In Re the Liquidation of Integrity Insurance

685 A.2d 1286, 147 N.J. 128, 1996 N.J. LEXIS 1086

• Court: Supreme Court of New Jersey
• Decided: December 12, 1996
• Status: Published

Opinions

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 partnerships.

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(l), 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 es-topped from challenging this interpretation. The Appellate Division upheld Credit Lyonnais’s claim for the full amount of the unpaid balance and vacated the award of unearned premiums. We granted Integrity’s petition for certification. 142 N.J. 510, 665 A.2d 1104 (1995).

II

The Legislature has enacted a statutory design to govern insolvent insurance companies, N.J.S.A. 17:30C-1 to -31. Under N.J.S.A. 17:30C-8, the Commissioner can apply to the Superior Court for an order directing the liquidation of an insolvent insurance company. The court will grant an order of liquidation if the insurer is indeed insolvent, and the Commissioner will be appointed the liquidator.

The order of liquidation effectively ends the insurer’s business, and the court is required to set a specific date for the termination of all policies. “When a company of this character becomes insolvent, and passes into the hands of a receiver, it ceases to be for all purposes, except that declared by the statute, the winding up of its affairs----”. Doane v. Milville Mut. Marine & Fire Ins. Co., 43 N.J.Eq. 522, 535, 11 A. 739 (Ch. 1887), rev’d on other grounds, 45 N.J.Eq. 274, 17 A. 625 (E. & A. 1889). After liquidation and termination, any losses suffered by policyholders “should be disallowed. The date of the decree of insolvency is the time at which the [insurer’s] liability for future losses terminated.” Withers v. Great Am. Nat’l Life Guardian, 124 N.J.Eq. 4, 9, 200 A. 485 (Ch.1938); accord Mayer v. Attorney General, 32 N.J.Eq. 815 (E. & A. 1880).

N.J.S.A. 17:30C-9 requires the Commissioner to marshall all assets of the estate, and N.J.S.A. 17:30C-20 provides a mechanism for those with claims against the insurer to submit them and collect from the marshalled assets. 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.

The common-law rule is that. “[w]here 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 the contract.” 19A John A. Appleman & Jean Apple-man, Insurance Law & Practice § 10721, at 196 (1982).

On the date of liquidation, Integrity breached its contract with every policyholder, because it repudiated its prior promise to provide insurance and bear future losses. As a result of that breach, each policyholder was entitled to pursue a claim for damages pursuant to ordinary contract rules. Contract damages are “designed ‘to put the injured in as good a position as he would have had if performance had been rendered as promised.’ ” Donovan v. Bachstadt, 91 N.J. 434, 444, 453 A.2d 160 (1982) (citation omitted).

For most policyholders, damages should not be a simple return of premiums, but rather “the difference between the cost of a new policy and the present value of the premiums yet to be paid on the policy at the date of the breach.” 19A Appleman, supra, § 10721, at 204; see also American Lead Pencil Co. v. New Jersey Title Guarantee & Trust Co., 130 N.J.Eq. 148, 151, 21 A.2d 341 (Ch.1941) (awarding cost of replacement insurance), aff'd o.b., 131 N.J.Eq. 473, 24 A.2d 849 (E. & A. 1942); In re Citizens Title Ins. & Mortgage Co., 127 N.J.Eq. 551, 554, 15 A.2d 57 (Ch.1940) (awarding cost of replacement insurance upon liquidation). The cost of replacement insurance is evaluated as of the date of termination, and should include consideration of any increased risk of loss due to events since the issuance of the policy that have increased the cost of insurance. See Davis v. Amra Grotto M.O.V. P.E.R., Inc., 169 Tenn. 564, 89 S.W.2d 754 (1936) (stating that cost of replacement life insurance, including fact that policyholder is now older and disabled, is proper award), reh’g denied, 170 Tenn. 19, 91 S.W.2d 294. Allowing a claim for the cost of reinsurance makes sense, because the damages suffered by a policyholder, on the date of breach, are limited to the cost of replacement insurance. “The insured is enabled to place himself in the same position he would [have] been in if his insurance policy had not been cancelled by receiving [funds] sufficient to obtain similar insurance....” Caminetti v. Manierre, 23 Cal.2d 94, 142 P.2d 741, 747-48 (1943).

