In the Matter of the Rehabilitation of Frontier Insurance Company.
Dornbush Schaeffer Strong in & Venaglia, LLP Attorneys for Rehabilitator (William F. Costigan, of counsel)
Law Offices of Christopher DuBois Attorneys for Frontier Insurance Company in Rehabilitation 195 Lake Louise Marie Road Attorneys for Commonwealth of Kentucky Department of Workers' Claims and Kentucky Coal Employers' Self-Insurance Guaranty Fund (Jonathan L. Gay, of counsel)
Hargraves McConnell & Costigan, P.C. Attorneys for Commonwealth of Kentucky Department of Workers' Claims and Kentucky Coal Employers' Self-Insurance Guaranty Fund (John McConnell, of counsel)
The Helmsley Building 230 Park Avenue New York, New York 10169 Stuart F. Delery, Acting Assistant Attorney General Attorney for the United States (Frances M. McLaughlin, of counsel)
United States Department of Justice, Civil Division Ficara & Associates, P.C. Attorneys for Callon Petroleum, The Martin Family Charitable Trust and Logo Holdings, LLC (Donald J. Cayea, of counsel)
Attorneys for The Martin Family Charitable Trust (Mary Cannon Veed, of counsel) 120 South Riverside Plaza, Suite 1200
Wharton Law Group. Attorneys for Logo Holdings, LLC (Margaret A. Wharton, of counsel)
Chadbourne & Parke, LLP (Richard G. Liskov, of counsel)
Morrison Cohen LLP Attorneys for Unit 82 Joint Venture (Y. David Scharf, of counsel)
Patrick F. Adams, P.L.L.C. Attorney for St. John's the Baptist Diocesan High School (Gary A. Pagliarello, of counsel)
Lazlo Komjathy, Jr., Esq. Attorney for California Department of Insurance Legal Division, Corporate Affairs Bureau
Locke & Lord, LLP Attorneys for Frontier Insurance Company Coordinating Committee (Thomas W. Jenkins, of counsel)
RICHARD M. PLATKIN A.J.S.C.
More than a decade ago, on October 10, 2001, Supreme Court, New York County (Lehner, J.) granted the application of the Superintendent of Financial Services ("the Superintendent")  to be appointed as rehabilitator ("Rehabilitator") of Frontier Insurance Company ("Frontier") pursuant to Article 74 of the Insurance Law ("Article 74").
In a Decision & Order dated July 9, 2010, this Court determined that it was necessary to: " (1) examine the progress that the Rehabilitator has made in removing the causes and conditions' that have made this rehabilitation proceeding necessary (see Insurance Law § 7403 [a]); (2) require the Rehabilitator to develop and submit to the Court for its approval a plan of rehabilitation for restoring Frontier to solvency, including an assessment of how long continued rehabilitation efforts are expected to take; and (3) give Interested Parties an opportunity to be heard regarding the efficacy of the Rehabilitator's past efforts and to comment on his future plans." The Decision & Order explained that these measures would assist the Court in "discharging its responsibility to oversee this statutory receivership, ensure openness and transparency, allow Interested Parties a meaningful opportunity to be heard, promote public confidence in the rehabilitation process, and allow for development of a factual record that may be useful in guiding this proceeding in the future."
By Order to Show Cause dated January 13, 2012,  the Rehabilitator proposed a plan of continued rehabilitation for Frontier ("Plan of Rehabilitation" or "the Plan"). The Plan proposes an ongoing run-off of Frontier's liabilities, with additional protection for "Claims under Policies", as such term is defined in the Plan. The Plan does not establish a detailed timetable for restoring Frontier to solvency, but includes annual milestones over the next five years for reducing the amount of the insolvency. The Rehabilitator contends that these efforts are warranted to ascertain whether Frontier's liabilities for "Claims under Policies" and then its other liabilities can be satisfied. The Rehabilitator further submits that continued rehabilitation efforts are preferable to immediate liquidation for at least three reasons: (1) the existence of an experienced staff at Frontier with significant institutional knowledge; (2) the ability in rehabilitation to effectively and efficiently coordinate the payment of liabilities and the collection of reinsurance proceeds; and (3) the delays in payment of claims attendant to the liquidation process.
