Bankruptcy No. 98-00167-C Chapter 7, Adversary No. 00-9056-CUnited States Bankruptcy Court, N.D. Iowa
September 20, 2000

PAUL J. KILBURG, Chief Bankruptcy Judge.

On August 17, 2000, the above-captioned matter came on for hearing pursuant to assignment. The matters before the Court are competing Motions for Summary Judgment as to Count II of the Complaint. Attorney Thomas Fiegen appeared for Plaintiff J.E. Adams Industries, Ltd. and Attorney Eric Lam appeared for Plaintiff Republic Credit Corp. Attorney Jeff Taylor appeared for Defendant Aurora National Life Assurance Co. After hearing argument of counsel, the Court took the matter under advisement. The parties stipulated to all operative facts and filed prehearing briefs. This is a core proceeding pursuant to 28 U.S.C. § 157
(b)(2)(A), (G), and (O).

This adversary proceeding arises in the case of J.E. Adams Ltd., a Chapter 11 reorganization. A plan has been confirmed in the Chapter 11 reorganization. The question presented is whether the automatic stay prevents an insurance company, which carries a life insurance policy owned by Debtor, from declaring the policy lapsed for failure to pay premiums and failure to cure defaults within the grace period provided in the policy. Additional threshold questions are also presented in this context.

Debtor J.E. Adams Industries filed the pending adversary complaint on March 31, 2000, and Republic Credit Corp. joined as a party plaintiff. The complaint is in two counts. Count I is entitled “Breach of the Duty of Good Faith and Course of Dealing”. This Count seeks monetary damages based upon the alleged loss of the life insurance policy in question. Count II is captioned “Violation of the Automatic Stay”. In this Count, Debtor asserts a violation of the automatic stay by Defendant Aurora National Life. Only Count II is at issue in the parties competing Motions for Summary Judgment. Republic Credit Corp. moves for summary judgment on Count II, joined by Debtor J.E. Adams Indus. Defendant Aurora National Life filed a cross-motion for summary judgment. They seek a determination of whether there was a violation of the automatic stay.

J.E. Adams Industries, Ltd. (Debtor) purchased a whole life insurance policy covering its CEO, Jack E. Adams, from Executive Life Insurance Company (ELIC) on March 26, 1988. On September 3, 1993, as the result of ELIC’s insolvency and rehabilitation plan, Aurora National Life Assurance Company (Aurora) assumed and reinsured substantially all of the life insurance policies and annuity contracts previously held by ELIC.

Debtor’s policy had a March 26 anniversary date and required the payment of premiums to keep the policy in force. Debtor elected to pay the premiums in quarterly installments. According to the terms of the insurance policy, if the policyholder fails to pay a premium payment when due, Aurora would attempt to continue coverage by the application of available funds under the policy.

The policy in question contains a non-forfeiture option that converts it from a whole life policy to a term life policy, subject to cancellation, at the end of a 31 day grace period after a default in payment. The default options in the policy require Aurora to provide notice to the policy holder. Additionally, Aurora is obligated by the terms of the contract to provide notice to the policy holder of the due dates for the quarterly payments prior to the date when those payments come due.

Debtor filed a voluntary Chapter 11 petition on January 21, 1998 in the United States Bankruptcy Court for the Northern District of Iowa. After the filing, J.E. Adams operated the company as debtor-in-possession. Aurora had actual knowledge of this filing no later than December 18, 1998 by way of an overnight letter dated December 17, 1998 from counsel for Debtor disclosing the Chapter 11 filing and requesting a loan against the available cash value in the policy.

The Court confirmed Debtor’s Chapter 11 Plan on March 24, 2000. In the plan, Debtor assigned its interest in the policy to Firstar, a creditor. Confirmation of the plan does not impact the resolution of this adversary proceeding.

In December 1998, Debtor requested and received a loan from Aurora for $65,802.67, the maximum amount available under the insurance policy. After the loan, the policy with Aurora had only enough remaining cash value to support the payment of the quarterly premium due on December 26, 1998. Because Debtor did not otherwise pay the December 26, 1998 premium payment, the remaining cash value in the policy converted into an automatic premium loan according to the terms of the policy. On March 5, 1999 Aurora mailed Debtor a notice stating that the next quarterly payment was due on March 26, 1999.

