Opposition Brief — Republic Insurance Group v. Maleski

Supreme Court, U.S,

FILED

No. 92-868 DEC 21 1992

ee | OFFICE OF THE CLERK

n e ond

Supreme Court of the United States

October Term, 1992

7

REPUBLIC INSURANCE GROUP, ET AL.,

Petitioners,

V.

CYNTHIA M. MALESKI, Acting Insurance

Commissioner of the Commonwealth of Pennsylvania,

as Rehabilitator of the Mutual Fire, Marine and

Inland Insurance Company,

Respondent.

a

Petition For Writ Of Certiorari

To The Supreme Court Of Pennsylvania

¢

P2°EF IN OPPOSITION

~ .

RicHarD DiSatte, Esquire

Counsel of Record

ROGER Curran, Esquire

Rose, ScHMipT, Hastey &

DiSatte, P.C.

900 Oliver Building

Pittsburgh, PA 15222-5369

(412) 434-8600

Attorneys for Respondent,

Cynthia M. Maleski,

Acting Insurance Commissioner

of the Commonwealth of

Pennsylvania, as Rehabilitator

of The Mutual Fire, Marine

and Inland Insurance Company

COCKLE LAW BRIEF PRINTING CO., (800) 225.6964

OR CALL COLLECT (402) 342-2831

i

3

COUNTERSTATEMENT OF THE

QUESTIONS PRESENTED

(1) Where the sole issue presented is whether or not

the Plan of Rehabilitation grants more restrictive rights of

setoff than Petitioners would receive in a liquidation and

where the Pennsylvania Supreme Court held, based upon

its interpretation of the Pennsylvania Insurance Depart-

ment Act, that, with respect to setoff, the rights of credi-

tors set forth in the Plan of Rehabilitation are the same as

they would be in liquidation, should the Petition for Writ

of Certiorari be denied?

(2) Where the Pennsylvania Supreme Court, in

interpreting the Pennsylvania Insurance Department Act,

has held that the substantive law of the Commonwealth

of Pennsylvania (in the context of insurance insolvency

proceedings) grants creditors the same setoff rights in

rehabilitation as it does in liquidation, and where the sole

issue raised in the Petition is that Petitioners will not

receive the same rights in rehabilitation as they would in

liquidation, should this Court consider issues involving

the state court’s interpretation of substantive state law?

(3) Where Petitioners concede that the specific con-

tract provisions relied upon for their Contract Clause

claim, as well as the “representative” contract provisions

appended to their Petition, were not entered into the

record below, should this Court consider Petitioners’

claim that the Plan impairs those contract provisions in

violation of Article I, Section 10 of the United States

Constitution?

il

TABLE OF CONTENTS

Page

COUNTERSTATEMENT OF THE QUESTIONS PRE-

SENTED ... cos unsucscescsecaneaewneeeeeeeeeennan

TABLE OF AUTHORITIES ........ccseccccedsesesss

COUNTERSTATEMENT OF THE CASE ............

REASONS FOR REFUSAL OF THE WRIT..........

A. THE PENNSYLVANIA SUPREME COURT’S

DECISION APPROVING THE PLAN DEALS

EXCLUSIVELY WITH MATTERS OF SUBSTAN-

TIVE PENNSYLVANIA LAW ..............-.+--.

B. THE PENNSYLVANIA SUPREME COURT

EXPRESSLY FOUND THAT THE PLAN SATIS-

FIES THE REQUIREMENTS OF NEBLETT......

C. THE SPECIFIC CONTRACT PROVISIONS

RELIED UPON BY PETITIONERS WERE NOT

ENTERED INTO THE RECORD BELOW; IN

ANY EVENT, THE PLAN DOES NOT VIOLATE

THE CONTRACT CLAUSE .........0..eeeseess

CONCLUSION 0. cccdscannenvatanaussceessetegues

ili

11

eens iii

ili

TABLE OF AUTHORITIES

Page

CasEs

Accord, Appeal of Commonwealth Trust Co. of Pitts-

burgh, 324 Pa. 161, 188 A. 200 (1936).............. 12

Commonwealth ex rel. Bell v. Tradesmen’s Trust Com-

pany, 250 Pa. 372, 95 A. 574 (1915)............-- ‘, is

Dougherty Bros. & Co. v. Central National Bank, 93

ef errr re ere 13

Energy Reserves Group, Inc. v. Kansas Power and

Light, 459 U.S. 400 (1983).......... OP IP ECT Te 6, 17

FDIC v. Liberty Nat'l Bank & Trust Co., 806 F.2d 961

SE MUN, ead i Ghee deed cocesnaveensedtenacas 13

Foster v. Mutual Fire, Marine & Inland Insurance

Company, 1992 W.L. 210948 (Pa. Aug. 21, 1992)..... 2

Grode v. Mutual Fire, Marine & Inland Insurance

Company, 132 Pa. Commw. 196, 572 A. 2d 798

EEE NOP TORTI TTT Tee ee 5

Henz v. Superior Trucking Co., 96 F.R.D. 219 (M.D.

