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In re Liquidation of Indemnity Insurance Corp., RRG

Court of Chancery of Delaware

May 15, 2019


          Date Submitted: February 25, 2019

          Christopher P. Simon and Kevin S. Mann, CROSS & SIMON, LLC, Wilmington, Delaware; James J. Black III, Jeffrey B. Miceli, Mark W. Drasnin, BLACK & GERNGROSS, P.C., Philadelphia, Pennsylvania; Attorneys for the Honorable Trinidad Navarro, Insurance Commissioner of the State of Delaware, as Receiver for Indemnity Insurance Company, RRG, in Liquidation

          David S. Eagle and Sally E. Veghte, KLEHR HARRISON HARVEY BRANZBURG LLP, Wilmington, Delaware; Francis M. Correll, KLEHR HARRISON HARVEY BRANZBURG LLP, Philadelphia, Pennsylvania; Attorneys for Intervening Third-Party Plaintiff Branch Banking & Trust Company



         Indemnity Insurance Corporation, RRG ("IIC") is undergoing delinquency proceedings after years of internal fraud. Delaware's Insurance Commissioner administers IIC's liquidation as its Receiver. Prior to these proceedings, IIC and its controller entered into a $5 million loan with a bank and then allegedly defaulted on their obligations. That bank's successor in interest, Branch Banking and Trust Company ("BB&T"), brought this third-party action seeking a declaratory judgment that it has a valid and enforceable security interest to the proceeds of that loan. The Receiver raised affirmative defenses asserting that BB&T's predecessor committed acts tantamount to fraud, and that BB&T's purported security interest is thus unenforceable as a matter of equity. The Receiver also asserts that IIC's guaranty of the loan and BB&T's security interest are void for failure to disclose those agreements to, and secure the approval of, the Commissioner.

         BB&T moved for summary judgment to exclude the Receiver's affirmative defenses.[1] I grant that motion in part. BB&T has brought a purely legal claim: a declaratory judgment as to rights under a series of contracts. The Receiver's equitable defenses are unavailable to bar that legal relief. In addition, I conclude that the Receiver's requested relief of declaring some of the relevant agreements void is a statutory remedy that the Commissioner must exercise in the first instance, not this Court. The Commissioner, here synonymous with the Receiver, has not requested appropriate relief under that statutory scheme, rendering the relevant agreements, at most, voidable by the Commissioner. Summary judgment is granted against any affirmative defenses that rely on the theories I reject in this opinion.

         I. BACKGROUND

         Delaware courts have already described the long and tumultuous history of these proceedings.[2] This opinion only addresses facts essential to the Motion, drawn from the record to date.

         BB&T brought its third-party complaint as successor to Susquehanna Bank.[3]Throughout 2012, Susquehanna entered into a series of transactions with IIC; its controller, Jeffrey Cohen; and other entities controlled by Cohen and related to IIC. One of those transactions was a $3 million revolving line of credit (the "LOC").[4]After the parties entered into the LOC, Cohen attempted to change its structure to place him as borrower and IIC as guarantor. In email correspondence with Susquehanna, Cohen acknowledged that the point of his ask was to "add capital without a corresponding liability" to help IIC capture a larger number of "very profitable accounts that we can write with increased rate levels."[5] A Susquehanna representative hesitated, remarking to Cohen that his plan "really comes across the wrong way in my opinion," and that Susquehanna's "preliminary thoughts are that we would prefer not to do this" without regulatory sign-off.[6] Susquehanna held fast on its position when Cohen suggested the idea a second time in September 2012.[7]

         By October 2012, Cohen and Susquehanna were discussing a $5 million term loan (the "Loan") to either Cohen or RBE Entertainment ("RBE"), an entity that controlled IIC and was, in turn, controlled by Cohen. The Loan's purpose, at least as framed by Cohen and according to BB&T, was to help IIC prepare for an initial public offering by increasing its ability to write premiums.[8] Cohen's pitch was that the Loan, payable on demand, would be made to RBE to provide a capital injection to IIC. IIC would guarantee the Loan. But Susquehanna would hold the cash in a restricted account in IIC's name.

         To support the Loan, Cohen and IIC gave Susquehanna a series of audited financial statements, but Susquehanna also requested an opinion letter from counsel to Cohen, RBE, and IIC, addressing the Loan's propriety. The borrowing parties agreed and furnished an opinion letter stating, among other things:

[N]o consent, approval, authorization, or other action by, or filing with, any governmental authority is required for the execution and delivery by the Company of the [Loan] Documents or, if required, the requisite consent, approval, or authorization has been obtained, the requisite filing has been accomplished, or the requisite action has been taken.[9]

         On December 12, 2012, Susquehanna, RBE, Cohen, IIC, and another Cohen entity closed on the Loan transaction.[10] The Loan was payable on demand, and guaranteed by IIC as well as by Cohen and one of his entities.[11] Although RBE was technically the borrower, the funds were for IIC's benefit. Susquehanna held the proceeds in a collateral account in IIC's name, and IIC granted Susquehanna a security interest in those proceeds.[12] The agreement establishing that security interest between Susquehanna and IIC agreed that all funds held in the Loan collateral account "shall be under the sole dominion and control of" Susquehanna.[13]In short, the funds were not available to IIC to fulfill policyholders' claims.