After Debtor defaulted on the March 26, 1999 payment, Aurora sent Debtor three additional notices. The April 16, 1999 notice was a 20-day reminder advising Debtor that the premium had not been paid, and if the premium remained unpaid at the expiration of the grace period, the policy would convert to an extended term life policy. This conversion is consistent with the non-forfeiture option in the policy. The April 26, 1999 notice informed Debtor that the grace period had expired on the policy. The June 3, 1999 notice advised Debtor that as a result of the default the policy had converted into a term life policy and the expiration date would be July 3, 1999 in the event that no additional payments were made toward maintaining the policy. Aurora’s final letter dated July 3, 1999 notified Debtor that the policy had lapsed and that Aurora would provide no further coverage under the terms of the policy.

On July 9, 1999, Debtor sent Aurora a letter stating that it had not received any notice prior to the July 3 letter informing it of the cancellation of the policy. With this letter, Debtor sent a check to Aurora for the continuation of the whole life policy in an amount intended to cover the premiums for the last two quarters. The amount that Debtor sent would have been insufficient to cover the amount overdue on the whole life policy. Aurora did not file a motion for relief from the automatic stay, or to compel assumption or rejection of the policy. Jack E. Adams died on December 9, 1999.

Plaintiffs Republic Credit Corp. and Debtor assert that Aurora violated the automatic stay. They allege that violations occurred both when Aurora sent notification letters of payments due and of cancellation and when Aurora terminated the policy. They base these assertions on the premise that the insurance policy is a part of Debtor’s estate and as property of the estate, it is protected by the automatic stay from action that would exert control over or otherwise remove that property from the estate.

Aurora claims that it may cancel the policy based on Debtor’s failure to pay premiums. It asserts the contract is contingent on the timely payment of premiums. Aurora also argues that Debtor may not remedy the breach after the grace period expires, because the grace period for remedy is not tolled indefinitely by the application of the automatic stay. Finally, Aurora claims that it took no affirmative action against the property of the debtor, but rather the contract reached its natural end and lapsed.

Three questions are presented. First, is the insurance policy a part of the debtor’s estate. Second, is the insurance policy an executory contract and, if so, what are the parties’ obligations. Finally, if the policy is property of Debtor’s estate, the Court must decide how the automatic stay applies, whether the grace period for default is tolled, and whether Aurora’s actions constitute a violation of the automatic stay.

If the insurance policy is not a part of the debtor’s estate, there can be no violation of the automatic stay. The automatic stay only applies to property that is a part of the bankruptcy estate. 11 U.S.C. § 362; Inre National Cattle Congress Inc., 179 B.R. 588 (Bankr.N.D.Iowa 1995) (explaining the application of the automatic stay to property of the estate, and expansively defining what constitutes property of the estate). Section 541(a) defines the property of the estate as “all legal or equitable interests of the debtor in property as of the commencement of the case.” This includes both tangible and intangible interests in property. S. Rep. No. 95-989 95th Cong., 1st sess. 82 (1978). Courts have acknowledged that insurance policies are part of the debtor’s estate.See, e.g., Bursch v. Beardsley Piper, 971 F.2d 108, 115 n. 8 (8th Cir. 1992) (stating that “a debtor’s interest in an insurance policy is property of the debtor’s estate.”); In re Titan Energy, 837 F.2d 325, 328
(8th Cir. 1988) (finding that products liability insurance is a part of the estate); Estate of Lellock v. Prudential Ins. Co., 811 F.2d 186, 189
(3rd Cir. 1987) (discussing an unmatured life insurance policy, the court stated, “We hold that an insurance policy is property of the estate . . . `even though the policy has not matured, has no cash surrender value and is otherwise contingent.'”). The weight of authority supports the conclusion that the insurance policy in question here is an asset of Debtor’s estate and this Court so finds.

It is critical to determine if the policy in question is an executory contract. If it is, the nature of the estate’s property interest and the obligations of the parties are contingent on assumption or rejection of the contract. 11 U.S.C. § 365. The Bankruptcy Code does not expressly define “executory contract”. The Supreme Court has stated that “the legislative history to § 365(a) indicates that Congress intended the term to mean a contract `on which performance is due to some extent on both sides.'” N.L.R.B. v. Bildisco Bildisco, 465 U.S. 513, 522 (1984) (citing H.R. Rep. No. 95-595 p. 347 (1977)). An executory contract is defined as one where so much of the contract is unperformed that a failure to perform on the part of either party would constitute a breach that would excuse the other’s performance. Vern Countryman, ExecutoryContracts in Bankruptcy Part I, 57 Minn. L. Rev. 439, 460 (1973). Thus, the Court must decide whether performance is due on both sides of the insurance policy.

