Conseco, Inc. v. Schwartz (In Re Conseco, Inc.)Conseco, Inc. v. Schwartz (In Re Conseco, Inc.)
MEMORANDUM OPINION
This matter is before the court on New Conseco’s motion to enforce the discharge injunction and a related injunction contained in Old Conseco’s (the debtor) confirmed Plan of Reorganization and the confirmation order (“Plan Injunction”). The Plan Injunction enjoins all actions against Old Conseco’s reorganized successor (“New Conseco”) based on any act occurring before confirmation. The defendants in this adversary proceeding are plaintiffs in a class action filed in Pennsylvania state court against New Conseco and various insurance entities that were fourth and fifth tier subsidiaries of Old Conseco and are now fourth and fifth tier subsidiaries of New Conseco. The Schwartz class action claims are based primarily on changes made under certain variable life insurance contracts that took effect after confirmation of Old Conseco’s plan.
The parties have briefed both the question of whether this court has jurisdiction over this adversary proceeding and the substantive question of whether the discharge injunction or the Plan Injunction bars the Schwartz plaintiffs’ suit. The court concludes that it has jurisdiction but that neither the discharge injunction nor the Plan Injunction bars the Schwartz plaintiffs from pursuing their claims against New Conseco.
I. Issues
This case presents two jurisdictional issues and one substantive issue. First, the court must decide whether a case or controversy exists, even though at the eleventh hour the Schwartz Plaintiffs filed an
II. Background
The facts are not disputed. On December 17, 2002, Conseco, Inc. and various related entities (collectively “Old Conse-co”) filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. The court confirmed a plan of reorganization on September 9, 2003 (“Plan”). Article X.F. of the Plan precludes all persons from “asserting against the Reorganizing or Reorganized Debtors, their successors or their assets or properties any other or further Claims or Equity Interests based upon any act or omission, transaction or other activity of any kind or nature that occurred on or prior to the Confirmation Date.” Plan, Art. X.F. Paragraph 45 of the Confirmation Order enjoins the same actions.
Pursuant to the Plan, a new corporate entity was created, also called Conseco, Inc. (“New Conseco”). The plan transferred all of Old Conseco’s assets to New Conseco free and clear of all claims, liens, or other encumbrances, and the creditors of Old Conseco became the shareholders of New Conseco. The Plan was substantially consummated on September 10, 2003. Old Conseco was dissolved in November 2003.
Through a series of holding companies, Old Conseco owned a number of insurance companies, none of which was in bankruptcy. Two weeks before confirmation, one of those insurance companies, Conseco Life Insurance Co., sent notices to policyholders of a change in the formula for calculating amounts due under certain variable life policies. The changes took effect after confirmation in October 2003. In March 2004, Conseco Life sent similar notices concerning changes to other variable life policies that took effect in May 2004.
On February 11, 2005, William Schwartz filed a class action complaint in the Court of Common Pleas of Allegheny County, Pennsylvania, asserting causes of action arising from the increase in insurance premiums. The complaint alleges that New Conseco is liable as the alter ego of the insurance defendants based on a course of conduct that stretches many years before Old Conseco’s discharge.
New Conseco then filed its Complaint for Injunctive and Dеclaratory Relief seeking an injunction prohibiting the Schwartz plaintiffs from proceeding against New Conseco to the extent that their claims are based on events occurring before confirmation of Old Conseco’s Plan. The complaint also seeks a declaration that any of the Schwartz plaintiffs’ claims based on pre-discharge acts of Old Conseco are discharged. Conseco also filed a motion to enforce the discharge injunction and an emergency motion to temporarily stay the Schwartz action against New Conseco. The parties then agreed to an order staying the state court litigation as to New Conseco, and the parties briefed the jurisdictional and substantive issues before the сourt.
After an initial review of the pleadings and briefs, the court asked the parties to address whether the fact that New Conse-co is not the debtor but the reorganized successor to the debtor affects the court’s jurisdiction over this adversary proceeding. The Schwartz and the MDL plaintiffs then raised other jurisdictional arguments, which are addressed below.
