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Does Rhode Island Hold the Key to the Future of Schemes of Arrangement?

by ~ Michael F. Aylward (Email) (Web Site)

A scheme of arrangement is a mechanism by which an insurer or reinsurer in run off can go to court to commute its liabilities with the approval of a statutory majority of its insureds or other creditors. Whereas such schemes were originally used primarily for insolvent companies, they are now principally used by solvent insurers and reinsurers to dramatically shorten the amount of time for a company to complete the run off process.

Despite their ubiquity in the UK and certain former Commonwealth countries, schemes of arrangement have never been permitted in the United States. Rather, U.S. companies are typically wound down or liquidated pursuant to receivership and liquidation procedures approved by state insurance departments and local legislatures.

As various states look for ways to attract insurers to their borders, however, attitudes to schemes of arrangement may be changing. Whether other states follow may depend on an appeal now pending in the Rhode Island Supreme Court.

In 2002, the Rhode Island legislature enacted the Voluntary Restructuring of Solvent Insurers Act, R.I. Gen. Laws 5-1, et seq. which, as amended in 2007, created a scheme by which a solvent insurance or reinsurance company in runoff may propose a commutation plan extinguishing its liabilities for past and future claims of its creditors and then terminate its business. Such insurers must be domiciled in Rhode Island, have liabilities under policies for property and casualty lines of business, have ceased underwriting new business and only be renewing ongoing business to the extent required by law or by contract.

An insurer seeking commutation under the Act must first submit a detailed plan to state insurance regulators for review. Only after an applicant has addressed the comments of regulators or the 60-day period for review has expired may the insurer seek court approval and implementation of its proposed commutation plan. Within 90 days of the submission of a commutation plan for court approval, a meeting of creditors shall be held to consider the proposed commutation plan.

To obtain approval of the proposed commutation plan, the runoff insurer must obtain the consent of 50% of each class of creditors and 75% in value of the liabilities owed to each class of creditors. Upon approval by the creditors, the runoff insurer must petition the court to enter an order confirming the approval, which may only be granted by the court if it determines that the implementation of the commutation plan will not materially adversely affect either the interests of the objecting creditors or the interests of assumption policyholders.

The constitutionality of the Restructuring Act is now being tested in a case that has recently been accepted for review by the Rhode Island Supreme Court. At issue in In Re GTE Reinsurance, Case No. 11-197-A, are the claims of several cedents of GTE Re—Hudson Insurance, Odyssey Re and Skandia-American (collectively “the Odyssey Insureds)—that the plan proposed by GTE Re unconstitutionally impaired their contractual rights by proposing to pay them a sum certain based on actuarial estimates as a substitute for the open-ended indemnity obligations called for by the insurance contracts.

Throughout most of its history, GTE Re was domiciled in Bermuda as the captive insurer and reinsurer of GTE Corporation. During this period, however, GTE Re also reinsured certain third-party property and casualty risks of U.S. companies. Included among these reinsurance contracts were certain quota share treaties entered into between GTE Re and Hudson from 1980 to 1985 and with Clearwater from 1984 to 1987.

In 1994, GTE Re moved its domicile to Vermont and in June 2010 re-domiciled in Rhode Island for the apparent purpose of seeking runoff commutation pursuant to the Restructuring Act. Shortly after moving to Rhode Island, GTE Re submitted a plan for commutation to the Department of Business Regulation (DBR). DBR undertook an extensive actuarial analysis of the commutation proposal and concluded that the estimated reserves and exposures set forth in the plan were reasonable and conservative and that the plan otherwise fairly treated parties entitled to seek recovery from GTE Re.

Having received the opinion of DBR that its commutation plan was fair and did not materially adversely affect any creditor, GTE Re petitioned the Superior Court in June 2010 to implement it. The Court granted GTE Re’s motion to convene a meeting of a single class of creditors to consider the proposal. Such a meeting was duly held in November 2010 and resulted in a majority vote in which 34 of 39 cedents representing 87.2% of the creditors and 97.4% of the total liabilities voted to approve the plan. Five cedents, including Hudson and Clearwater, voted against it. These entities (the Odyssey Insureds) objected to the valuation ascribed to their claims which they claimed were worth $300,000 more than the plan provided for. Further, the Odyssey Insureds objected to the extinction of their contractual rights based on an actuarial estimate of what their long-term obligations might ultimately prove to be. They argued that there is a fundamental difference between an ongoing, open-ended indemnity obligation and any sum certain based upon an actuarial estimate (especially in a context as uncertain as environmental and products claims), as the essence of an insurance contract is not the measurement of the risk, but the shifting of the risk (and the risk that the estimates are wrong) from one party to another.

These objections were overruled by a Rhode Island judge earlier this year. In In re: GTE Reinsurance Co., No. PB 10-3777 (R.I. Super. April 25, 2011), Judge Silverstein declared that the Restructuring Act was constitutional and that GTE Re’s proposed commutation plan had not unreasonably impaired the Odyssey Insureds contractual rights.

