IN THE MATTER OF THE LIQUIDATION OF FREESTONE INSURANCE COMPANY
Date Submitted: October 30, 2014
Eric Lopez Schnabel, Robert W. Mallard, Alessandra Glorioso, DORSEY & WHITNEY LLP, Wilmington, Delaware; Michael R. Stewart, Michael B. Fisco, FAEGRE BAKER DANIELS LLP, Minneapolis, Minnesota; Attorneys for U.S. Bank National Association.
Christopher P. Simon, Joseph Grey, CROSS AND SIMON, LLC, Wilmington, Delaware; James J. Black, III, Jeffrey B. Miceli, Mark Drasnin, BLACK & GERNGROSS, P.C., Philadelphia, Pennsylvania; Attorneys for the Insurance Commissioner of the State of Delaware as Receiver for Freestone Insurance Company.
LASTER, VICE CHANCELLOR.
Freestone Insurance Company ("Freestone"), a Delaware-domiciled insurer, is currently in receivership under the administration of the Insurance Commissioner of the State of Delaware (the "Commissioner"). When delinquency proceedings began, Freestone maintained cash and securities valued at approximately $175 million (the "Assets") in a custodial account at U.S. Bank, N.A. As part of the delinquency proceedings, the court entered an order directing that Freestone be rehabilitated, causing title to Freestone's property to vest in the Commissioner as receiver. The court's rehabilitation order directed the Commissioner to marshal Freestone's assets and called upon third parties to turn over property belonging to Freestone to the Commissioner.
Relying on the rehabilitation order and the authority conferred by the Delaware Uniform Insurance Liquidation Act ("DUILA"), the Commissioner terminated the custodial relationship and instructed U.S. Bank to return the Assets. U.S. Bank turned over approximately $19 million but kept the rest, contending it was security for potential indemnification claims and present and future expenses. The Commissioner disputed U.S. Bank's position and threatened to seek to hold U.S. Bank in contempt of the rehabilitation order. U.S. Bank then filed the current motion, which seeks an order establishing its right to retain the Assets or, alternatively, declaring that any amounts turned over to the Commissioner will be subject to a security interest.
U.S. Bank's request for an order establishing its right to retain the Assets is denied. U.S. Bank shall turn over the Assets to the Commissioner. Before doing so, U.S. Bank may deduct from the Assets the fees and expenses it has incurred for administering the account. U.S. Bank may not deduct legal expenses. If U.S. Bank chooses not to make a deduction, it shall have a security interest in the Assets equal to the amount of fees and expenses incurred for administering the account. U.S. Bank is not entitled to retain the Assets or to have a security interest in the Assets for indemnification claims or future expenses.
I. FACTUAL BACKGROUND
The factual background is drawn from the submissions made by the parties in connection with U.S. Bank's motion. The relevant facts consist of a series of undisputed events and the details of certain agreements.
A. The Custody Agreement
U.S. Bank held the Assets for Freestone pursuant to an Insurance Custody Agreement dated July 25, 2013 (the "Custody Agreement" or "CA"). Under the Custody Agreement, U.S. Bank's duties were ministerial in nature, see id. § 9, and U.S. Bank had "no duties or responsibilities except those specifically set forth" in the Custody Agreement, id. § 1(e). U.S. Bank held the Assets "subject to the instructions of [Freestone], " and the Assets could be withdrawn "upon the demand of [Freestone]." Id. § 2(b).
In Section 12 of the Custody Agreement, Freestone agreed to "(i) reimburse [U.S. Bank] for costs incurred by it hereunder, and (ii) pay to [U.S. Bank] fees for its services under this Agreement . . . ." Id. § 12(a). Under Section 14 of the Custody Agreement, Freestone agreed to indemnify U.S. Bank and its agents for any "Claim, " defined broadly to include any cost, loss, claim, liability, or fee arising out of the agreement. Id. § 14(a). Under Section 17 of the Custody Agreement, "[a]ny fees or expenses [U.S. Bank] incurs in responding to any Legal Action (including, without limitation, attorneys' and other professionals' fees) [could] be charged against the Account." Id. § 17(l). The term "Legal Action" was defined to include any "subpoena, restraining order, writ of attachment or execution, levy, garnishment, search warrant or similar order relating to the Account." Id.
Under Section 15(a) of the Custody Agreement, either party could terminate the relationship upon 30 days written notice. Id. § 15(a). At that point, U.S. Bank was obligated to
follow reasonable [Freestone] instructions concerning the transfer of the Assets; provided that:
. . . .