Courts and commentators have concluded that insurance policies are executory contracts. See, e.g., Counties Contracting Constr. v.Constitution Life, 855 F.2d 1054, 1060 (3d. Cir. 1988); In re PesterRef., 58 B.R. 189, 191 (Bankr.S.D.Iowa 1985); In re American MedicalImaging Corp., 133 B.R. 45, 55 (Bankr.E.D.Pa. 1991). In reference to insurance policies, Colliers states “the policy is essentially an executory contract that may be assumed or rejected by the trustee. Continued coverage should be based on the trustee’s assumption of the contract.” 1 Collier Bankruptcy Manual ¶ 362.03[3][b], at 362-17 (Lawrence P. King ed.,3d ed. 1999). Debtor’s policy is an executory contract. Debtor was obligated to perform by paying premiums and Aurora was obligated to pay out at the death of Jack E. Adams.

If the policy is an executory contract, the debtor-in-possession must assume the contract to enforce its terms. Bildisco, 465 U.S. at 529. The trustee or debtor-in-possession has the option, pending court approval, to assume or reject the terms of an executory contract. Id. “In a chapter 11 reorganization a debtor-in-possession has until a reorganization plan is confirmed to decide whether to accept or reject an executory contract.” Pester Ref., 58 B.R. at 191 n. 1. Thus, Debtor has until plan confirmation to assume or reject the policy.

The Third Circuit has rejected the notion that the chapter 11 debtor-in-possession has the option of waiting until plan confirmation to assume or reject the contract, if the contract will expire by its own terms. Counties, 855 F.2d at 1061. Counties is distinguishable because the breach was pre-petition. Counties, 855 F.2d at 1056. Here, it is post-petition. If the breach occurs post-petition, the debtor’s obligation to pay the premiums is stayed, while the creditor is obligated to provide service pending acceptance or rejection of the contract. In re FeylinePresents, Inc., 81 B.R. 623, 626 (Bankr.D.Colo. 1988) (stating that “an executory contract under Chapter 11 is not enforceable against the debtor party, but is enforceable against the non-debtor party prior to the debtor’s assumption or rejection of the contract.”). This means that Aurora is still obligated to honor the policy, despite the debtor’s failure to pay the premiums, until the policy is assumed or rejected.

The Bankruptcy Code functions to protect the interests of the estate by allowing an evaluation of the benefits and burdens of an executory contract before it must be assumed or rejected. Bildisco, 465 U.S. at 528-33. This takes into account the possibility that the debtor may default because when a debtor assumes an executory contract, the estate must pay full dollar value for the contract as well as remedy any breach that may exist. Id.at 531. Section 365(b)(1)(a) specifically provides that “[i]f there has been a default in an executory contract . . . the trustee may not assume the contract . . . unless, at the time of the assumption of such contract . . . the trustee cures . . . such default.” The Supreme Court elaborated on § 365(b)(1)(a) inBildisco. “If the debtor-in-possession elects to continue to receive benefits from the other party to an executory contract pending a decision to reject or assume the contract, the debtor-in-possession is obligated to pay for the reasonable value of those services . . .” Bildisco, 465 U.S. at 531. In the event the debtor rejects the contract, the non-debtor will assume a place in line as a general unsecured creditor under the plan. Id. Thus, in the case at bar, Aurora will be paid the total amount of the premiums that are in arrears if and when the estate assumes the contract.

The Code also effects its purpose by enforcing the contractual obligations of the non-debtor in an executory contract, thereby providing the debtor with breathing room from the claims of its creditors. Id.; Inre Public Serv. Co., 884 F.2d 11, 15 (1st Cir. 1989). The policy rationale behind enabling debtors to wait until plan confirmation to assume or reject contracts is central to bankruptcy as a whole.Bildisco, 465 U.S. at 528-33 (discussing how successful reorganization depends on easing the burdens of prepetition contracts until the plan is confirmed); In re Whitcomb Keller Mortgage Co., 715 F.2d 375, 379 (7th Cir. 1983) (while discussing the assumption of executory contracts, the court noted that “the purpose of the Bankruptcy Code” is to alter contractual relations to ease the burden on the reorganizing debtor).

As a creditor, Aurora may have sought Court intervention to compel Debtor to assume or reject the contract within a specified time frame.Public Serv., 884 F.2d at 15. “Parties who wish to know where they stand may, pursuant to § 365(d)(2) seek to compel an early election: `the court, on the request of any party to [an executory] contract . . . may order the trustee to determine within a specified period of time whether to assume or reject such contract. . . .'” Id. at 15 (quoting 11 U.S.C. § 365(d)(2)). However, the decision to grant this order is still subject to approval of the court which acts at its discretion. Id. Aurora has not petitioned the Court to compel an early election under § 365(d)(2).

