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United States District Court, S.D. New York

October 11, 2005.

GREGORY SERIO, Superintendent of Insurance of the State of New York, as Rehabilitator of FRONTIER INSURANCE COMPANY, Plaintiff,

The opinion of the court was delivered by: MICHAEL DOLINGER, Magistrate Judge


The Insurance Superintendent of the State of New York commenced this lawsuit earlier this year in his capacity as the court-appointed rehabilitator of Frontier Insurance Company.*fn1 He seeks by this litigation to recover premiums allegedly owed to Frontier by defendant Black Davis and Shue Agency ("BDS") under a brokerage contract that authorized BDS to place certain types of insurance with Frontier and required BDS to collect and transmit premiums to the carrier.

BDS in turn has filed a series of counterclaims against plaintiff, on the basis of which it asserts that Frontier owes it substantial sums of money based on a variety of legal theories. The counterclaims include claims of negligence, breach of contract, breach of fiduciary duty, unjust enrichment and defamation. Among the claims asserted by BDS is a contention that Frontier owes it a sum of money representing commissions that it earned in the placement of the insurance in question.

  The Superintendent has moved to stay the counterclaims of BDS based on the abstention principles recognized by the United States Supreme Court in Burford v. Sun Oil Co., 319 U.S. 315 (1943), and its progeny. Specifically, plaintiff contends that claims against Frontier — which is now in a rehabilitation process before the New York State Supreme Court under the provisions of Article 74 of the New York Insurance Law — should be heard exclusively in the state rehabilitation forum. In support of that argument, the Superintendent asserts that adjudication of those counterclaims in this court would interfere with the orderly Article 74 process for putting the affairs of the carrier in order. Alternatively, plaintiff seeks the dismissal of all of the non-contract counterclaims for failure to state a cognizable claim.

  BDS opposes both aspects of plaintiff's motion. It contends that plaintiff has not satisfied the Burford criteria, and that to stay the counterclaims while permitting plaintiff to seek a recovery here against it would be fundamentally unfair and indeed would threaten BDS with financial ruination. It further argues that the counterclaims that it asserts against plaintiff are legally sufficient.

  For the reasons that follow, we grant plaintiff's motion to stay the adjudication of defendant's counterclaims at this time in light of the showing by plaintiff as to the availability of an alternative, state-court forum. We therefore do not address the Rule 12(b) (6) arguments proffered by the parties. We further conclude, however, that any obligation by Frontier to pay withheld commissions to BDS constitutes a proper set-off in this litigation and may therefore be proven by BDS in calculating the amount owed by BDS to Frontier.

  The Pertinent Facts

  Frontier was initially incorporated in 1962 under the name P.T.F. Health Insurance Co. (Declaration of H. Neal Conolly, Esq., executed June 1, 2005, at ¶ 11). In 1977 its name was changed to Frontier, and it began to perform as an insurance carrier. (Id. at ¶¶ 12, 14). Frontier's operations proved relatively profitable, and in 1986 it was acquired by the Frontier Insurance Group, Inc. (Id. at ¶¶ 16-17).

  Although Frontier's business expanded considerably through 1996, by the late 1990s its financial situation had deteriorated, and by the first quarter of 2000 it was operating at a loss of $13.6 million. (Id. at ¶¶ 22, 24). With a net loss of more than $50 million in 2000, Frontier was examined by the New York Insurance Superintendent, who reported that, as of year-end 1999, Frontier was insolvent in the amount of $145,736,693, that its capital was impaired by $150,736,693, and that its required surplus of $6.7 million was impaired by $152,436,693. (Id. at ¶ 28).*fn2

  On March 1, 2001, the New York Insurance Department ordered Frontier to show cause why it should not be subjected to regulatory action, and on March 12 the company stipulated with the Department that its surplus was inadequate in relation to its liabilities and current financial needs. It further agreed not to write any new or renewal insurance policies until authorized by the Department. (Id. at ¶¶ 31-32).

