Chapter 4, I. The Court in Which an Insurer Can Seek Declaratory Relief

• Jurisdiction: United States

I. The Court in Which an Insurer Can Seek Declaratory Relief

When an insurance company is interested in obtaining a determination regarding a noncore coverage issue under its policy and the insured is in bankruptcy, it has three options. As one option, the insurer may file an adversary proceeding in the bankruptcy proceeding and request a determination of coverage by the bankruptcy judge. The findings of fact and conclusions of law submitted by the bankruptcy judge will not be a final order and will be submitted to the district court in the form of a recommendation. The district court may then adopt the findings of fact and conclusions of law, which then become a final order.

Often, however, the insurer would prefer to have the matter heard in a nonbankruptcy forum. This preference arises because there is a general perception that the bankruptcy court will favor the debtor. In that instance, the insurer may pursue the second option: obtain a determination regarding a noncore coverage issue in a nonbankruptcy forum. The insurer must first request a modification of the stay in order to file a declaratory action in state or federal court. Courts routinely modify the automatic stay to allow the litigation to continue in a nonbankruptcy forum when the matter involves state law issues. Relief from the stay to commence litigation, on the other hand, is somewhat more scrutinized. Modification of the automatic stay is discussed more fully in Chapter 11, infra.

In seeking a modification of the stay, an insurer would make the argument that a declaratory action seeking a determination of coverage is a contractual matter in which state law applies and, as such, does not invoke substantive rights provided by title 11 and is not a "proceeding that, by its nature, could arise only in the context of a bankruptcy case."¹⁰³ Generally, a declaratory action seeking a determination of coverage will be a noncore "related to" proceeding. A coverage action does not arise under the Bankruptcy Code and involves rights under the insurance policy and state contract law. For example, the applicability of an exclusion in a pre-petition insurance policy is ancillary to the liquidation of pre-petition claims of the debtor for which state law governs the interpretation.¹⁰⁴ A coverage action would be ancillary to the liquidation of pre-petition...