Le rege een cia r ees khehu car heeeeceesea 13

Hortonville Dist. v. Hortonville Ed. Assoc., 426 U.S.

eee eva sc itsane kaw xn 8, 9

In Re Cabrillo, 101 Bankr. 443 (E.D. Pa. 1989)........ 13

In Re Midland Insurance Company, 590 N.E.2d 1186

EN ap hi nas Sha Seka etaeeccecaeewbaeeessaes 9

Keystone Coal Association v. DeBenedictis, 480 U.S.

pan VeK eps nes CK 0 deb 6h 6004-004 P4S Re 8 XO 17

Liberty Sav. Ass'n v. Sun Bank of Jacksonville, 572

OR ae Be Se, |) ener: Saree 13

iv

TABLE OF AUTHORITIES - Continued

Page

National Railroad Passenger Corp. v. Atchinson, Top-

eka & Santa Fe Railway Co., 470 U.S. 451 (1985) .... 16

Neblett v. Carpenter, 305 U.S. 297 (1938) reh’g

denied, 305 U.S. 675 (1939)................. 6, 7, 8, 11

Ridgway v. Ridgway, 454 U.S. 46 (1981)......... 8,9, 14

Stamp v. Insurance Company of North America, 908

eee SUT EOE WE POEs 6k ha ne eee escscusssaayar 9

Vickodil v. Commonwealth Insurance Dept., 126 Pa.

Commw. 390, 559 A. 2d 1010 (1989) .............. 15

Unrtep States CONSTITUTION

i eae baeceanes 8, 17

STATUTES

. Pennsylvania Insurance Department Act

rr RC Cc ten cos fares 2, 15

TIE CLL Gorka iets Le ttanee 1

ke Ek Ream rend Ge meee en 1

"fe SE” RRR enter nO imntaee Mr Mle Ne 1

40 PS. § 221.16(b) ........... ccc cece cc eeeccceeccees 2

40 PS. § 221.16(d)..........0....000. Peer ere 2

ee SF Fe er er 6, 7, 9, 12, 16

TABLE OF AUTHORITIES - Continued

Page

GD Fak B Sac es 6.040005 ans hanes eawneeeeeleeees 4

es DF ee ee re Te rt 3

New York Insurance Law

DS PRE ad cad dtc Ronee sea eD REE Ee aR ee 16

COUNTERSTATEMENT OF THE CASE

Respondent is Cynthia M. Maleski, the Acting Insur-

ance Commissioner of the Commonwealth of Pennsylva-

nia, as Statutory Rehabilitator (“Rehabilitator”) of The

Mutual Fire, Marine and Inland Insurance Company

(“Mutual Fire”). On December 8, 1986, the Common-

wealth Court of Pennsylvania entered an Order placing

Mutual Fire into rehabilitation pursuant to the Pennsylva-

nia Insurance Department Act (the “Act”), 40 P.S.

§ 221.15(a), and appointing the Insurance Commissioner

of the Commonwealth of Pennsylvania as Rehabilitator

pursuant to 40 PS. § 221.15(c).!

Mutual Fire is a mutual insurance company which

was incorporated in 1902 under the laws of the Common-

wealth of Pennsylvania.? Before it ceased writing busi-

ness in 1986, Mutual Fire’s business included a broad

range of property, casualty and special risks insurance,

with substantial reliance upon reinsurance. Mutual Fire is

licensed to do business in Pennsylvania, Delaware, New

York and Puerto Rico, and operates on a surplus lines

(non-admitted) basis in virtually every other state.

1 Under the Pennsylvania Insurance Department Act, the

Commonwealth Court is assigned jurisdiction over, and super-

visory responsibility for, insurance rehabilitations and liquida-

tions. 40 P.S. § 221.4.