  On August 24, 2001, the Superintendent commenced a rehabilitation proceeding in New York State Supreme Court, New York County under Article 74 of the New York Insurance Law. (Id. at ¶ 34). The court appointed the Superintendent as Frontier's temporary receiver. (Id. at ¶ 35 & Ex. A). On October 15, 2001 the court issued an order designed to govern the rehabilitation process. Under its terms, the court deemed Frontier to be insolvent and authorized the Superintendent


to immediately take possession of its property, conduct its business, including but not limited to settling claims within his sole discretion, take such steps toward the removal of the causes and conditions which made this proceeding necessary as he shall deem wise and expedient, and deal with the property and business of [Frontier] in its name or in the name of the Superintendent as Rehabilitator.
(Id., Ex. A at p. 2). The order also provided, under N.Y. Insur. Law § 7419(b), that "[a]ll persons are enjoined and restrained from commencing or prosecuting any actions, lawsuits, or proceedings against [Frontier] or the Superintendent as Rehabilitator". (Id., Ex. A at p. 3). As further protection, the court ordered that "[a]ll persons are enjoined and restrained from obtaining preferences, judgments, attachments or other liens or making any levy against [Frontier's] assets or any part thereof." (Id.).

  The Superintendent authorized the filing of the current lawsuit in federal court this year as part of his effort to marshal the assets of the carrier. According to plaintiff, the decision to file in this forum was triggered by the expectation that Frontier's claims would be adjudicated more quickly and efficiently here than in state court, thus ensuring reasonably prompt and low-cost recovery of assets belonging to Frontier. (Id. at ¶ 47).

  As for the state-court proceeding, the process of rehabilitation continues, and, according to the Administrator of Frontier, who was appointed by the Superintendent in 2002, it is still not clear whether the company will emerge from rehabilitation as a functioning carrier or will be required to go to liquidation. (Id. at ¶¶ 2, 4. But see Sept. 30, 2005 letter to the Court from William D. Chapman, Esq., at annexed exhs.). The Administrator represents that plaintiff's application for a stay is intended to implement the injunction of the rehabilitation court and to ensure that, by enforcing the centralized claim-adjustment process prescribed by the Insurance Law, the Administrator will be able to minimize the costs of litigation, prevent BDS from obtaining an improper preference over creditors who have filed their claims in the rehabilitation court, and ensure uniformity of treatment of similarly-situated claimants. (Id. at ¶¶ 3, 6-8, 52-53).


  The underlying premise for the stay motion is the holding of the Supreme Court in Burford that federal courts have the discretion to abstain from deciding cases to "avoid interfering with state efforts to maintain a coherent policy in an area of comprehensive regulation or administration." American Disposal Servs., Inc. v. O'Brien, 839 F.2d 84, 87 (2d Cir. 1988). In Burford, the High Court held that the district court should not, "as a matter of sound equitable discretion", have exercised jurisdiction over a challenge to a state order permitting a party to drill oil wells on a specific piece of land, because the order was issued as part of a complex regulatory scheme that would be disrupted if the federal courts intervened on a piecemeal basis. 319 U.S. at 318. See Hartford Courant Co. v. Pellegrino, 380 F.3d 83, 102 (2d Cir. 2004). As the Second Circuit has observed, in the wake of Burford "[t]he federal courts have abstained in numerous areas where state regulation involved matters of substantial state concern and where state policies were carried out in a statutorily established regulatory program by state officials." Levy v. Lewis, 635 F.2d 960, 963 (2d Cir. 1980) (citing cases).

  The regulation of insurance has long been recognized as an appropriate area for detailed state regulation, as mandated by the McCarran-Ferguson Act, 15 U.S.C. § 1011 et seq. Moreover, the Second Circuit has repeatedly held that the New York regulatory framework for supervising the insurance industry and, most pertinently, for rehabilitating and liquidating failing insurance carriers is an administrative process meriting Burford abstention in appropriate circumstances. See, e.g., Corcoran v. Ardra Ins. Co., 842 F.2d 31, 36-37 (2d Cir. 1988); Law Enforcement Ins. Co. v. Corcoran, 807 F.2d 38, 43-44 (2d Cir. 1986); Levy, 635 F.2d at 963-65. Those circumstances are typically found to exist when a party seeks to assert a federal-court claim that would otherwise be dealt with in an ongoing rehabilitation or liquidation proceeding. See, e.g., Corcoran, 842 F.2d at 32-33, 36-37 (remanding removed action by Superintendent in the context of liquidation proceeding); Law Enforcement Ins. Co., 807 F.2d at 39-40, 43-44 (abstaining from federal-court challenge by dissatisfied claimant to Superintendent's disallowance of claim in liquidation proceeding); Levy, 635 F.2d at 961-62, 963-64 (abstaining from federal-court challenge to Superintendent's termination of retirement benefits of carrier's former employees in liquidation proceeding). Compare Alliance of American Insurers v. Cuomo, 854 F.2d 591, 599-601 (2d Cir. 1988) (rejecting abstention in case that involved challenge to state insurance statute but no interference with any ongoing rehabilitation or liquidation proceeding).

