Three Inter-Related Issues in Scottish Re
Scottish Re is a pure reinsurer of coinsurance and yearly renewable term (“YRT”) life insurance obligations. The company stopped writing new business in 2008, and agreed to regulatory supervision in 2018, before it consented to and was ordered into rehabilitation in March 2019 due to financial impairment and unsound condition. The supervising Chancery Court appointed the Delaware Insurance Commissioner as receiver and has consistently referred to him by his executive title. Pursuant to injunctions against disposition of any assets, the company stopped paying its cedent and retrocessionaire counterparties, and the counterparties were prohibited from terminating or declaring default under their contracts.
The First Issue – Pre-Plan Payments. In June 2020, the Commissioner filed a proposed rehabilitation plan (“Rehab. Plan”)[12] which drew objections. The Rehab. Plan followed a March 2019 “Offset Plan,” pursuant to which the Commissioner made loss payments to cedents by offsetting the premium payments they otherwise would owe the company. In March 2021, the Commissioner filed a motion to approve the Commissioner making “Pre-Plan Payments” to cedents who had received value through offsets for less than 43% of their undisputed and unpaid losses.
Numerous cedents objected to the revised motion on the basis, inter alia, that the Pre-Plan Payments impermissibly created a subclass in violation of the Delaware Code’s classification of claims against a delinquent insurer (the “Priority Provision”)[13], that that offset provision in the Code[14] prohibited the Commissioner from treating offsets like payments, and that the Commissioner’s accounting figures were “uncertain and likely materially wrong.”[15] During the hearing on the revised motion, the court observed that the Commissioner had not provided sufficient factual detail in his written submissions to support his proposal.[16]
The court approved the Pre-Plan Payments, applying a deferential standard of review. The court observed that the parties had “broadly agree[d] that an abuse of discretion standard governs the Commissioner’s request.”[17] Noting that “[b]lack letter authorities generally state than an abuse of discretion standard applies when a court reviews the decision of an insurance commissioner acting as receiver for a delinquent insurer,”[18] the court observed that no case had applied the standard “to a one-off issue like the request to make the Pre-Plan Payments that is not part of a broader rehabilitation plan.”[19] The court was persuaded that the same standard should apply based on the application of six factors:
(i) the Commissioner’s status as an elected official charged with exercising statutory authority,
(ii) the specialized nature of the insurance industry,
(iii) the complexities of regulating insurers,
(iv) the expertise of the Commissioner and his Department of Insurance (“DOI”) developed over time,
(v) the fact that the Commissioner assumes operational control of an insurer’s business and affairs and must make judgment-laden decisions about its operations, and
(vi) the court acts in an oversight role.[20]
The court declared the issue to be “how to operationalize the abuse of discretion standard.”[21] Likening the situation to judicial review of a decision made in an administrative proceeding, the court reviewed authorities from other jurisdictions and held that:
[T]he abuse of discretion standard operates in the following manner for purpose of the Motion. The Commissioner has the initial burden of making out a prima facie case for the requested relief. If the Commissioner has identified a source of authority, articulated a rationale for the requested relief, and created a factual record to support the proffered rationale, then the burden shifts to the objecting party to show that (i) the Commissioner lacked authority to make the decision or that the decision does not otherwise comply with applicable law, (ii) the Commissioner's rationale does not have substantial evidentiary support, or (iii) that the decision is an abuse of discretion.[22]
The court thus described operationalization of the abuse of discretion standard as a three-stage process:
(1) determining whether the Commissioner has authority to make the challenged decision and that it complies with (or does not contravene) “positive” law (i.e., the U.S. and state constitutions, federal and state statutes and regulations, and common law)[23];
(2) determining whether the Commissioner presented a rationale for his decision and created a factual record that contains substantial evidentiary support for that rationale; if not, the court must reject the decision as arbitrary and capricious; and
(3) under the presumption that the Commissioner’s decision was rational and made in good faith, determining whether the Commissioner’s judgment is the product of fraud or bad faith or exceeds the bounds of reason.[24]
In the first stage, the court exercises plenary jurisdiction, in the second the court reviews the Commissioner’s proffered evidentiary support, and in the third the court defers to the Commissioner’s judgment unless evidence of abuse is presented.[25]
The court explained that Delaware courts do not employ Chevron[26] deference to a government official’s interpretation of the applicable law, except when construing the official’s own rules or regulations.[27] At the same time, “it is not the function of the courts to reassess the determinations of act and public policy made by the [commissioner].”[28] However,“[a] lack of reasons, a lack of substantial evidence to support them, or the absence of any correspondence between the two indicates an ill-considered, unsupported decision that is therefore arbitrary and capricious.”[29]