2 Mutual Fire has no parent company. Mutual Fire’s subsid-

iaries, as defined by Sup. Ct. R. 29.1, are: Endmark Data Process-

ing Corporation; Ryansure Intermediaries, Inc.; Cable Life

Insurance Co.; UMI Asset Management; and UMI Holdings.

2

Article V of the Act governs the rehabilitation and

liquidation of insolvent insurance companies in Pennsy]-

vania. Its stated purpose is “the protection of the interests

of insureds, creditors, and the public generally” through,

inter alia, “equitable apportionment of any unavoidable

loss.” 40 P.S. § 221.1(c). The Act affords the Insurance

Commissioner, as statutory rehabilitator, broad discretion

and authority to “take such action as [s]he deems neces-

sary or expedient to correct the condition or conditions

which constituted the grounds for the order of the court

to rehabilitate the insurer.” Foster v. Mutual Fire, Marine &

Inland Insurance Company, 1992 W.L. 210948 (Pa. Aug. 21,

1992) (A-6 - A-7),3 citing 40 P.S. § 221.16(b). This includes

the discretion and authority to formulate a plan for reha-

bilitating an insolvent insurance company. 40 P.S.

§ 221.16(d).

On January 31, 1989, pursuant to 40 P.S. § 221.16(d),

the Rehabilitator submitted to the Commonwealth Court

_ a Plan of Rehabilitation for Mutual Fire (the “Plan”).

Various creditors, including Petitioners, who are both

cedents to and reinsurers of Mutual Fire,‘ filed objections

to the Plan. On July 25, 26, 28, and August 1, 1989,

hearings were held before the Honorable James Crumlish,

Jr., then President Judge of the Commonwealth Court, to

consider the proposed Plan.

3 References to the Appendix in the Petition are designated

6 PP lt OP eink

4 Cedents are companies whom Mutual Fire reinsures.

Reinsurers are companies obligated to Mutual Fire under con-

tracts of reinsurance, having assumed Mutual Fire business.

Mutual Fire Plan, § 1(4), (26).

The Plan establishes separate classes of creditors

based upon the priority of distribution set forth in 40 PS.

§ 221.44. Pertinent classes include:

Class 1- Secured Cedents;

Class 2- Administrative Claims;

Class 3 - Wage Claims;

Class 4- Policyholder Claims (which

excludes surety bond lenders,

cedents and reinsurers);

Class 5- Surety Bond lenders;

Class 6 ~ General Unsecured Creditor Claims

(including those of cedents and

reinsurers).

The Plan directs the Rehabilitator to marshal estate

assets, in particular, reinsurance recoveries, which consti-

tute the most significant and substantial asset of Mutual

Fire. (Hearing Transcript, T. 40, 44.) Nevertheless, the

Plan gives appropriate recognition to the traditional equi-

table remedy of setoff between cedents and reinsurers.

Under Section III(D), mutual debts and credits, to the

extent that such obligations were due and owing as of

December 4, 1986 (the date on which the Insurance Com-

missioner filed her Petition for Rehabilitation) may be set

off.5 Thus, the Plan expressly permits creditors to exercise

° The term “due and owing” refers to reinsurance amounts

recoverable on paid Losses (i.e., payments by cedents to poli-

cyholders and claimants), paid Loss Adjustment Expenses,

Claim settlements and reimbursement agreements. Mutual Fire

Plan, § I(11).

their right to set off matured, liquidated obligations as of

the date of the filing of the Rehabilitation Petition. Case

reserves as of December 4, 1986 (which are estimates of

the amounts required to cover future payments on

account of known claims) and IBNR as of that date

(amounts predicted to be paid in the future on account of

events that have occurred but have not been reported as

claims) are not mutual debts under Pennsylvania law and

thus, are not available for setoff.

While the Plan allows setoff of mutual debts and

credits as stated above, Section III(B) preciudes setoff of

any premium obligations due to Mutual Fire. This provi-

sion is based upon 40 P.S. § 221.32(b)(4), which expressly

prohibits setoff of premium obligations:

(b) No setoff or counterclaim shall be allowed

in favor of any person where:

(4) The obligation of the person is to pay

premiums, whether earned or

unearned, to the insurer.

40 PS. § 221.32(b)(4). This provision applies both to reha-

bilitations and liquidations. (A-15 - A-16.)

During the course of four days of hearings on the

Plan, Petitioners, while contending, inter alia, that the

foregoing Plan provisions impaired their rights under

reinsurance contracts with Mutual Fire, failed to offer

those reinsurance contracts with Mutual Fire into evi-

dence. Petitioners now concede that the contract provi-

sions which are the subject of their Petition “were not

entered into the record below.” (Petition, p. 2, n.2.)