  There is no question that to allow BDS to litigate affirmative claims against Frontier in federal court would pose a recognizable danger to the ongoing administrative process that is being supervised by the New York State Supreme Court, under which the Superintendent and his Administrator are charged with marshaling assets, paying or compromising claims, and otherwise overseeing the affairs of Frontier in an effort to either put it back on its financial feet or determine that rehabilitation is not feasible and that the company must be liquidated. Indeed, the need for uniformity of treatment and centralization of the claims process is precisely the reason why the Insurance Law authorizes the state court to issue the type of injunction that was granted in the Frontier proceeding, and it explains why the state court exercised that authority with regard to Frontier. To allow BDS to pursue its counterclaims would permit it to violate that injunction and to undercut the policies that the state-court order embodies.

  It is therefore not surprising that the numerous courts around the country in which various plaintiffs have filed claims against Frontier have consistently refused, since commencement of the rehabilitation action, to entertain those suits in deference to the New York State proceeding. (See Declaration of Barton W. Bloom, Esq., executed June 24, 2005, at ¶¶ 5-66 & Exs. 1-54; Oct. 3, 2005 letter to the Court from William S. Gyves, Esq., annexing Resource Mgt., Inc. V. Frontier Ins. Co., Civil Action No. 01-11218-DPW, Judgment (D. Mass. Sept. 29, 2005)). We reach the same conclusion and accordingly grant the application to stay the counterclaims of the defendant.*fn3

  There remains, however, one significant issue to consider. In opposing the stay, BDS makes the point that plaintiff has chosen to sue it in federal court, and it suggests that, in assessing the amount it may owe to Frontier for premiums allegedly not forwarded to the carrier, account must also be taken of any amounts owed by Frontier to the broker.*fn4 Defendant appears to imply by this assertion that its counterclaims should survive here, although its argument on this point is not a model of precision. In response, the Superintendent argues that any claims by the broker for moneys owed it can be satisfactorily determined in the rehabilitation proceeding, and that even the claim by BDS for offsetting premiums is properly dealt with in the state court.

  We conclude that plaintiff's filing of suit here does not preclude Burford abstention with respect to defendant's counterclaims. The state-court injunction precludes potential claimants from commencing lawsuits or obtaining a judgment against Frontier other than in the context of the rehabilitation proceeding. Neither that order nor the Insurance Law, however, limits the discretion of the Superintendent to determine how most efficiently to marshal the assets that properly belong to the estate of the carrier. The decision of the Superintendent to proceed in this court in amassing some of those assets is thus legally permissible. Moreover, it does not pose any danger of undermining the state rehabilitation process. Indeed, to the contrary, if the Superintendent is correct in his estimate that this case can more efficiently be brought to a conclusion in this court, it will enhance the effectiveness of the rehabilitation process.

  Under these circumstances, we reject the implicit argument of BDS that its counterclaims should be adjudicated here because the Superintendent has sued here. Nonetheless, one aspect of defendant's position must be upheld.

  BDS notes that, as one part of its claimed damages, it seeks an award of commissions allegedly owed and unpaid by Frontier. It suggests that, to measure the amount it owes Frontier under their contractual brokerage arrangement while ignoring the offsetting debt of Frontier is fundamentally unfair as well as inefficient. In response, the Superintendent argues that any debt owed by Frontier to BDS for premiums is properly addressed as an independent claim, not a setoff, and hence must be included within the scope of the stay order.