III. Jurisdiction
The Schwartz and MDL plaintiffs argue that the court does not have jurisdiction over this adversary for three reasons. First, they assert that there is no case or controversy because the Schwartz plaintiffs dropped New Conseco as a defendant from the state court suit. Second, they contend that the court lacks jurisdiction under the well-pleaded complaint rule because New Conseco’s complaint simply raises an affirmative defense to the state court action. Third, they argue that the court lacks jurisdiction because New Con-seco is not the debtor, but instead is only a successor to the debtor that is too remote from the bankruptcy estate for the court to have jurisdiction. None of these arguments has merit.
A. Case or Controversy
First, the Sсhwartz and MDL plaintiffs assert that the court lacks jurisdiction because there is no present case or controversy. As noted above, New Conseco and the Schwartz plaintiffs agreed to a temporary stay of the state court action against New Conseco. The stay was to remain in effect until after a hearing scheduled for May 18, 2005, at which the parties expected a ruling on the discharge issue. Just before the May 18 hearing, the Schwartz plaintiffs amended their state court complaint to eliminate New Conseco as a defendant. They now assert that there is no justiciable controversy for the court to resolve.
This argument fails under the “voluntary cessation” doctrine. A defendant’s voluntary cessation of a challenged рractice does not render the case moot “unless it is absolutely clear that the allegedly wrongful behavior could not reasonably be expected to recur.”
Buckhannon Bd. & Care Home, Inc. v. W. Va. of Health & Human Res.,
Here, the allegedly wrongful behavior is bringing suit against Conseco for actions that were discharged in the bankruptcy. Although the Schwartz plaintiffs amended their complaint to remove New Conseco as a defendant, New Conseco presented a letter confirming a conversation with counsel for the Schwartz plaintiffs who stated that they were preрaring a separate complaint relating to the insurance contracts against New Conseco based on the same alter ego allegations. Nowhere in the many briefs filed in this action have the Schwartz plaintiffs denied the accuracy of the letter or stated that they do not in fact intend to pursue a
B. The Well-Pleaded Complaint Rule
The MDL plaintiffs also contend that the court does not have subject matter jurisdiction under 28 U.S.C. § 1334 because of the well-pleaded complaint rule. Under this rule, the court must determine whether it has subject matter jurisdiction from the face of the complaint only, not from any potential defenses that may be asserted.
Vorhees v. Naper Aero Club, Inc.,
When evaluating jurisdiction over a declaratory judgment action, the well-pleaded complaint rule is applied “baсkwards” — the court must examine the claims against the declaratory judgment plaintiff, not the allegations in the complaint, to determine if federal jurisdiction exists.
See Nuclear Eng’g Co. v. Scott,
The MDL plaintiffs contend that New Conseco’s adversary complaint merely raises an affirmative defense (the discharge) to the class plaintiffs’ state law claims against New Conseco, which do not involve any bankruptcy issues. However, New Conseco’s adversary complaint does more than merely recast an affirmative defense as a complaint for declaratory relief. New Conseco asks the court to enforce the statutory discharge injunction and the Plan Injunction by enjoining the Schwartz plaintiffs from pursuing New Conseco in state court for pre-discharge acts. Enforcement of the discharge injunction is more than a mere defense to the state court action; it is a cause of action on its own.
A debtor confronted by a creditor seeking to collect on a debt in possible violation of the discharge injunction may
either
“assert the discharge as an affirmative defense ... in state court”
or
“bring an Adversary Complaint in bankruptcy court to enforce the statutory injunction under § 524(a)(2) of the Code.”
In re Ke-
C. Bankruptcy Jurisdiction
Finally, the Schwartz and MDL plaintiffs argue that this adversary is not within the court’s jurisdiction under 28 U.S.C. § 1334 because New Conseco is not the debtor, but a mere successor to the debtor without sufficient connection to the estate for the court to have jurisdiction over this proceeding. As noted above, the court invited briefs on this subject because the Seventh Circuit takes the most restrictive view of bankruptcy jurisdiction of any circuit. However, on further consideration of the issue, the court concludes that this adversary proceeding falls squarely within its core jurisdiction.
