In Re: Benz
(9th Cir. B.A.P. 2007) 2007 WL 1119893

Insurer's Withdrawal Of A Defense Postpetition Does Not Violate Automatic Stay

The United States Bankruptcy Appellate Panel of the Ninth Circuit held that an insurer's communications to a debtor insured that the terms of its policy do not obligate the insurer to provide a defense does not, in and of itself, violate the automatic stay provisions of the Bankruptcy Code.

Appellants Rodger and Maria Benz ("Insureds") held a homeowners' insurance policy with DTRIC Insurance Company, Limited ("DTRIC") with a term running from August 15, 2002 to August 15, 2003. On August 4, 2003, the Insureds requested that the policy be cancelled effective July 25, 2003, the date of the recordation of a deed conveying title of their residence to David and Patricia Knight ("Knights").

On May 25, 2004, the Knights filed a state court lawsuit against the Insureds arising out of their purchase of the Insureds' former residence. In particular, the Knights alleged that the property contained significant construction and other defects resulting in injury to their son. Because the wrongful acts asserted by the Knights purportedly occurred while the Insureds' homeowners policy was still effective, the Insureds tendered the defense of the lawsuit to DTRIC. DTRIC agreed to provide a defense to the lawsuit subject to a reservation of rights.

On October 14, 2005, the Insureds filed for bankruptcy. The Knights filed a motion for relief from stay, noting that modifying the stay to allow prosecution of their lawsuit would not harm the Insureds or the estate since DTRIC was defending the lawsuit and any recovery would be limited to insurance proceeds. The Insureds did not file a substantive objection to the motion because, at the time, DTRIC was paying for the defense of the lawsuit. The bankruptcy court granted the Knights relief from the automatic stay.

On May 11, 2006, DTRIC sent a letter to the Insureds informing them that it would no longer defend the lawsuit or indemnify them for damages or expenses arising from the lawsuit, based on its decision that there was no possibility of indemnity coverage and, accordingly, no duty to defend. Eleven days later, the Insureds filed a Motion for Order to Show Cause Why DTRIC Should Not Be Held in Violation and Contempt of the Automatic Bankruptcy Stay ("Contempt Motion"). DTRIC opposed the Contempt Motion, arguing that pulling the defense did not violate the automatic stay. The Court denied the Insured's Contempt Motion. The Insureds then appealed the decision to the Bankruptcy Appellate Panel for the Ninth Circuit.

The Bankruptcy Panel affirmed the lower court ruling, holding that an insurer's postpetition denial of a claim does not violate the automatic stay. The Bankruptcy Panel explained that communication by an insurer of its position that an insurance policy excludes or otherwise does not cover a claim is not "an act to exercise control over property of the estate" under 28 U.S.C. § 362. The Bankruptcy Panel also rejected the Insureds' argument that the withdrawal of coverage violated the automatic stay based on precedent holding that the postpetition cancellation of an insurance policy violates the automatic stay, explaining that the cancellation of a policy destroys the policy and takes property away from the estate. In contrast, by withdrawing coverage, an insurer is honoring the policy and is merely making a contractually-permitted determination regarding its scope. Therefore, the withdrawal of coverage does not violate the automatic stay.

This opinion may be withdrawn from publication, modified on rehearing, or review may be granted by the United States Supreme Court. These events may impact the availability of the decision for use as legal authority.

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