Many courts have followed this breach-of-contract approach to valuing claims, awarding the cost of replacement insurance. See, e.g., Carr v. Hamilton, 129 U.S. 252, 9 S.Ct. 295, 32 L. Ed. 669 (1889) (stating that, on insolvency, policyholders have claim for equitable value of policy); Shloss v. Metropolitan Surety Co., 149 Iowa 382, 128 N.W. 384 (1910) (holding that policyholders become creditors in amount equal to equitable value of policies); Kentucky Home Life Ins. Co. v. Miller, 268 Ky. 271, 104 S.W.2d 997, 1000 (1937) (“[U]pon the insolvency of the [insurance company] the policyholder became entitled to his proportionate share in the reserve or cash value ... of his policy ... against the estate of the defunct company.”); New York v. Security Life Ins. & Annuity Co., 78 N.Y. 114 (1879) (awarding damages in amount of cost of replacement insurance); Smith v. St. Louis Mut. Life Ins. Co., 2 Tenn. Ch. 727 (1877) (stating that upon insolvency each policyholder is entitled to recover difference between cost of new policy and present value of premiums yet to be paid on policy at time of breach through insolvency); Universal Life Ins. Co. v. Binford, 76 Va. 103 (1882) (holding policyholders entitled to amount required to purchase replacement insurance); accord 2A Couch on Insurance 2d § 22:70, at 673 (rev. ed. 1984) (“[T]he company is liable in damages measured by the net value of such policies, calculated as of the date of dissolution.”); -Annotation, Basis for Allowance of Claims Under Policies of Insolvent Life Insurance Company, 106 A.L.R. 1513 (1937). But see State v. Surety Corp. of Am., 162 A. 852, 856 (Del.Ch.1932) (holding that damage award for default is return of unearned premium); Guy v. Globe Ins. Co., 9 Ins. L.J. 466 (Va.1880) (recognizing that, ordinarily, claimant’s damage award should be calculated as cost of replacement insurance, but holding that when claimant is uninsurable, claim is limited to return of premiums).

If the debtors in the current appeal had never indicated any sign of default, but then suffered financial setbacks after liquidation and subsequently defaulted, Credit Lyonnais’s claim would be limited to the cost of replacement insurance on the date of termination; it would not be able to recover for the cost of replacement insurance based on post-termination losses. When a life-insurance policyholder died several days after insolvency, the Pennsylvania Supreme Court awarded the net value of the policy, calculated on the date of insolvency, and refused to award a death claim. Commonwealth ex rel. Kirkpatrick v. American Life Ins. Co., 162 Pa. 586, 29 A. 660 (1894); see also Shloss, supra, 128 N.W. at 384 (“[H]e cannot maintain a claim ... for the amount provided in the policy to be paid in the event of loss on account of a loss suffered subsequently to the date of such final decree of dissolution.”). That rule implements a basic principle of contract law: once the policy is terminated, Credit Lyonnais should secure reinsurance; if it does not, then it should bear the cost of that failure to mitigate. Integrity is not liable for damages suffered as the result of post-termination losses due to Credit Lyonnais’s failure to mitigate.

If, however, the debtors’ defaults 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. “[T]he claim of a policyholder should be valued as a death claim [for the entire amount], where, from the age and health of the claimant, reinsurance would be impossible.” 19A Appleman, supra, § 10721, at 204. Thus, the California Supreme Court has held that an uninsurable policyholder should receive the face amount of his or her policies “less the premiums payable during his [or her] life expectancy, each reduced to its value at the time of cancellation.” Caminetti, supra, 142 P.2d at 747; accord Commissioner of Ins. v. Massachusetts Accident Co., 314 Mass. 558, 50 N.E.2d 801, 807-08 (1943) (upholding award to policyholders of full value of disability insurance). The unavailability of insurance indicates that the insured event is no longer a risk but a certainty, and the insured should obtain compensation based on that reality.

