to pay to Credit Lyonnais the entire amount of the note if the principal debtor defaulted. In sum, Integrity guaranteed repayment of Credit Lyonnais's loans to the partnerships. Integrity also issued surety bonds to other banks for similar arrangements with limited partnerships. To limit its risk, Integrity reinsured those bonds. At the time of insolvency, Integrity had reinsurance policies in the amount of $63.5 million.

In 1986, the investors began to default. Credit Lyonnais sent timely notice to Integrity, demanding payment of the missed installments; Integrity covered the missed payments pursuant to the surety bonds. The obligation to pay the entire unpaid balance on the notes was not accelerated. Integrity sought to collect the unpaid amounts from the defaulting investors. In some cases, Integrity sued and obtained judgment for the entire amount of the bond, not simply the amount of the missed payment. Although Integrity obtained judgments for the entire amount, it apparently never actually collected more than the amount of missed installments.

In 1987, Integrity filed an action for insolvency and liquidation in the Superior Court, Chancery Division, under the statutory scheme governing regulated insurance companies, N.J.S.A. 17:30C-1 to -31. On March 24, 1987, the Chancery Division issued an Order of Liquidation declaring Integrity to be insolvent. The Commissioner was appointed to serve as Liquidator and was authorized to wind up the company's affairs. Although the reinsurance policies were to remain in effect, the court ordered Integrity's surety bonds to terminate on April 24, 1987. The reinsurers were required to pay the full amount of any claim to the Liquidator, even if the underlying claimants received only a percentage of their claims from Integrity's remaining assets. In addition, the order set a deadline for filing proofs of claim against Integrity.

On July 8, 1987, the court established the procedure for the determination of proofs of claim. The Liquidator was required to recommend whether the court should accept the proofs of claim by issuing Notices of Determination. Claimants that disagreed with the Liquidator's determination could demand a hearing.

Credit Lyonnais submitted seven proofs of claim under the surety bonds. Hundreds of proofs of claim were submitted against other surety bonds that had been issued by Integrity. The Liquidator recommended that the trial court deny all the proofs of claim to the extent they made claims for installments that were due after April 24, 1987, the date the surety bonds terminated. He relied on N.J.S.A. 17:30C-28a(1), which provides that proofs of claim can encompass all claims that "[became] absolute against the insurer on or before the last day fixed for filing proofs of claim . . . ."

The Liquidator then filed a motion for summary judgment, which Credit Lyonnais and other banks opposed. The trial court appointed a Special Master to hear the claims. The Special Master concluded that the surety bonds terminated under the Liquidation Order and recommended denying the claims for defaults on installments due after termination, because they neither occurred nor existed at the time the bonds terminated. The Special Master further recommended refunding unearned surety premiums attributable to post-termination coverage.

The trial court adopted the Special Master's recommendation, in November 1992, and granted summary judgment to the Liquidator, denying claims for post-termination defaults but ordering the return of unearned premiums. The trial court remanded to the Special Master, however, to create a formula for calculating unearned premiums. The Special Master's calculations were approved in an additional order in April 1994. Credit Lyonnais then appealed the portions of the trial court's order, granting the Liquidator's motion for summary judgment and confirming the disallowance of the proofs of claim to the extent they sought a distribution for post-termination defaults. The Liquidator cross-appealed on the limited basis that if the entire claim was upheld, the order returning the premiums should be reversed.

The Appellate Division reversed. 281 N.J. Super. 364, 657 A.2d 902 (1995). It held that Credit Lyonnais's claim was valid, because under the text of the bond Integrity's obligation to pay the outstanding bond amount arose when it issued the bond. In addition, the panel held that the Liquidator was judicially estopped from challenging this interpretation. The Appellate Division upheld Credit Lyonnais's claim for the full amount of the unpaid balance ...


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