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From Banking and Finance Law Daily, August 21, 2015

Court derails creditor’s claim to railway’s insurance proceeds

By Lisa M. Goolik, J.D.

The U.S. Court of Appeals for the First Circuit has concluded that a creditor, Wheeling & Lake Erie Railway Company, that held a valid, perfected security interest in the accounts and payment intangibles of a debtor, Montreal, Maine & Atlantic Railway, Ltd. (MMA), did not have a perfected security interest in a settlement payment arising out of MMA’s insurance policy with Travelers Property Casualty Company of America. Affirming the lower court’s decision, the court concluded that claims arising under insurance policies are specifically exempt from the scope of Revised Article 9, and as a result, a filed UCC-1 financing statement was not enough to perfect Wheeling’s interest in the proceeds of the insurance policy (In re Montreal, Maine & Atlantic Railway, Ltd., Aug. 19, 2015, Selya, B.).

Background. In June 2009, MMA and its Canadian subsidiary, Montreal, Maine & Atlantic Canada Co. (MMAC), along with their affiliates, executed a promissory note for a line of credit with a maximum amount of $6 million. To secure the note, the parties executed a security agreement granting Wheeling a security interest in all of the debtor’s accounts and other rights to payment, including payment intangibles. The security agreement provided that it was governed by Maine law. On Aug. 25, 2009, Wheeling filed a UCC-1 financing statement with the Delaware Secretary of State to perfect its security interest.

Insurance claim. In April 2013, Travelers issued a commercial property insurance policy insuring MMA and MMAC for total coverage in the amount of $7.5 million. Four months later, a train operated by the MMA derailed in Quebec, resulting in the death of 47 people, total destruction of or damage to nearby structures, and significant environmental damage.

After the derailment, MMA filed an insurance claim for the policy limit of $7.5 million for the resulting damage and expenses MMA incurred as a result of the accident. Travelers denied payment for MMA’s business interruption and extra expenses because Travelers believed the claimed loss did not arise out of “Covered Property” as defined in the policy. Travelers also argued that, to the extent business interruption coverage existed, the coverage was included in the policy by mistake.

After MMA filed a petition for bankruptcy protection, Travelers filed a motion for relief from the automatic stay in order to file a declaratory judgment action seeking a declaration that the policy did not include business interruption coverage for the claimed loss. Eventually, the bankruptcy trustee, MMAC, and Travelers reached a settlement whereby Travelers agreed to pay $3.8 million to be allocated to MMA and MMAC. The payment would be full and final satisfaction of any and all claims arising under the policy, and Travelers would be released from any liability under the policy.

The Trustee sought court approval of the settlement, and Wheeling objected. Wheeling argued that it had a valid, perfected security interest in all of MMA’s payment intangibles, which Wheeling contended, included MMA’s rights to payment under the policy. As a result, the settlement impaired its security interest and right to the entire insurance proceeds, Wheeling believed.

The Bankruptcy Appellate Panel for the First Circuit held that Wheeling did not have a perfected security interest in the settlement payment, concluding that claims arising under insurance policies are specifically exempt from the scope of Revised Article 9, and as a result, the UCC-1 financing statement filed by Wheeling was not enough to perfect its interest in the debtor’s insurance policy. Wheeling appealed.

Scope of Article 9. Section 9-1109 of the Maine UCC specifically provides that Article 9 does not apply to “[a] transfer of an interest in or an assignment of a claim under a policy of insurance.” The section operates to exclude certain secured transactions relating to insurance policies from Article 9’s operation, and “by the exclusion applies to the use of an insurance policy as original collateral or to any assignment of a claim under an insurance policy,” the court explained.

“The insurance exclusion is broadly worded. It was inserted in Article 9 to ensure that financing arrangements involving the use of insurance policies as collateral would remain matters of state insurance law.”

Moreover, the court noted that courts have regularly interpreted the section remove from the reach of Article 9 “any transaction involving the transfer of rights under an insurance policy,” such as unearned insurance premiums. “Viewed against this backdrop, the assignment of a right to payment under an insurance policy, which is inseparable from the policy itself, falls squarely within the heartland of the exclusion,” the court concluded.

The court also rejected Wheeling’s argument that there was a distinction because the payment right did not come into existence until Travelers agreed to pay the settlement amount to MMA. “[T]his alternative theory does not sufficiently disentangle the right to receive payment under the Policy from an interest in the Policy itself,” said the court. The court also concluded that Wheeling’s alternative theory would fail as a matter of bankruptcy law.

Thus, the settlement payment was excluded from the scope of Article 9 because it “clearly arose from the [insurance policy].” Consequently, Wheeling’s security interest in the settlement payment was not perfected by the filing of a UCC-1 financing statement.

Common law perfection. Wheeling also challenged the lower court’s ruling that its filing of the UCC-1 financing statement was not enough to perfect its interest in the insurance proceeds under Maine common law. Under Maine’s common law, a creditor claiming a security interest through a chattel mortgage is required to perfect its interest by taking possession of the collateral. The Maine legislature subsequently provided that perfection could also be accomplished by recording the chattel mortgage with the appropriate municipal official. “The purpose of requiring possession or recordation was to prevent the creation of secret liens and ensure that bona fide purchasers as well as creditors were given fair notice of the encumbrance,” wrote the court.

However, Wheeling’s financing statement described the collateral as "[a]ll of [MMA's] inventory, accounts and payment intangibles (as those terms are defined in the Uniform Commercial Code),” which the court explained, do not include rights under an insurance policy. “It follows, we think, that the financing statement was wholly inadequate to give fair notice (or, indeed, any notice at all) to others of Wheeling's purported interest in the Policy,” said the court. Thus, the court concluded that Wheeling never perfected its security interest under Maine common law.

The case is No. 15-9003.

Attorneys: George J. Marcus, David C. Johnson, and Andrew C. Helman (Marcus, Clegg & Mistretta, PA) for Wheeling & Lake Erie Railway Company. Robert J. Keach (Bernstein Shur Sawyer & Nelson PA) for Robert J. Keach, Trustee.

Companies: Montreal, Maine & Atlantic Railway, Ltd.; Montreal, Maine & Atlantic Canada Company; Travelers Property Casualty Company of America; Wheeling & Lake Erie Railway Company

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