         In May 2013, the Commissioner initiated this action by petitioning for a seizure order under the Delaware Uniform Insurance Liquidation Act ("DUILA").[14]Those proceedings progressed to a petition for the entry of a liquidation order in July 2013, followed by a failed attempt at rehabilitating IIC in November 2013.[15]Ultimately, in April 2014, the Court entered a Liquidation and Injunction Order with Bar Date (the "Liquidation Order"), placing IIC into liquidation.[16]

         Under the Liquidation Order, the Commissioner, as Receiver, is tasked with overseeing the administration of claims by IIC's creditors and policyholders. "The object to be attained by the liquidation of an insolvent insurance company is the orderly and equitable apportionment among creditors of losses that may result and to ensure the equitable distribution of an insolvent debtor's property or assets among creditors."[17] The Liquidation Order permits the Receiver to "take and continue exclusive possession of the property of [IIC], "[18] and also provides that:

All persons or entities . . . that have in their possession Assets or possible Assets and/or have notice of these proceedings or of this Order are hereby enjoined, restrained and prohibited from . . . transferring, destroying, wasting, encumbering or disposing of any property, assets, books or records of [IIC] whether such assets, property, books or records are or may be the property of [IIC], without the prior written permission of the Receiver or until further Order of this Court.[19]

         On May 27, 2016, Susquehanna's successor BB&T filed its third-party complaint ("the Complaint") to prevent the Loan funds from being marshalled into IIC's Assets under the Liquidation Order.[20] BB&T purports that the Loans are in default due to "nonpayment by RBE of principal and interest due, and the commencement of delinquency proceedings against" IIC.[21] Additionally, as of the Complaint's date, the amount due under the Loan was $5, 314, 538.24, against a balance in the Loan's collateral account of only $5, 060, 601.09.[22] That gap has, presumably, widened since then.

         BB&T seeks a declaratory judgment that the Loan funds are not an Asset or possible Asset of IIC under the Liquidation Order, that BB&T has a first priority lien against and security interest in those funds, that it can set-off amounts due under the Loan against funds held in the Loan's collateral account, and that any deficiency after that set-off will be an unsecured claim against IIC's general assets.[23] BB&T also seeks relief from the Liquidation Order in these proceedings, or, alternatively, a decree that the Liquidation Order is unconstitutionally vague.[24] The Receiver answered BB&T's pleadings with narrative denials and several affirmative defenses, many of which assert that the Loan and its corollary agreements are invalid and unenforceable due to, essentially, fraud by Susquehanna.[25]

         On November 21, 2018, BB&T filed the Motion. On November 26, it amended the Motion, but kept the same opening brief.[26] The parties completed briefing, and on February 25, 2019, I heard argument at the Hearing.

         II. ANALYSIS

         "The function of summary judgment is the avoidance of a useless trial where there is no genuine issue as to any material fact."[27] Summary judgment is appropriate where the "pleadings, depositions, answers to interrogatories and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and the moving party is entitled to judgment as a matter of law."[28] "A fact is material if it 'might affect the outcome of the suit under the governing law.'"[29] A material issue of fact exists if "a rational trier of fact could find any material fact that would favor the non-moving party in a determinative way, drawing all inferences in favor of the nonmoving party."[30]

         The parties' dispute essentially boils down to whether BB&T can enforce its first priority lien in this action, which reduces further to whether the Loan funds are IIC's Assets or possible Assets that must be turned over to the Receiver as part of the claims administration process under the Liquidation Order and DUILA. Answering this question begins with Delaware's claims administration structure for a liquidation. That structure gives secured creditors the ability to remove their claim from the general pool of assets under the Receiver's control for purposes of liquidation. DUILA Section 5918 sets out the priority of claims for delinquency proceedings. Section 5918(e) describes the waterfall for all payments "from the insurer's general assets" under the Receiver's control per the Liquidation Order. Policyholders, beneficiaries, and insureds are paid in Class III, while general creditors are not paid until Class VI. "Under this priority scheme, general creditors are unlikely to recover from an insolvent insurer."[31] Section 5918(d), however, provides that "[t]he owner of a secured claim . . . may surrender his or her security and file a claim as a general creditor, or the claim may be discharged by resort to the security, in which case the deficiency, if any, shall be treated as a claim against the general assets of the insurer on the same basis as claims of unsecured creditors." In other words, Section 5918 permits security holders either to execute on their security and channel that portion away from the waterfall process, or to pursue the entire interest as a general creditor claim from the insurer's general assets.[32]