1. 28 U.S.C. § 1334
Bankruptcy jurisdiction under 28 U.S.C. § 1334 includes the power to adjudicate matters “arising in,” “arising under,” or “related to” a case under Title 11. 28 U.S.C. §§ 1334(b), 157(a);
Celotex Corp. v. Edwards,
In contrast, related matters generally encompass actions under state law that are brought into the bankruptcy because of their impact on the size of the debtor’s estate and, thus, on the amount of property available for distribution to the debtor’s creditors.
Kewanee Boiler,
2. Core Jurisdiction
This adversary proceeding is within the court’s core jurisdiction because it is based on rights explicitly provided in the
New Conseco was a new corporation formed in accordance with the terms of the Plan to carry out the Plan. On the effective date of the Plan, New Conseco received virtually all the assets of Old Conseco. The original shareholders of New Conseco were the creditors of Old Conseco who received shares of New Conseco as a part of their distribution under the Plan. New Conseco was created to functiоn as the reorganized debtor, even though it was a newly formed corporation. New corporations are often created to function as the reorganized debtor in complex chapter 11 cases, for tax and other reasons.
Courts have routinely enforced the discharge injunction or the equivalent to the Plan Injunction in favor of the reorganized successor to the debtor. In
CD Realty Partners,
the court enforced an injunction in the plan in favor of a new corporation formed in accordance with the plan to carry on the debtor’s business after confirmation, even though the new company had been restructured at least twice after confirmation.
The Seventh Circuit has twice enforced the equivalent to the Plan Injunction in favor of the second successor to a debtor, holding that the reorganization court should not abstain from deciding whether an injunction in a consummation order barred a lawsuit against the successor because the reorganization court was in the best position to interpret its own consummation order and to determine whether a contingent claim should have been filed in the reorganization.
In re Chi., Milwaukee, St. Paul & Pac. R.R. Co.,
The Bankruptcy Code contemplates the formation of a new corporation to function as the reorganized entity. 11 U.S.C. § 1123(a)(5). The reorganized debtor is in fact a new legal entity separate and dis
Even if the court were to conclude that the discharge injunction does not apply to a new corporation formed to function as the reorganized debtor, the Plan Injunction in this case in effect applies the discharge injunction to the reorganized successor, New Conseco. Although bankruptcy jurisdiction does not extend to all questions involving interpretation of plans or confirmation orders after confirmation, when the question involves a central bankruptcy right like the discharge, the court has core jurisdiction.
Kewanee Boiler,
The Schwartz and MDL plaintiffs have not cited a single case in which a bankruptcy court refused to enforce the discharge injunction or an injunction like the Plan Injunction simply because the reorganized entity was a new corporation formed to function as the reorganized debtor. Most of the cases they rely on involve third party purchasers of the debtor’s assets, not new corporations created specifically to carry out the plan.
E.g., FedPak,
Under the Schwartz and MDL plaintiffs’ view, the bankruptcy court could not perform one of its central functions — enforcing the discharge injunction — whenever a plan contained an entirely permissible provision calling for the creation of a new corporation to function as the reorganized debtor. The court rejects that view, and concludes that this adversary proceeding falls within its core jurisdiction.
IV. Discharge Injunction and Plan Injunction Do Not Apply to Class Plaintiffs’ Claims
The court must next determine whether the discharge injunction or the Plan Injunction bars the Schwartz plaintiffs from asserting their claims against New Conseco. Whether the court applies
The Schwartz plaintiffs are owners of variable life insurance policies issued by-predecessors of Conseco Life, which was a fourth tier subsidiary of Old Conseco that is now a fourth tier subsidiary of New Conseco. The Schwartz plaintiffs assert four causes of action against Conseco Life and the other insurance subsidiary defendants: breach of contract, common law fraud, violation of a statute prohibiting bad faith by insurers and violation of a consumer protection statute. Each claim is based on Conseco Life’s elimination of a variable (the “R-factor”) on which a monthly “cost of insurance” charge is calculated. The alleged purpose of this change was to increase premiums in an attempt to force elderly policyholders to surrender policies that were no longer profitable to Conseco Life. This change took effect after Conseco’s discharge. 2
The Schwartz plaintiffs also seek to hold New Conseco liable as the alter ego of the insurance subsidiaries on each of their four causes of action against the insurance subsidiaries. They allege that, through a course of conduct over many years, Old Conseco (and later New Conseco) manipulated the affairs of the insurance subsidiaries without regard for their separate corporate existences in order to divert hundreds of millions of dollars to the parent entity. New Conseco argues that the discharge injunction and the Plan Injunction prohibit these actions against it because the alter ego “claim” is based primarily on alleged actions of Old Conseco before its discharge. The Schwartz and MDL plaintiffs argue that the claims are based on the change in the policies made after discharge and so are not covered by the injunctions. Thus, the court must determine whether claims asserted on an alter ego basis against New Conseco are discharged when the acts giving rise to the underlying claims took place after the discharge, but the proof regarding the alter ego allegations will consist mostly of pre-discharge actions by Old Conseco.
