Debtors considering filing bankruptcy may want to consider a recent decision of the Bankruptcy Court for the Middle District of Florida. In the case of In re James B. Simmons and Cynthia C. Simmons, the court held that an alleged “bad faith” claim against an insurance carrier accrued prior to the bankruptcy filing and therefore it was property of the bankruptcy estate. As a result, the proceeds from the settlement of the claim did not go to the debtors, but instead went to the estate and creditors. This is also an important decision for creditors because it prevents debtors from attempting to unfairly game the system by delaying the accrual of a bad faith claim.

The alleged “bad faith” claim arose from sinkhole damage to the debtors’ homestead property. Before the bankruptcy was filed, numerous actions were taken to administer the claim, including an initial and supplemental payment by the insurance carrier. However, before the final element necessary to bring a bad faith claim occurred, the debtors filed a Chapter 13 bankruptcy.

The debtors did not disclose the “bad faith” claim on their Chapter 13 bankruptcy schedules. A year after filing their Chapter 13 case, the debtors amended their schedules to include the alleged bad faith claim as an asset, but did not claim it as exempt. Ultimately, the Chapter 13 case was converted to Chapter 7 case and a Chapter 7 Trustee was appointed.

Post-conversion, the Chapter 7 Trustee and the insurance carrier reached a settlement with regard to the alleged “bad faith” claim and sought court approval of the settlement. No creditors objected, but the debtors filed objections claiming that the settlement was unreasonable and was not property of the bankruptcy estate because it was exempt under Florida’s homestead exemption.

In reviewing motion to approve the settlement and the debtors’ objections, the bankruptcy court preliminarily concluded that the Chapter 7 Trustee lacked authority to settle the bad faith claim because the claim accrued post-petition under Florida law and therefore was not an asset of the estate. If the court’s preliminary conclusion stood, the proceeds of the settlement could have potentially gone into the debtors’ pockets leaving creditors empty handed. However, the court invited additional briefing on the issue.

The insurance carrier and the Chapter 7 Trustee argued that the court’s preliminary conclusion based on the narrow “accrual test” should not be a bright line test, especially in alleged “bad faith” cases. The “accrual test” focuses on when a cause of action accrues under state law to determine if a claim is an asset of the bankruptcy estate. There was no dispute that the debtors’ “bad faith” cause of action accrued, if at all, post-petition, but the insurance carrier and the Chapter 7 Trustee argued that accrual of the cause of action is not the end of the analysis. Instead, they argued the broader test which considers whether the events giving rise to a claim are sufficiently rooted in the pre-bankruptcy past so that the cause of action becomes a part of the bankruptcy estate should apply.

The court agreed for two reasons. First, the court held that the insurance carrier’s alleged “bad faith” conduct “if it indeed existed, must have occurred pre-petition…” Second, the court held that the accrual of the last element – determination of liability – was distinguishable from the 11th Circuit case of In re Witko which involved a legal malpractice claim which accrued post-petition. Chief Judge Jennemann wrote “Several factors distinguish Witko from the present case, most importantly the type of claim. The court in Witko emphasized that ‘[t]he machinations of legal malpractice, especially the element requiring the conclusion of judicial proceedings, distinguish legal malpractice actions from virtually all other tort claims.’ Because the court specifically identified the cause of action’s uniqueness, the Court declines to apply Witko’s holding as a bright-line rule. The mere fact that an element accrued post-petition is not dispositive of whether a claim is property of the estate; the significance of the element in relation to all other facts and circumstances should be considered.”

The court held that the claim was an asset of the estate and properly administered by the Chapter 7 Trustee because it was sufficiently rooted in the pre-bankruptcy past.

The full opinion can be viewed here.