Upon this foundation, the court determined that the Commissioner’s proposed Pre-Plan Payments did not contravene the Priority Provision. Noting that the Provision is included in a section of the Code that expressly applies in liquidation but does not mention or preclude application in rehabilitation, the court surveyed the rehabilitation and liquidation statutes and court decisions in other jurisdictions and determined that the Priority Provision could apply in a rehabilitation if adopted as part of a plan:
While seeking to rehabilitate the Company, the Commissioner can exercise a measure of discretion, particularly when the decision to pay certain creditors over others will confer benefits to the Company. The question of whether rehabilitation remains a viable option is itself a judgmental question where the abuse of discretion standard applies.”[30]
The court also found nothing in the Offset Statute to preclude the Pre-Plan Payments.
The court summarized its holding thus:
This decision has held that under the circumstances presented by this case, the Priority Provision does not prevent the Commissioner from making the Pre-Plan Payments to the Participating Cedents. That result applies because (i) the Company is in rehabilitation, not in liquidation, (ii) the Pre-Plan Payments will not jeopardize the Company's prospects for rehabilitation, and (iii) the Pre-Plan Payments will not operate as a de facto liquidation payment or affect the Company's ability to comply with the Priority Provision in the event of a liquidation.[31]
The Second Issue – Rehabilitation Plan Approval and the Liquidation “Standard”. In 2022, the receivership was in its third year, but the Commissioner still had not presented a rehabilitation plan to the court for approval.[32] Two impediments were identified: disputes over the types of information the Commissioner must provide so that parties could evaluate the plan and determine whether to object; and the legal standard of review that the court must apply when determining whether to approve the plan.[33] The second issue was deemed critical:
Whether the Commissioner will have to prove that he validly determined that the rehabilitation plan treats each claimant at least as well as the claimant would fare in a liquidation of the Company. This decision refers to this component as the “Liquidation Standard.” It refers to the value that a claimant would receive in liquidation as the “Liquidation Value.” Thus, Liquidation Value is the minimum amount that a claimant would receive under a rehabilitation plan that satisfies the Liquidation Standard.[34]
The court found this to be an issue of first impression because the Code did not address the role of the Liquidation Standard (if any) and no Delaware court had spoken on the issue. [35] Accordingly, the court turned to the question of whether it should require compliance with the Liquidation Standard as a matter of common law. The court extensively considered 10 state court decisions, all of which derived from a 1937 California Supreme Court decision and subsequent 1938 U.S. Supreme Court decision, Carpenter.[36] The Carpenter decisions arose out of a proposed plan for the rehabilitation of an insolvent California life insurer, Pacific Mutual. Pressing for adoption of the Liquidation Standard as a prerequisite to a rehab plan’s legality were 57 cedents and 5 retrocessionaires of Scottish Re, while seven retrocessionaires joined the Commissioner in arguing against the Liquidation Standard.[37]
The court found that the Carpenter decisions were about standing – the right of a party to invoke a court’s jurisdiction to enforce a claim or to redress a grievance – and not the merits;[38] that a rehabilitation plan that satisfies the Liquidation Standard would not give rise to constitutional challenges; and that the decisions did not hold that a rehabilitation plan must meet the Liquidation Standard.[39] In other words, the Liquidation Standard is not a per se requirement or bright line test of plan validity or legality.[40] The court also found that “[t]he weight of authority . . . counsels against imposing the Liquidation Standard as a common law requirement.[41] Instead:
To have standing to advance a constitutional objection to the rehabilitation plan, a claimant will have to show that the plan does not provide the claimant with Liquidation Value. If the claimant can make that showing, then the claimant will have standing to assert its objection, and the court will consider its merits.[42]
For example, U.S. constitutional challenges to a plan could include or be based upon an asserted violation of the Contracts Clause (that a law impairs the claimant’s contract rights),[43] violation of the Takings Clause (results in a taking of private property for public use without just compensation),[44] violation of the Due Process Clause (wrongful deprivation of property),[45] and/or violation of the Equal Protection Clause (denies the claimant of equal protection of the laws).[46] In each case the claimant must demonstrate that a plan “substantially impairs the claimant’s contract rights; insubstantial impairments are part of the frictional costs of rehabilitation and do not warrant objection.[47] The court considering such a challenge then must analyze under the standards that govern each type of challenge.[48]
The court next considered secondary source material, including a legal encyclopedia, a treatise and the NAIC’s Receiver’s Handbook. The court found that none added meaningfully to the analysis.