         "Although the Rehabilitation Order and the Liquidation Order vested title to [IIC's] property in the Commissioner, those orders only gave the Commissioner the same rights that [IIC] possessed."[33] The Receiver stepped into IIC's shoes for purposes of determining who has claim over the Loan funds, and thus "did not gain greater rights than [IIC] had."[34] If BB&T is correct that it holds a secured claim against the defaulted Loan funds, then the Receiver does not have any greater claim to those funds than IIC would have had. Thus, in order to determine whether the Loan funds are Assets or possible Assets of IIC's estate, such that they must be turned over through the Liquidation Order and added to IIC's general assets under Section 5918, the Court must first determine whether BB&T holds a valid and enforceable security interest. If it does, BB&T can execute on that security interest to recover the secured amount from the Loan collateral account, and then submit any deficiency claim for additional amounts owed as a general creditor.[35]

         The Receiver does not dispute at this time that the Loan Agreement and its corollary materials create an enforceable security interest in the Loan funds.[36]Instead, the Receiver asserts a series of equitable affirmative defenses to preclude the validity or enforceability of BB&T's security interest. As developed in briefing, those theories largely fall into three doctrines: unclean hands, [37] quasi-estoppel, [38] and equitable subordination.[39] The Receiver also argues that the Loan and BB&T's security interest are generally unenforceable because the Commissioner did not approve their terms under the applicable regulatory provisions.[40]

         One of the Receiver's defenses fails on procedural grounds. The Receiver never pled equitable subordination as an affirmative defense or counterclaim. Nor did the Receiver raise the argument, even informally, prior to the Answering Brief. Although the parties dispute whether equitable subordination is a defense or a remedy, I need not reach that question where, as here, the Receiver failed to plead it as either. I GRANT summary judgment against the Receiver's equitable subordination claim.

         A. The Receiver Cannot Assert Its Equitable Defenses Against BB&T's Declaratory Judgment Seeking Legal Relief.

         Unclean hands and quasi-estoppel are equitable defenses. "The doctrine of unclean hands provides that he who comes into equity must come with clean hands; in other words, equitable relief will be denied to a party who has engaged in inequitable conduct related to the matter in which he is seeking such relief."[41]"Under Delaware law, the doctrine of quasi-estoppel applies 'when it would be unconscionable to allow a person to maintain a position inconsistent with one to which he acquiesced, or from which he accepted a benefit.'"[42]

         "'The Court of Chancery jealously guards its domain as a court of equity,' and accordingly, 'the Court will refuse equitable relief in circumstances where the litigant's own acts offend the very sense of equity to which he appeals.'"[43]"Typically, a party may not assert an equitable defense against a purely legal claim, even when the legal claim is pending in a court of equity."[44] Similarly, "the vindication of purely statutory rights represents an exercise of the prerogative of the legislature, and not this equity Court," and "a purely statutory right, therefore, will be enforced by this Court not as a matter of equity, but of law, even where . . . the claimant has acted inequitably in a collateral matter."[45]

         Here, BB&T is asserting a purely legal claim: declaratory judgment as to its rights under the Loan documents, in the context of IIC's statutory liquidation. BB&T asks this Court to examine the Loan documents and conclude that "[t]he Collateral Account has been pledged and deposited for the exclusive benefit of [BB&T] and, therefore, does not constitute a general asset of [IIC]."[46] I find that the Receiver's unclean hands and quasi-estoppel theories are "unavailable because [BB&T's] claims do not invoke equity and are not, therefore, subject to equitable defenses."[47] Accordingly, I GRANT summary judgment against the affirmative defenses relying on unclean hands and quasi-estoppel.[48]

         B. The Commissioner Has Not Properly Voided The Loan Guarantees And Security Interest For Failure To Disclose To The Commissioner.

         BB&T also moved for summary judgment on the Receiver's sixth and seventh affirmative defenses, which claim that the guaranty agreement, and BB&T's security interest provided therein, are invalid and unenforceable because the guaranty was made without the Commissioner's approval.

         At the time of the Loan transaction in 2012, 18 Del. C. § 5005(a)(2)(a), in the Insurance Holding Company System Registration Act ("the Registration Act"), provided in relevant part:

The following transactions involving a domestic insurer and any person in its holding company system may not be entered into unless the insurer has notified the Commissioner in writing of its intention to enter into such transaction at least thirty days prior thereto . . . and the Commissioner has not disapproved it within such period: (a) Sales, purchases, exchanges, loans or extensions of credit, guarantees, or investments, provided such transactions are equal to or exceed . . . the lesser of three percent of the insurer's admitted assets or twenty-five percent of surplus as regards policyholders.[49]

         BB&T claims Section 5010(c) of the Registration Act provides that the exclusive remedy for noncompliance with Section 5005, a sort of statutory rescission, and vests that remedy in the Commissioner. Section 5010(c) reads:

Whenever it appears to the Commissioner that any insurer subject to this chapter or any director, officer, employee or agent thereof has engaged in any transaction or entered into a contract which is subject to ยง 5005 of this title and which would not have been approved had such approval been requested, the Commissioner may order the insurer to cease and desist immediately any further activity under that transaction or contract. After notice and hearing, the Commissioner may also order the insurer to void any ...

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