At the time that Integrity was adjudged insolvent, the investors and limited partnerships had defaulted on several payments. Those investors, however, still were obliged to make additional installment payments that were not due until after Integrity’s date of liquidation. Although those later payments were not yet due, Integrity -has conceded below that, as a result of the investors’ prior failure to pay, the risk of default on the remaining payments was so great that Credit Lyonnais could not have obtained alternative insurance. “The Liquidator now acknowledges that replacement insurance was unavailable once Integrity became insolvent.” In re Integrity Ins. Co., 281 N.J.Super. 364, 376, 657 A.2d 902 (App.Div.1995).

When Integrity terminated its policy with Credit Lyonnais, the investors had not yet defaulted on not-yet-due payments. As of that date, however, the risk of default was such a certainty that no other insurance company would provide insurance. On that date, the market had determined that Credit Lyonnais faced a loss in the total amount of its bond (which loss Integrity had promised to bear), and no one was willing to purchase that potential loss. Under ordinary principles of contract law, Integrity is liable for all damages that occurred due to its wrongful termination of the insurance contract. Any other result is unfair and contrary to well-established principles .of contract law. Therefore, under breach-of-contract rules, Credit Lyonnais should be entitled to file a claim, as damages for Integrity’s breach, for an amount equal to each bond’s face value less payments already made by Integrity and the investor and future amounts recoverable from the defaulting debtor. Although Credit Lyonnais can file a claim for the entire amount due, it will collect only a small percentage of its claim.¹

Recall that Credit Lyonnais made loans to partnerships secured by the promissory notes of investors in the partnerships. From this record it cannot be determined whether some of those investors 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 (less payments already received from the surety) due to the partnerships’ defaults on their loan payments, without first seeking payment under the promissory notes. On remand Credit Lyonnais will have to show that no recovery is available from the investors.

The surety’s liability under each irreplaceable bond will be the face value of the bond reduced by both the amount of assets recoverable under the collateral promissory notes and payments already made by the surety and the investor on each bond. Before the trial court, Credit Lyonnais must quantify its loss by providing evidence of the amount of recovery available under the promissory notes.

Ill

The Appellate Division held that “[t]he clear language of the Bonds indicates that Integrity was liable at the time of execution and delivery for the full amount under the Bonds, and such amount was reduced if only the investors made their scheduled payments under the Notes.” Integrity, supra, 281 N.J.Super. at 380, 657 A.2d 902. The panel also invoked judicial estoppel against Integrity based upon Integrity’s prior assertion that the contract’s terms imposed liability for the full amount of the bonds prior to termination. We disagree and hold that the bond language demonstrates that Integrity was liable only for payments as missed by the investors and that judicial estoppel should not apply.

We conclude that any policyholder whose insured risk was no longer insurable on the date of default should be entitled to file a claim for the full amount of the policy, less amounts already paid and amounts recoverable, from the debtors. Those policyholders who can purchase alternative insurance should be entitled to file a claim for the cost of that insurance, because that recovery would be sufficient to place them in the same position as before the breach of contract. That rule does not provide coverage for post-termination losses but simply applies general contract rules to value claims on the date of breach.

We affirm the judgment of the Appellate Division and remand the matter to the trial court for further proceedings consistent with this opinion.

1 The Appellate Division observed that a decision in favor of Credit Lyonnais would actually help Integrity’s other policyholders. Integrity, supra, 281 N.J.Super. at 381-82, 657 A.2d 902. Pursuant to the liquidation order, Integrity would pay only a small percentage of each allowed claim (approximately twenty-five cents on the dollar) to the claimant, but it was entitled to collect reinsurance for the entire amount of an allowed claim. Integrity had reinsured at least two-thirds of its liability on surety bonds ($63.5 million out of $99 million). Supra at 132, 685 A.2d at 1289 . Thus, if this Court allowed claims for the entire $99 million worth of bonds, Integrity would pay out approximately $25 million to the holders of those bonds but would receive $63.5 million in insurance proceeds. The remaining $40 million would then be disbursed among all policyholders by raising the payout to more than twenty-five cents on the dollar.