The objectors also pressed public policy concerns, arguing that the Liquidation Standard would promote stability in the insurance marketplace by providing a predictable, bright-line rule. Although Scottish Re is a pure reinsurer, they expressed concern about implications for guaranty associations in other receiverships, which provide “a mandatory floor of benefits that policyholders receive when an insurer is in liquidation,.” since a rehabilitator could design a plan to keep them from accessing an insurer’s assets[49] Next they argued that the Standard would promote national and international uniformity by causing the same test to apply across jurisdictions.[50] And third they argued that a receiver should not be empowered to “artificially keep[ ] insurers in rehabilitation when they really belong in liquidation.” The court reiterated the three-stage process articulated in Scottish Re I, and “personally [saw] value in a regime that incorporates the Liquidation Standard,” but determined that whether to do so “is more appropriately left to the General Assembly.”[51]
Finally, the court laid out the procedure for the rehabilitation plan approval process. The court reiterated the Commissioner’s obligation to provide, in a single document, information sufficient for the claimants to evaluate for themselves whether they will receive Liquidation Value.[52] In response, interested parties could file objections and seek discovery. At the conclusion of discovery, the receiver would file an opening brief supported by a factual record of affidavits and documentary evidence sufficient to establish a prima facie case for plan adoption; the objectors then would file their oppositions, the receiver would file a reply, and an evidentiary hearing would follow.[53] This never happened.
The Third Issue – Liquidation Implementation: Claim Procedures. In July 2023, the Commissioner moved for an order converting the receivership into a liquidation, based upon consent. In March, April and June 2024, the Commissioner proposed four sets of procedures to govern a claims process, including the submission of cedent claims occurring on or before September 30, 2023 – the date at which the Commissioner declared all cedents contracts were terminated, the submission of other (including retrocessionaire) claims, dispute resolution procedures, and final determination procedures. Numerous parties objected on various grounds. Following an extended meet and confer period, 24 objections were presented to the court for resolution.[54]
An overriding issue presented by the objections was the standard of review for adopting liquidation procedures. The court began its legal analysis with a review of the Code and the differences in the types of receivership. The court noted that while liquidation is “more structured” and involves marshalling assets and paying claims in order of priority, the process “involves many discretionary decisions.”[55]
Because the Code does not answer the standard of review question, the court surveyed the law of other jurisdictions and returned to its six factor analysis of the need for a deferential standard of review.[56] Again, the court noted that merely stating that an abuse of discretion standard applies “is not the same as operationalizing it.”[57] And again the court explained what the Commissioner must do to receive deference following a three stage review process: (i) the threshold inquiry of whether the Commissioner’s decision complies with positive law, then (ii) examination of the Commissioner’s rationale to determine if it has substantial support in the record the Commissioner presented, and (iii) determining whether an objecting party has shown arbitrary conduct. The Commissioner bears the burden of proof in the first two stages, but the burden shifts to an objector in the third.[58]
This time the objectors comprised both cedents and retrocessionaires who joined in certain objections but made separate presentations on others. They collectively argued against discretionary review because the Commissioner wears two hats: one as regulator and the other as the delinquent insurer’s representative, where he “stands in the shoes” of the insurer with no greater rights than the insurer had.[59] The court described the two-hats analogy as “almost right,” but determined that it is subject to limitations that do not permit an objector to trump statutory provisions or the state’s public policy.[60] The court held discretionary review should apply because under the six factor review articulated in Scottish Re I, when making a recommendation on a claim, the Commissioner:
- operates as an elected public official charged with exercising the Code’s authority and protecting all stakeholders, including the public generally, and thus operates in a hybrid public-private status;
- operates in the specialized insurance industry, over which he and the DOI develop expertise over time;
- is at the center of the claims process pursuant to statute, which requires that all claims be filed with him;
- must make judgment-laden decisions to evaluate liabilities and wind up the insurer’s affairs in a comprehensive and efficient manner (while the court acts in an oversight role; and
- values claims, which is a judgment-laden exercise.[61]
The court also rejected the objectors’ argument that the Commissioner functioned like a magistrate, because he must present his claim recommendation to the court for dis/approval under Code section 5917(c). The court reasoned that a magistrate is court-appointed and his/her rulings have no effect until subjected to de novo review by a constitutional judge.[62]
The court then reviewed the only three cases that had addressed the issue in the US – in California, Washington, and Alaska – and found the first two states’ precedent more persuasive because their reasoning “more closely resembles how Delaware courts have approached the Commissioner’s authority.”[63]
In the remaining balance of the opinion, the court overruled or otherwise resolved all objections, effectively approving the proposed procedures subject to the Commissioner modifying the proffered draft orders to include certain procedures he had agreed to make. The court found in respect of their challenges to the claims procedures, the objecting:
- cedents and retrocessionaires had no right to compel arbitration pursuant contract provisions due to anti-suit injunctive provisions in the liquidation order precluding independent legal actions, but instead could seek relief from the anti-suit injunctions, consistent with other Delaware receivership precedent;[64]
- cedents had no statutory right to discovery under the Code; “[t]he claims process is not a plenary litigation”; the proposed procedures permit claimants to request additional information, and the Commissioner cannot abuse his discretion when denying requests for information;[65]
- retrocessionaires could not enforce their contractual insolvency clause rights against the Commissioner because unlike in other states, the Delaware Insurance Law accords no such right, and the Commissioner had previously represented that he would provide reasonable notice of pending claims;[66] and
- retrocessionaires were not entitled to have their contracts terminated at September 30, 2023, the same date when the cedents’ contracts were terminated; however, a retrocessionaire could seek judicial relief in the event that the Commissioner stops paying premium to them and the premium exceeds the company’s claims (and thus set-off is not an effective remedy).[67]
The Commissioner obviated an objection that he was not seeking court approval of his administrative expenses; he agreed to do so. In respect of each of the other four points, the court found that the Commissioner had not abused his discretion. On most of these points, the court invoked the Commissioner’s need to maintain control and attain efficiencies in receivership administration, and found no unfairness or undue hardship arising from the proposed procedures.
Conclusion
In most (if not all) receiverships, creditors and reinsurers of a delinquent receiver believe that the deck is stacked against them; that the receiver has an unfair advantage. They decry the fees paid to lawyers, accountants, actuaries and other service vendors who recover fees for their services many years before claims are paid to the creditors (without interest) and the reinsurers’ liability ends. They also need information about their claims against or obligations owed to a delinquent insurer in order to manage their own operations. In the Scottish Re receivership, the court has granted all of them full voice to express their objections and has tackled difficult issues left unanswered by an outdated statute. The court has made clear that under different statutory provisions, the court could have reached different conclusions. It may be trite to say, but whether the Commissioner or the insurance industry will seek to redress this situation remains to be seen. Until then, and even if the Code is amended, the court has provided useful guidance to receivers, creditors and reinsurers who find themselves embroiled in a Delaware insurer receivership.
After nearly seven years of receivership, Scottish Re’s cedents and reinsurers have worked hard to obviate issues and reach agreements with the Commissioner. We hope this will continue.