In In re Montreal, Maine & Atlantic Railway, Ltd.,1 the United States Court of Appeals for the First Circuit upheld a lower court decision that a lender did not have a perfected security interest under Article 9 of the Uniform Commercial Code in proceeds of a policy of business interruption insurance.
Background
In 2009, Wheeling & Lake Erie Railway Company ("Wheeling") extended a line of credit to Montreal, Maine & Atlantic Railway Ltd. (the "Debtor"), the Debtor's Canadian subsidiary and certain of their affiliates. To secure their obligations, the borrowers granted Wheeling a security interest in certain collateral, including accounts, payment intangibles and inventory. Wheeling perfected its security interest by filing a financing statement under the UCC.
In April 2013, Travelers issued a commercial property insurance policy insuring certain of the borrowers; this policy included coverage for loss of business income following certain insured events.
The Debtor filed bankruptcy shortly after one of its trains, which carried a number of tank cars containing crude oil, derailed in Quebec; the resulting explosions destroyed part of a town and caused substantial loss of life. The Debtor made a claim under the Travelers insurance policy for casualty losses and for loss of business income. Travelers, the bankruptcy trustee and the Canadian subsidiary eventually reached a settlement whereby Travelers agreed to pay $3.8 million to the Debtor and the Canadian subsidiary. Wheeling objected to the settlement.
The bankruptcy court ruled that Wheeling did not have a security interest in the settlement payment. Wheeling appealed to the Bankruptcy Appellate Panel of the First Circuit, which affirmed. In February 2015, we issued a client alert on the BAP decision (see http://www.icemiller.com/ice-on-fire-insights/publications/security-interests-in-business-interruption-insura/).
Analysis
This case examined whether it was possible for the lender to obtain a perfected security interest in the business interruption insurance policy or the settlement payment by virtue of its UCC filing. The lender apparently took no other steps to perfect its security interest.
Section 9-109(d)(8) of the UCC excludes from the scope of Article 9 of the UCC "a transfer of an interest in or an assignment of a claim under a policy of insurance . . . but sections 9-315 and 9-322 apply with respect to proceeds and priorities in proceeds." The definition of "proceeds" in Article 9 includes "insurance payable by reason of the loss or nonconformity of, defects or infringement of rights in, or damage to, the collateral" (UCC §9-102(64)(E)). To the extent that a creditor wishes to takes a security interest in a policy of insurance that is outside the scope of Article 9, it must comply with non-UCC law in order to do so. Wheeling did not comply with applicable non-UCC law to take a security interest in the insurance policy.
Where a secured party has a perfected security interest in a debtor's after-acquired accounts and payment intangibles, a good argument exists that, because a policy of business interruption insurance insures the debtor for the loss of revenue that would constitute collateral had no business interruption occurred, the secured party should be perfected in the payments made under such policy as proceeds of its original collateral.2 Business interruption insurance is intended to replace the lost income, in the same way that proceeds of casualty insurance covering a piece of damaged equipment -- which is clearly within the proceeds exception to UCC Article 9's insurance exclusion -- is intended to replace the equipment. Few court cases have examined whether business interruption insurance can be the subject of a security interest in UCC Article 9 as proceeds of other collateral.
For some reason, the lender in Wheeling did not argue that the business interruption insurance claim was proceeds of its collateral consisting of accounts and payment intangibles. The lender made several attempts to convince the court that it had an Article 9 security interest in the insurance policy as original collateral despite the insurance exclusion in Section 9-104(d)(8). The First Circuit found all these arguments unpersuasive.
In a footnote, the First Circuit noted the proceeds exception to Article 9's general insurance exclusion, and stated that "the exception requires that a creditor have a valid security interest in some other collateral as to which an insurance payment is 'proceeds.'" The First Circuit found the lender's argument that the policy was original collateral did not make the proceeds exception applicable: "Because Wheeling's asserted interest in [the Debtor's] contingent right to payment under the Policy is invalid, it does not have a security interest in any collateral as to which the settlement payment can be considered proceeds."3
Final Observations
It is curious that the lender in this case did not argue that the business interruption insurance payments were proceeds of its other collateral. There is caselaw precedent for this argument, and the argument has also received substantial support from a number of legal commentators over the years.4 By arguing that the insurance policy itself was its original collateral, rather than arguing that the business interruption insurance payments were proceeds of its original collateral consisting of the lost income stream, the lender ran smack into Article 9's insurance exclusion.
The BAP opinion had included some dicta which criticized MNC Commercial Corp. v. Rouse, a 1992 U.S. district court case which is the leading case in support of the view that payments under a business interruption insurance policy can be proceeds of accounts and general intangibles that would have been included in the lost income stream covered by the policy. The First Circuit did not repeat this criticism or discuss MNC Commercial at all.
From a creditor's perspective, it is somewhat heartening that the First Circuit did not repeat the BAP's criticism of MNC Commercial. However, MNC Commercial is the only case we are aware of that has come out in favor of treating business interruption insurance payments as proceeds of original collateral consisting of a lost income stream. While there is a good argument to support this result, given the few cases that have considered the issue, it may be prudent for lenders to seek to perfect liens in business interruption insurance policies under non-UCC law.
Footnotes
1 2015 WL 4934212 (1st Cir. Aug. 19, 2015).
2 See MNC Commercial Corp. v. Rouse, 1992 WL 674733 (W.D. Mo. 1992), in which the court held that a secured party that had a perfected security interest in the debtor's accounts, general intangibles, contract rights, documents, instruments, chattel paper and inventory also had a perfected security interest in proceeds of the debtor's business interruption insurance policy following a suspension of the debtor's operations caused by a fire.
3 Wheeling at n. 3.
4 See, e.g., Clark & Clark, The Law of Secured Transactions under the Uniform Commercial Code, ¶1.08[8][F].
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