  The distinction between an independent claim and a set-off is the controlling concern in determining the scope of the stay. Indeed, although the Insurance Law authorizes an injunction in the form issued by the state court in this case, see N.Y. Insur. Law § 7419, that injunction precludes the filing of lawsuits — that is, the assertion of independent claims (or counterclaims) — or the obtaining of a judgment or other preference, but it does not prevent the assertion of set-offs in response to a lawsuit on behalf of the carrier. See, e.g., New York Title & Mortg. Co. by Van Schaick v. Irving Trust Co., 268 N.Y. 547, 549, 198 N.E. 397, 397-98 (1935); New York Title & Mortg. Co. v. Friedman, 153 Misc. 697, 700, 276 N.Y.S. 72, 77 (Sup.Ct., N.Y. Cty. 1934). See also N.Y. Insur. Law § 7427.

  Plaintiff appears at least implicitly to recognize this distinction by arguing, at some length, that any obligation by Frontier to BDS for commissions is in the nature of an independent claim and not a set-off. (Pl's Reply Mem. at 10-17). New York law, however, does not support this assertion.

  In support of plaintiff's argument, it notes — correctly — that a defendant's demand for payment will not constitute a set-off unless that asserted debt and the claim against which the defendant seeks a credit are in the nature of "mutual" debts. Id. at 11. See also N.Y. Insur. Law § 7427(a). Under New York law, to be mutual, the debts must derive from the same transaction or set of transactions, and the defendant's claimed credit must have been earned in the same capacity as it owes the debt that forms the basis for the plaintiff's claim. See, e.g., Beecher v. Peter A. Vogt Mfr. Co., 227 N.Y. 468, 473, 125 N.E. 831, 833 (1920). As we understand plaintiff's argument here, he asserts that defendant owes the premiums to Frontier in a different capacity from that in which it claims a credit for unpaid commissions. According to the Superintendent, BDS owes the premiums to Frontier as a trustee, whereas it is owed the commissions in its personal, or non-trustee, capacity. (Pl's Reply Mem. at 13-14).

  The short answer to this argument is that, in its only decision that directly addresses the question, the New York Court of Appeals appears to have treated claims for withheld premiums and for unpaid commissions in a dispute between a carrier and a broker as reflecting a claim and a set-off. See Amusement Business Underwriters v. American Int'l Group, Inc., 66 N.Y.2d 878, 498 N.Y.S.2d 760 (1985). In that case an insurance broker initially sued a carrier for unpaid commissions, and the insurance company asserted a counterclaim for premiums that the broker had allegedly failed to remit to the carrier. Subsequently the carrier terminated a large number of policies placed by the broker, and as a result the broker filed a separate lawsuit for tortious interference and subsequently went out of business. Id. at 879, 498 N.Y.S.2d at 762.

  During the litigation, the carrier failed to provide discovery responses, and the trial court therefore struck its answer to the broker's complaint and its counterclaims, leading to an inquest on damages on the broker's unpaid-premium claim and its tortious-interference claim, and to substantial awards on each claim. Id. at 879, 498 N.Y.S.2d at 762. On appeal, however, the Court of Appeals reversed the award for unpaid commissions, holding that "[e]vidence of plaintiff's failure to remit $689,000 in premiums to defendants . . . should have been admitted in evidence as a proper setoff" to the claim for commissions. Id. at 880, 498 N.Y.S.2d at 762. In reaching this conclusion, the Court acknowledged that the claim for commissions and the demand for premiums arose from two separate contracts between the parties, but it observed that both arose "out of the same basic transactions put in issue by plaintiff's complaint." Id. at 880, 498 N.Y.S.2d at 762.

  In this case it appears that the demand by BDS for commissions arises "out of the same basic transactions" as the plaintiff's claim for withheld premiums. At the least, plaintiff does not proffer evidence suggesting the contrary or otherwise distinguish the holding of the Court of Appeals on this point. Under the circumstances, and on the current record, we will not preclude BDS from demonstrating the amount of commissions owed it as a set-off against the amount of premiums that it may owe Frontier.*fn5


  For the reasons noted, we grant plaintiff's motion to stay the adjudication in this case of defendant's counterclaims. Consistent with plaintiff's representations, this determination is without prejudice to an application by BDS to lift the stay in the event that it is unable to obtain reasonably prompt consideration of its counterclaims as claims in the rehabilitation proceeding.

  We further direct that defendant will not be precluded from presenting its case with respect to commissions allegedly owed it by Frontier as a set-off to any liability to Frontier for withheld premiums.


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