Having determined that the insurance policy is both property of the estate and an executory contract, the Court must decide whether the lapse of policy violated § 362 of the bankruptcy code. 11 U.S.C. § 362
(h). Any action that violates the automatic stay is void ab initio. Inre Vierkant, 240 B.R. 317, 321-23 (B.A.P. 8th Cir. 1999). Property of the estate is protected by the application of the automatic stay under § 362. The automatic stay precludes creditors from taking action against the property of the estate in the absence of a grant of relief from the court. 11 U.S.C. § 362.

In some cases, the automatic stay has prevented the cancellation of insurance policies by the insurance company. See, e.g., In re MinocoGroup of Companies, Ltd., 799 F.2d 517, 520 (9th Cir. 1986) (stating that cancellation of liability insurance policies is automatically stayed by section 362(a)); Pester Ref., 58 B.R. at 191; In re J L Transp. Inc., 47 B.R. 51, 52 (Bankr.W.D.Wis. 1985). Even the enforcement of a contractual provision against the debtor in possession is prevented until the debtor assumes the contract. Pester Ref., 58 B.R. at 191. These courts hold that after the debtor has filed for bankruptcy protection, § 362(a)(3) prevents the insurer from canceling the policy. J LTransp., 47 B.R. at 52. The cancellation could injure the debtor in a manner that makes reorganization impossible, and essentially takes property from the estate. Id.

By the terms of the contract, the policy lapses if a default is not cured within 31 days. Aurora argues that the operation of the automatic stay will not alter the terms of the contract. Hazen First State Bank v.Speight, 888 F.2d 574, 576 (8th Cir. 1989) (stating that the automatic stay “does not enlarge the rights of individuals under a contract nor does it toll the running of time under a contract. It will not prevent the termination of a contract by its own terms.”). In Hazen however, the running of time related to a statutory redemption period for a security interest, not a contract clause that required prompt payments by the debtor. Id. at 575. The court in Hazen was also referring to a time period that began running pre-petition. Id. at 576-77. In this case, the Debtor made timely payments on the contract for more than a year after filing. The time period in the cancellation clause began running post-petition.

That Debtor defaulted post-petition is critical, because after the commencement of the case, the failure to pay premiums is neither a breach that operates as a rejection of the contract nor does it excuse Aurora’s performance. Bildisco, 465 U.S. at 528-33; Feyline, 81 B.R. at 626. The automatic stay tolls the grace period for executory contracts until the confirmation of the plan in a Chapter 11 case. Bildisco, 465 U.S. at 531. Aurora owed Debtor’s estate performance on the policy until the debtor-in-possession rejected the contract. Aurora’s cancellation of the policy is void as an act that takes a property interest from the estate and violates the automatic stay.

Aurora sent Debtor multiple letters notifying it that payments were due and that non-forfeiture options would be exercised. Section 362(a)(3) prohibits actions that exercise control over property of the estate. Money is property of the estate under § 541(a)(6). In re Southmark Corp., 49 F.3d 1111 (5th Cir. 1995). Section 362(a)(6) prohibits acts to collect claims that arose before commencement of the case. The insurance payments were current up to the default on March 26, 1999. Debtor filed for bankruptcy protection on January 21, 1998. The letters were not an attempt to collect a claim that arose pre-petition, and do not a violate § 362(a)(6). However, because each letter requested payment from the debtor, each was an act attempting to obtain possession of the property of the estate, and, as such, each letter violated § 362(a)(3). As each letter constituted a violation of the automatic stay, their effect was void ab initio.

Aurora argues that the automatic stay does not apply to its actions in this case because the policy ended on its own when the grace period to cure default ended. The question they pose is whether the automatic stay will toll the grace period until the stay is lifted. Several courts, including the 8th Circuit have held that the automatic stay will not permanently stay the running of a statutory time period, finding that 11 U.S.C. § 108(b) is the controlling section. See generallyHazen, 888 F.2d 574; In re Maanum, 828 F.2d 459 (8th Cir. 1987); Johnson v. FirstNat’l Bank, 719 F.2d 270 (8th Cir. 1983), cert. denied 465 U.S. 1012
(1984). Section 108(b) provides, in relevant part:

(b) Except as provided in subsection (a) of this section, if applicable nonbankruptcy law, an order entered in a nonbankruptcy proceeding, or an agreement fixes a period within which a debtor . . . may file a pleading, demand, notice, or proof of claim or loss, cure a default, or perform any other similar act, and such period has not expired before the date of the filing of the petition, the trustee may only file, cure, or perform as the case may be, before the latter of —
(1) the end of such period, including any suspension of such period occurring on or after the commencement of the case; or

(2) 60 days after the order for relief.