The Odyssey Insureds had argued that their rights were significantly impaired by reason of the negation of GTE Re’s future indemnification obligations and the risk that an up-front payout, based on an actuarial estimate of present and future claims, would be less than if GTE Re had remained in runoff. Judge Silverstein disagreed. He found that the transfer of risk in the context of reinsurance was “essentially about the right to receive, and the obligation to make, a monetary payment when a claim arises. He found, therefore, that “put simply, the Odyssey Insureds contracted for the payment of money and, under the commutation plan, that is exactly the benefit they will receive. While agreeing that the plan would alter the rights of cedents pursuant to these reinsurance treaties, the Court declined to find that impairment alone was sufficient to constitute a violation of the contract clause to the U.S. or State Constitutions.

The fact that the payment would reflect certain actuarial estimates rather than the actual amounts owed pursuant to underlying liabilities did not, in the Court’s view, constitute a substantial impairment of these contractual rights or the parties reasonable contractual expectations. The Superior Court was particularly influenced by the fact that the Odyssey Insureds had failed to establish beyond a reasonable doubt that the actuarial-based payout will, as a matter of fact, be less than their recovery if GTE Re had remained in runoff. He noted, in fact, that it was possible that the Odyssey Insureds might receive more under the commutation plan than they would have otherwise. In the absence of evidence of definite or actual impairment, the Court declined to accept the Odyssey Insureds constitutional arguments.

The Odyssey Insureds had also argued that the Restructuring Act and commutation plan impaired other contractual rights, notably their rights to arbitration and certain choice of law provisions contained in their treaties. Judge Silverstein declined to find that these terms were material or reflected the “central undertaking of the contracts or that the Odyssey Insureds were substantially induced to enter into these contracts on the basis of these terms. In any event, the Court remained unconvinced that any impairment resulting from their alteration would be substantial.

Judge Silverstein further found that it was within the contemplation of the parties that their rights might be altered pursuant to the similar schemes of regulation. In particular, the Court noted that at the time these treaties were entered into, GTE Re was domiciled in Bermuda, which has an Arrangements and Reconstructions Act (the 1975 Act) that similarly permits schemes of arrangement between local companies and their creditors. Even though the first solvent scheme of arrangement in Bermuda did not occur until the 1990s, the Court noted that relevant portions of Bermuda’s companies act are drawn from and identical to prior English law that had been applied to solvent companies since at least 1917. The Superior Court found, therefore, that:

In light of Bermuda’s legal and legislative framework . . . the actions taken by the State under the Restructuring Act were reasonably foreseeable. Moreover, given the highly regulated nature of the commercial insurance industry . . . the contractual alterations and modifications authorized by the Restructuring Act and commutation plan should have been within the reasonable expectations of the parties.

Judge Silverstein declared that “the Restructuring Act is a legitimate legislative enactment which addresses the State’s economic concerns and protects commercial insurance creditors against the harms of run-off. The court also observed that “the Restructuring Act protects several of GTE RE’s current creditors, domiciled in Rhode Island, from the risks and harmful effects of run-off. The court also noted that the Restructuring Act “promotes the ‘[a]ccelerated release of capital to shareholders . . . allowing for more efficient deployment of capital to non-run-off operations and ‘attract[s] capital to the industry . . . creat[ing] an active market for investment in run-off companies’” and thus “is a means to address economic issues endemic to the insurance industry.
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Apart from finding that the Restructuring Act and commutation plan did not substantially impair the Odyssey Insureds contractual rights, Judge Silverstein held that any such impairment was justified by the significant public purpose underlying the Restructuring Act of attracting segments of the insurance industry to Rhode Island. The Court ruled, therefore, that “the Restructuring Act was a reasonable and necessary means by which to address a legitimate public purpose.

Finally, Judge Silverstein rejected the Odyssey Insureds due process arguments, wherein they claimed that the Act amounted to an unconstitutional retroactive legislation for which there was no rational basis or legitimate government purpose. In this case, the Court ruled that, even if the Restructuring Act had a retroactive application, it had already passed constitutional muster under the contract clause and would unquestionably survive a due process challenge. Further, the Court found that the Act itself presented procedures for adequate notice and fair mechanisms for addressing and commuting the claims of a solvent insurance company’s creditors.

The Odyssey Insureds have appealed Judge Silverstein’s ruling to the Rhode Island Supreme Court. Briefing has not yet gone forward and the case is unlikely to be argued before early 2012. Meanwhile, the Rhode Island statute and Judge Silverstein’s ruling may well spur interest by other state regulators in similar regulatory mechanisms for schemes of arrangement.

The Rhode Island Department of Business Regulation is represented by Gary Lee, Deanne Maynard and Seth Galanter of Morrison & Foerster LLP. GTE Re is represented by attorneys from Kirkland & Ellis LLP and Roberts, Carroll, Feldstein & Peirce Inc. The Odyssey Insureds are represented on appeal by Jeffrey Lamken of Molo Lamken and Thomas Bender of Hanson Currran.Choose right burberry uk sale, replica patek philippe watches,replica breitling watches and breitling watches for sale also can make you shiny.

Michael F. Aylward may be reached at
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