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September 21, 2005.


The opinion of the court was delivered by: NAOMI BUCHWALD, District Judge


The Maritime Asbestosis Legal Clinic ("MALC"), on behalf of thousands of former merchant marine employees of Prudential Lines, Inc. ("PLI") who have filed asbestos-related bodily injury proofs of claim (the "Asbestos Claimants") in PLI's Chapter 11 bankruptcy case, appeal from a ruling of the United States Bankruptcy Court (Gonzalez, J.) for this District denying the motion by the Asbestos Claimants and the confirmed debtor PLI's disbursement trustee (the "Trustee") seeking a ruling enforcing its interpretation of the set-off provision set forth in Section 4.05.07(a) (iv) of the Second Amended Plan of Reorganization (the "Plan") and deeming that the Trustee has received the necessary assurances and documentation noted under Plan section 4.05.07(a) (i) and is authorized to make payments of Allowed Insurance Claims. In reviewing the decision of a bankruptcy court, we "accept? its factual findings unless clearly erroneous but review? its conclusions of law de novo." DG Acquisition Corp. (In re DG Acquisition Corp.), 151 F.3d 75, 79 (2d Cir. 1998) (citing In re McLean Industries, Inc., 30 F.3d 385, 387 (2d Cir. 1994). For the reasons discussed below, the Bankruptcy Court's decision is affirmed.

Because this is the most recent of several opinions issued in this case, we do not reiterate all the facts and assume familiarity with them. See, e.g., In re Prudential Lines, Inc, 148 B.R. 730 (Bankr. S.D.N.Y. 1992), aff'd in part, rev'd in part on other grounds, 170 B.R. 222 (S.D.N.Y. 1994), aff'd, 158 F.3d 65 (2d Cir. 1998). Instead, we note only certain facts relevant to the motion before us appealing the decision of the Bankruptcy Court. In 1986 an involuntary petition for relief seeking to place PLI in a Chapter 11 bankruptcy proceeding was not contested. On October 4, 1990 PLI's Plan of Reorganization was confirmed. The Asbestos Claimants voted to accept the Plan.

  The American Steamship Owners Mutual Protection and Indemnity Association, Inc. ("American Club") is a non-profit mutual indemnity insurance association of shipowners. Each year, the American Club's members negotiate fully assessable insurance policies (the "Policies"), under which each member is assessed an amount to cover the costs of all claims against all members arising in each separate insurance year of its membership. PLI, the predecessor of the PLI Disbursement Trust, was a shipowner member of the American Club for a number of years. When PLI declared bankruptcy in 1986, it owed the American Club $1,278,000 in premiums and assessments. The American Club filed a proof of claim which gave rise to its set-off right in that amount. The Asbestos Claimants are not parties to the Policies.

  In the Plan, the Trust set aside $300,000 for use in a recycling arrangement. Pursuant to the recycling arrangement, the Trustee disbursed a damages payment to a claimant, who then returned the money to the Trustee as a non-recourse loan in exchange for a claim against the estate. The funds were then paid to the next claimant, and so on, until the Trustee had paid out $66 million in such claims. See In re Prudential Lines, Inc, 158 F.3d at 68-70. The United States Bankruptcy Court for the Southern District of New York held that the arrangement was legitimate, and the district court reversed. In re Prudential Lines, Inc, 170 B.R. at 242. The district court concluded that the recycling arrangement did not satisfy the "pay first" provisions of the payment and indemnification policies, which "require the insured to first pay a claimant before the insurers'? duty to indemnify the insured arises," because the proposed "payments" did not constitute an actual loss in good faith. 170 B.R. at 239, 242. It distinguished PLI's recycling arrangement from the arrangement in Liman v. Am. Steamship Owners Mut. Prot. and Indem. Ass'ns, 299 F. Supp. 106 (S.D.N.Y.), aff'd 417 F.2d 627 (2d Cir. 1969) (per curiam), cert. denied, 397 U.S. 936, (1970). The Liman court approved of an arrangement whereby the debtor's estate paid the claims for which it would be indemnified out of the estate's funds and only "financed" the deductibles, which it was forbidden to pay because they would be illegal preferences. Here, however, the Trust lacked the funds to pay the claims and sought to finance them in their entirety, creating enormous paper losses without any expenditure of assets, and the district court emphasized this difference from Liman in concluding that there would be no actual loss in good faith under the recycling arrangement.