The MDL court decided virtually the same issue with respect to the actions before it, and concluded that the discharge order did not bar the MDL plaintiffs’ claims.
In re Conseco Life Ins. Co. Cost of Ins. Litig.,
MDL No. 04-1610,
A. Contingent Claims
The starting place for any analysis of whether a claim is discharged is the definition of “claim.” The Bankruptcy Code defines “claim” broadly, and includes any
right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured.
11 U.S.C. § 101(5)(A). This definition is “designed to ensure that ‘all legal obligations of the debtor,’
no matter how
re
While state or other non-bankruptcy law generally applies to the merits of a claim, bankruptcy law governs when a claim arises for purposes of determining whether a party has a contingent claim that was discharged in bankruptcy.
Chi., Milwaukee, St. Paul & Pac. R.R. Co.,
The Schwartz plaintiffs seek to recover on an alter ego theory against New Conseco. However, as the MDL court noted, alter ego is not a free-standing cause of action. It is an equitable remedy that imposes liability for an underlying cause of action. Slip op. at 9;
Local 159, 342, 343 & 444 v. Nor-Cal Plumbing, Inc.,
B. Varying Standards for Contingent Claims Based on Post-Discharge Events
The Schwartz рlaintiffs’ claims are based primarily on the increase in the cost of insurance charge that took effect after confirmation of Conseco’s plan. Determining whether the discharge applies to claims based on conduct that occurs or knowledge that is gained after discharge is often difficult. Courts wrestling with these issues have taken different approaches depending on the type of claim involved and the particular facts of each case.
With respect to ordinary torts in which the victim has no previous contact with the tortfeasor, courts have generally concluded that no claim exists for purposes of the Bankruptcy Code until the injury occurs.
E.g., Fogel v. Zell,
Courts have also applied a “fair contemplation” test to determine whether a claim exists for breach of contract.
E.g., Pearl-Phil GMT (Far East) Ltd. v. The Caldor Corp.,
The court need not decide whether the view that a breach of an ordinary contract is always within the fair contemplation of the parties is correct or consistent with due process because the Schwartz Plaintiffs’ insurance contracts are executory contracts, not ordinary contracts. An executory contract is one in which “significant unperformed obligations remain on both sides.”
Mitchell v. Streets (In re Streets & Beard Farm P’ship),
Insurance contracts are generally considered executory contracts.
Camp v. Nat’l Union Fire Ins. Co. of Pittsburgh (In re Gov’t Sec. Corp.),
Executory contracts receive special treatment in bankruptcy. Under 11 U.S.C. § 365(a) and (d)(2), a Chapter 11 debtor must generally either assume or reject an executory contract by the time of confirmation. In order to assume an exec-utory contract, the debtor must cure or provide adequate assurance that it will promptly cure any pre-assumption default under the contract. 11 U.S.C. § 365(b)(1). Claims arising from failure to cure past defaults are not discharged. After assumption, the debtor must comply with all the terms of the contract going forward. The discharge of the debtor does not bar a claim for post-discharge breach of an exec-utory contract.
R.H. Macy & Co. v. Wongco (In re R.H. Macy & Co.),
C. The Schwartz Plaintiffs’ Claims
With these principles in mind, the court has considered each of the Schwartz plaintiffs’ underlying claims against New Con-seco, and concludes that none is barred by the discharge injunction or the Plan Injunction.