The Eighth Circuit has ruled that § 108 should be read in a manner harmonious with the automatic stay. Johnson, 719 F.2d at 277. Section 362 does not address the running of a statutory or contractual time period, while § 108 specifically provides a time frame that gives the debtor adequate temporal relief from the running of a grace or redemption period. 11 U.S.C. § 108(b), 362. The Eighth Circuit reasoned that if the automatic stay in § 362 tolls the running of a time period, then § 108 would be rendered ineffectual. Johnson, 719 F.2d at 278. Additionally, the court found that a historical analysis of the automatic stay, prior to the enactment of the current Code, supported the conclusion that the stay would not permanently toll the running of a statutory time period. Id. at 277.

Aurora relies heavily on Counties to support its argument that an insurance company may allow a policy to lapse despite the operation of the automatic stay. In Counties, the court extended Johnson, to apply to the grace period on an insurance contract, finding that the period of time could be tolled by operation of § 108(b) for up to 60 days but not indefinitely. 855 F.2d at 1061. The Third Circuit noted that theJohnson decision emphasized the difference between affirmative actions in the automatic stay and the “explicit running of time” in § 108. Id.
at 1058. In its analysis, the court held that the expiration of a grace period to cure the debtor’s default, when the debtor did not pay insurance premiums, and the subsequent cancellation of the policy, did not constitute an affirmative act by the insurer, but rather the explicit running of time. Id.

The critical distinction between Counties and the case at bar is that in Counties, the breach was pre-petition whereas in this case the breach is post-petition. Section 108(b) applies only to pre-petition claims. Inre Dougherty, 187 B.R. 883, 886 (Bankr.E.D.Pa. 1995) (stating that: “it has been held that § 108(b) extends the time period for asserting only pre-petition, as opposed to post-petition, claims.”). Debtor was current in its premium payments for over a year after filing for bankruptcy protection. The default occurred, and the grace period began running, post-petition. Thus, § 108(b) does not apply.

Aurora argues that its actions were specifically authorized by § 542(d), and that on that basis, it did not violate the automatic stay. Section 542(d) contains a specific provision for the operation of non-forfeiture options in life insurance contracts. Section 542(d) authorizes the good faith transfer of property of the estate to pay premiums or to carry out non-forfeiture options that are required by the insurance contract to be carried out automatically. This provision applies only to policies held by the debtor prior to the bankruptcy filing. 11 U.S.C. § 542(d). Plaintiffs allege that the cancellation, not the non-forfeiture options, constituted a violation of the automatic stay. Section 542(d) contains no language authorizing the insurance company to cancel the policy, and there is no case law suggesting that it does. Therefore, § 542(d) may not be read to authorize cancellation.

All parties have moved for summary judgment. Under Fed.R.Civ.P. 56, the Court renders summary judgment when “there is no genuine issue as to any material fact and the moving party is entitled to a judgment as a matter of law.” Because all parties concede there is no genuine issue as to any material fact, it is appropriate to grant summary judgment in favor of the party entitled to judgment as a matter of law.

The insurance policy is an executory contract and is property of the estate. The automatic stay applies to this contract, and prohibits Aurora from canceling the policy or enforcing other contractual provisions prior to confirmation of the plan. Section 542(d) enables Aurora to exercise the non-forfeiture options in the policy but does not function as an exception to the automatic stay and enable the policy to lapse. Section 108(b) only operates to toll the statutory or contractual time periods that are running at the time of filing. In this case, the grace period began to run postpetition. Allowing the insurance policy to lapse postpetition violates the automatic stay. In the absence of a genuine issue of material fact, summary judgment for Plaintiffs is warranted.

WHEREFORE, for the reasons set forth herein, Plaintiffs’ Motion for Summary Judgment is GRANTED as to Count II.

FURTHER, the effect of granting Plaintiffs summary judgment as to Count II is that the cancellation of the life insurance policy in question is ineffective and void ab initio. The life insurance policy in question remains in effect according to its terms.

FURTHER, for the reasons set forth herein, the Motion for Summary Judgment by Defendant Aurora National Life Assurance Company is DENIED.

FURTHER, Count I remains unadjudicated and this matter should be set for a scheduling conference to determine how Plaintiffs intend to proceed on this Count.

FURTHER, a scheduling conference is set for October 13, 2000 at 10:15a.m. by TELEPHONIC CONFERENCE. ATTORNEY FOR PLAINTIFF J.E. ADAMSINDUSTRIES, LTD. IS TO INITIATE THE TELEPHONE CALL. Parties should be ready and available to accept said call. The telephone number for Judge Kilburg’s chambers is (319) 286-2230. NOTE: THIS HEARING WILL BE TAPED ON ELECTRONIC RECORDING EQUIPMENT.