  The Second Circuit affirmed, noting that it did not "think that this sham transaction triggered an indemnification obligation under New York law." In re Prudential Lines, Inc, 158 F.3d at 74. The Second Circuit added that its holding was "independently supported by the doctrine of New York law that bars direct actions by claimants against marine indemnity insurers." Id. (citing Ahmed v. Am. Steamship Owners Mut. Prot. & Indem. Ass'n, 444 F. Supp. 569, 572 (N.D. Cal. 1978)). Under the New York common law, still applicable to marine insurance policies, "the insured's lack of assets to satisfy claims against the bankrupt estate typically leaves the insured unable [to] sustain a loss and pay the claim. This is simply one consequence of purchasing a marine policy of indemnity rather than a liability policy." Id. at 75. The Second Circuit therefore held that it "[would] not permit the Claimants, who are the only parties in interest," to evade the bar against direct actions by claimants against marine indemnity insurers "via an illusory transaction that is of no financial consequence or interest to Prudential as the supposed insured." Id. at 74.

  During 2004 the Trustee and Asbestos Claimants (collectively, the "Movants") filed a motion seeking a ruling from the Bankruptcy Court endorsing their interpretation of the set-off provision set out in section 4.05.07(a)(iv) of the Plan. Movants argued that section 4.05.07(a)(iv) provides that the Trustee can pay holders of allowed claims, apply the American Club's set-off ratably among them, and seek indemnification from the American Club under the Policies.*fn1 The Movants have not explicitly laid out the mechanics of the payments under their new interpretation of the Plan, but it appears that Trustee would (1) pay a claimant up to $300,000 toward his claim, less a pro-rated share of the American Club's set-off, (2) give that claimant a claim against the Trust for the amount of the claim withheld as part of the set-off, and then (3) seek indemnification from the American Club for the cash amount paid to the claimant. With its assets thus replenished, the Trustee would then repeat this process several thousand times until it had paid off all the Asbestos Claimants' millions of dollars in claims, spreading out the $1.2 million in the American Club's set-off among them ratably.

  The American Club opposed the motion, arguing that it is entitled to apply its $1,278,000 set-off against amounts the Trustee pays out. Under the American Club's view, the Trust must pay out an amount exceeding the American Club's set-off before the American Club is obligated to indemnify any claims against PLI.

  On January 16, 2005, the Bankruptcy Court denied the motion, holding that the Plan preserved the American Club's "pay first" insurance right under the Policies, that the Movants' interpretation of the Plan "would effectively result in Claimants having a direct action against American Club, which the Second Circuit found against," and that the Trust "has not in fact incurred a `loss' such that amount to be paid by the PLI Disbursement Trust will exceed the American Club's set-off amount." Memorandum Decision and Order, Record Item 2 ("January 19, 2005 Memorandum"), at 17. On January 26, 2005, Asbestos Claimants appealed the decision of the Bankruptcy Court.

  We concur with the reasoning of the Bankruptcy Court. Under appellants' proposed pro rata scheme, as in the recycling arrangement rejected in 1992, the Trustee would sustain no actual loss incurred in good faith. Appellants' reading of section 4.05.07(a)(iv) to permit pro-rating of American Club's set-off among the holders of all allowed insurance claims without first requiring the Trustee to pay more than the set-off amount to those claimants would effectively grant the Asbestos Claimants a prohibited direct action against the American Club. Furthermore, the language of section 4.05.07(a)(iv) contains important qualifying language ignored by Appellants' suggested interpretation. Holders of "Allowed Insurance Claims" are only to receive cash "to the extent recovered" and to share pro-rated claims "to the extent possible." The set-off provision is therefore consistent with the preservation of the American Club's legal rights as they existed as of the Plan's effective date, requiring that the Trustee "pay first" before it can seek indemnity from the American Club. We therefore affirm the decision of the Bankruptcy Court.



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