1. Contract Claim
The insurance contracts between Conse-co Life and the Schwartz class are execu-tory contracts that continued in force after confirmation of the Plan. The insurance subsidiaries were not in bankruptcy, so the insurance contracts were neither assumed nor rejected in Old Conseco’s bankruptcy. However, as Conseco acknowledges, because of the alter ego allegations, the court must treat the insurance contracts as though they werе between the plaintiffs and New Conseco. Because the agreements are executory contracts that the parties continued to perform after discharge, they are most analogous to assumed executory contracts that pass through bankruptcy. As discussed above, a debtor’s discharge in bankruptcy does not absolve it from complying with execu-tory contracts after discharge. The breaches of contract alleged by the Schwartz plaintiffs are based on events occurring after the discharge. Their contract claim therefore was not discharged in Old Conseco’s bankruptcy, and neither the discharge injunction nor the Plan Injunction bars the Schwartz plaintiffs from pursuing it against New Conseco.
2. Statutory Claims
The Schwartz plaintiffs’ claims for breach of insurance and consumer fraud statutes are also based on post-discharge conduct by the insurance subsidiaries. Just as a reorganized debtor must perform all of its on-going obligations under as
3. Fraud Claim
Regarding the Schwartz’ plaintiffs’ common law fraud claim, as discussed above, tort claims are generally not deemed to have arisen until an injury occurs. Here, no injury occurred as a result of the alleged fraud until the insurance companies changed the way they calculated the premiums due under the policies after Old Conseco’s discharge. Therefore, the Schwartz plaintiffs’ fraud claim is not barred by the discharge injunction or the Plan Injunction.
D. Evidence of Pre-discharge Actions of Old Conseco
As noted above, the Schwartz plaintiffs can only recover against New Conseco on these claims if they are able to prove it is the alter ego of the insurance subsidiaries. The Schwartz plaintiffs allege that Conse-сo, Inc. (Old and New) operated the insurance companies without regard for their separate corporate existences. They apparently will attempt to introduce evidence relating to pre-discharge actions of Old Conseco and its pre-discharge relationships with its subsidiaries. The only issue properly before this court is whether the discharge injunction or the Plan Injunction bars the Schwartz plaintiffs from proceeding on these claims. Having concluded that the Schwartz plaintiffs are not enjoined, this court cannot adjudicate in any way the merits of the alter ego issues. The state court presiding over the Schwartz class action is the proper court to determine what evidence is admissible to prove thе alter ego allegations and whether it is equitable to hold New Conse-co’s shareholders accountable for the acts of Old Conseco. 4 This court’s conclusion that the injunctions do not prevent the Schwartz plaintiffs from proceeding is not intended to suggest in any way that New Conseco should be held liable for the acts of the insurance subsidiaries based on pre-discharge actions of Old Conseco.
Y. Conclusion
For all the reasons stated, the court concludes that it has jurisdiction over Con-seco’s adversary complaint against the state court Schwartz plaintiffs. However, neither the discharge injunction nor the plan injunction bars the Schwartz plaintiffs’ class action against New Conseco. New Conseco’s motion to enforce thе discharge injunction is therefore denied.
Notes
. At a status hearing on August 3, 2005, after the court announced its conclusion that it had jurisdiction and would next address the discharge issue, counsel for the Schwartz plaintiffs orally asserted that the court's conclusion regarding their intention was "false.” The court invited the Schwartz plaintiffs to dismiss the claims against New Conseco with prejudice or otherwise demonstrate that they were not in fact going to pursue New Conseco with respect to the issues raised in their state court action. They have not done so.
. With respect to one of the two types of policies at issue (Lifestyle policies), the insurance companies sent notice of this change to policyholders on August 25, 2003, about two weeks before confirmation, and the change took effect in October 2003, about one month after confirmation. With respect to the second type of policy at issue (LifeTime policies), the insurance companies sent notice of the change on February 25, 2004 and the change took effect in May 2004, eight months after confirmation.
. However, if an executory contract is rejected by the debtor, the rejection is generally deemed a pre-petition breach that generates a pre-petition claim in the bankruptcy, which is therefore subject to discharge. 11 U.S.C. § 365(g).
. Under the Plan, the equity interests of Old Conseco's shareholders were completely elim-mated, and the shares of New Conseco were issued to the creditors of Old Conseco.