(ii) Unless required by proper regulatory agency, [U.S. Bank] shall not be required to make any delivery or payment until full payment shall have been made by [Freestone] of all liabilities constituting a charge on or against [U.S. Bank] and until full payment shall have been made to [U.S. Bank] of all its compensation, costs and expenses hereunder; and
(iii) [U.S. Bank] shall have been reimbursed for any advances of monies or securities made hereunder to [Freestone] . . . .
Id. § 15(b).
B. The Commissioner Demands The Return Of The Assets
On April 24, 2014, the Commissioner filed delinquency proceedings against Freestone. By order dated April 28, 2014, the court placed Freestone into rehabilitation. Dkt. 4 (the "Rehabilitation Order"). The Rehabilitation Order instructed the Commissioner to take "exclusive possession and control of" Freestone's property. Id. ¶ 6. To facilitate the Commissioner's efforts, the Rehabilitation Order instructed parties holding Freestone's property to turn it over to the Commissioner. Id. ¶ 13.
In May 2014, the Commissioner demanded the return of the Assets. U.S. Bank turned over cash and securities worth approximately $19 million, but kept the remaining $156 million. U.S. Bank justified its refusal on the theory that it may face potential claims arising out of its services to Freestone or otherwise be drawn into litigation involving Freestone. If that happens, then U.S. Bank anticipates making a claim for indemnification against Freestone under the Custody Agreement. U.S. Bank also anticipates incurring expenses as it continues to maintain the account.
In addition to its right to indemnification under the Custody Agreement, U.S. Bank cited trust agreements pursuant to which U.S. Bank held assets to secure obligations between Freestone and other insurance companies (the "Trust Agreements"). In each case, either Freestone or another insurance company acted as a reinsurer, and U.S. Bank held the assets in trust to secure the insurer's right to payment from the reinsurer. U.S. Bank provided examples of three Trust Agreements:
• The White Rock Trust Agreement. Pursuant to a trust agreement dated January 1, 2012, White Rock Insurance (SAC) Ltd ("White Rock") deposited cash and securities with U.S. Bank for the benefit of Freestone. U.S. Bank's duties and responsibilities under the agreement were "entirely administrative and not discretionary and determined only with reference to this Agreement and Applicable Insurance Law." Id. § 8(n). White Rock was obligated to reimburse U.S. Bank for its fees and costs. If White Rock failed to pay, then U.S. Bank could recover its fees and costs out of trust income. Id. § 9. The White Rock Trust Agreement was governed by New York law. Id. § 13.
• The Companion Trust Agreement. Pursuant to a trust agreement dated December 28, 2012, Freestone deposited cash and securities with U.S. Bank for the benefit of Companion Property and Casualty Insurance Company. U.S. Bank's duties and obligations were "only . . . such as are specifically set forth in [the] Agreement, as it may from time to time be amended, and no implied duties or obligations shall be read into this Agreement against the Trustee." Id. § 7(i). Freestone was obligated to reimburse U.S. Bank for its fees and costs. Id. § 8(a). If Freestone failed to pay, then U.S. Bank could recover its fees and costs out of trust assets. Id. The Companion Trust Agreement was governed by South Carolina law. Id. § 12.
• The Accident Trust Agreement. Pursuant to a trust agreement dated September 25, 2013, Freestone deposited cash and securities with U.S. Bank for the benefit of Accident Insurance Company. U.S. Bank's duties were "entirely administrative and not discretionary and determined only with reference to this Agreement and Applicable Insurance Law. Id. § 8(n). Freestone was obligated to reimburse U.S. Bank for its fees and costs. Id. § 9(a). If Freestone failed to pay, then U.S. Bank could recover its fees and costs out of the trust income. Id. § 9(b). The Accident Trust Agreement was governed by Delaware law. Id. § 13.
U.S. Bank believes that its security interest extends not only to claims under the Custody Agreement, but also to claims under the Trust Agreements.
U.S. Bank does not believe it has done anything that would warrant a lawsuit, much less result in liability, and U.S. Bank has not attempted to quantify its exposure to any claims. Given that each agreement defined U.S. Bank's duties as exclusively ministerial and limited to the contractual obligations set forth in the agreement, U.S. Bank would not seem to be at great risk. Nevertheless, U.S. Bank believes it is entitled to hold almost 90% of the Assets, worth approximately $156 million, because it is possible that a claim might be made. As a practical matter, that means U.S. Bank will hold the Assets for what might be years, until U.S. Bank feels confident that the relevant statutes of limitations have run or U.S. Bank receives releases in the interim from the parties who might assert claims.
C. The Current Motion
U.S. Bank and the Commissioner attempted without success to work out their differences. After the Commissioner took the position that U.S. Bank would be in contempt of the Rehabilitation Order if it did not ...