Of particular significance to this application is the Plan's definition of "Claims under Policies". The Plan defines this term as "claims under policies of insurance... for losses incurred, third party claims, claims for unearned premiums, and all claims of a security fund, guaranty association or the equivalent except claims arising under reinsurance contracts" (Plan 1.2 [c]). This definition was intended to exclude claims under surety bonds, fidelity bonds, contract bonds, performance bonds, indemnity bonds and similar instruments.  In addition to writing various lines of property and casualty insurance, Frontier had a significant book of surety business when it entered rehabilitation.
The Plan estimates Frontier's liabilities for "Claims under Policies" at $93.2 million as of September 30, 2011.  The Rehabilitator proposes to continue to pay these claims in full, but recognizes that "Frontier's $69.9 million in admitted assets and the earnings thereon, when matched with administrative expenses..., may not prove sufficient..." However, the Rehabilitator contends that it is premature at this time to reach a final conclusion as to whether all "Claims under Policies" can be paid in full.
The Plan further estimates Frontier's liabilities for surety claims at $24.5 million. This estimate, a substantial discount from a book value in excess of $100 million, reflects the Rehabilitator's belief that he can achieve highly discounted settlements of surety claims. This expectation, in turn, derives from the Rehabilitator's position that claims under surety contracts are entitled to lesser priority in liquidation than claims under Frontier's other insurance contracts. Accordingly, while the Rehabilitator proposes to attempt to negotiate the resolution of surety claims and other liabilities that are not "Claims under Policies", he does not intend to pay such claims without prior Court approval, and the Plan does not contemplate that these claims can be paid at their full book value.
In response to the Order to Show Cause, the Court received objections and/or comments from interested parties ("Interested Parties"). The issues raised by these submissions fall largely into five general groupings. First, several Interested Parties question whether a plan for the long-term run-off of Frontier's liabilities and marshaling of assets represents a "rehabilitation" of Frontier within the meaning of Article 74. Second, a number of Interested Parties assert that the Plan does not comply with Neblett v Carpenter (305 U.S. 297 ), which requires a plan of rehabilitation to provide claimants with no less favorable treatment than they would receive in liquidation. Third, the same objectors argue that the Plan's treatment of surety claims is inconsistent with Insurance Law § 7434 (a) (1), which establishes a hierarchy of priority classes, requires claimants within a particular class to be paid in full before claimants in a lower priority class receive anything, and prohibits the creation of sub-classes. Fourth, questions and concerns were raised regarding many of the factual premises and assumptions underlying the Plan and whether continued rehabilitation would actually benefit Frontier's claimants and other creditors. Finally, certain objectors maintain that access to additional information concerning Frontier and the rehabilitation is necessary in order to even evaluate the Plan.
The second and third categories of objection — whether the Plan's treatment of surety contracts complies with Carpenter and Insurance Law § 7434 (a) (1) — implicate a threshold legal question: whether surety claims are entitled to class two priority status under Insurance Law § 7434 (a) (1) (ii). If surety claims are entitled to class two status in liquidation, the Rehabilitator's exclusion of surety claims from the definition of "Claims under Policies" would result in surety claimants receiving less favorable treatment in rehabilitation than they would in liquidation, Such a conclusion would also mean that the Plan disadvantages the sub-class of class-two claimants who assert surety claims, thereby implicating Insurance Law § 7434 (a) (1).
A hearing on the Order to Show Cause was held on April 27, 2012. All in attendance agreed with the Court that an appropriate starting point for review of the Plan of Rehabilitation would be a ruling on the threshold question of whether surety claims are entitled to class two priority in liquidation pursuant to Insurance Law § 7434 (a) (1). This Decision & Order follows.