In an Opinion and Order dated January 23, 1990, the

Commonwealth Court (per then President Judge

Crumlish) approved, with certain modifications, the Plan

submitted by the Rehabilitator and concluded as follows:

Having considered all objections and found that

the proposed Plan, with modifications, consti-

tutes an equitable apportionment of unavoid-

able loss, is in the best interests of insureds and

other creditors, and does not constitute an abuse

of the Rehabilitator’s discretion, we modify the

Plan consistent with this Opinion and approve it

in all other respects.

Grode v. Mutual Fire, Marine & Inland Insurance Company,

132 Pa. Commw. 196, 572 A.2d 798 (1990) (B-23). In partic-

ular, the Commonwealth Court modified Section III(D)

and imposed the following additional requirements with

respect to setoff:

(i) the Rehabilitator is to notify creditors

of her setoff calculations within 90 days of

approval of the Plan;

(ii) creditors have 30 days to object to the

setoff calculation; and

(iii) any dispute over the setoff calculation

is to be resolved pursuant to the claim resolu-

tion procedures of Section VII of the Plan.

(B-24.)

Petitioners appealed this Order to the Pennsylvania

Supreme Court and argued, inter alia, that the Plan’s

setoff provisions restricted the setoff otherwise available

to them in a liquidation proceeding, and that Section III

of the Plan impermissibly impaired their contractual

rights.

The Pennsylvania Supreme Court rejected both of

these arguments. With respect to the question Petitioners

have presented for review by this Court, the Pennsylva-

nia Supreme Court made the following specific findings:

(1) Section III of the Plan “ensures that the

creditors herein, at a minimum, will fare at least

as well under the rehabilitation as they would in

a liquidation proceeding,” in accordance with

Neblett v. Carpenter, 305 U.S. 297 (1938). (A-16.)

(2) 40 PS. § 221.32, which establishes what

forms of setoff will be permitted, encompasses

both liquidation and rehabilitation in Pennsyl-

vania. (A-16.)

(3) “Mutual debts and credits” under 40

P.S. § 221.32 are limited to debts which are due

and owing (i.e., liquidated, matured) as of

December 4, 1986, the date upon which the peti-

tion for rehabilitation was filed. (A-19, citing

Commonwealth ex rel. Bell v. Tradesmen’s Trust

Company, 250 Pa. 372, 95 A. 574 (1915).)

(4) The “speculative and intangible

nature” of case reserves and IBNR at the time of

the filing of the petition for rehabilitation “does

not warrant their being available for setoff.”

(A-19.)

(5) Under Pennsylvania law, setoff is an

equitable remedy and accordingly, “is permis-

sive, not mandatory.” (A-19.)

(6) Allowing reinsurers/cedents to set off

obligations that had not matured as of the filing

of the rehabilitation petition would result in a

windfall. (A-19.)

(7) Section III of the Plan satisfied the

three-part test set forth by this Court in Energy

Reserves Group, Inc. v. Kansas Power and Light,

459 U.S. 400 (1983). (A-19.)

«

REASONS FOR REFUSAL OF THE WRIT

Petitioners’ entire argument in support of review is

premised upon a flawed assumption, i.e., that they

“would have been allowed to offset fully Case Reserves

and IBNR” in a liquidation under 40 P.S. § 221.32, and

thus, will not fare as well in rehabilitation. (Petition, p.

12.) To make this argument, however, Petitioners ignore

completely the Pennsylvania Supreme Court’s interpreta-

| tion of that statute provision and settled Pennsylvania

law.

The Pennsylvania Supreme Court specifically deter-

mined that the Mutual Fire Plan satisfied the require-

ments of Neblett v. Carpenter, 305 U.S. 297 (1938), reh’g

denied, 305 U.S. 675 (1939). According to the Pennsylvania

Supreme Court:

Under Neblett, creditors must fare at least as

well under a rehabilitation plan as they would

under a liquidation, which [Petitioners] cur-

rently argue, would not be the case under this

Plan. We disagree. . . . (A-12.)

The Court also found that Section III of the Plan complied

with the Act’s relevant provisions regarding setoff (40 P.S.

§ 221.32), which apply to rehabilitations, as well as to

liquidations. (A-16.)© Thus, the Court held, under the

Plan’s setoff provisions, creditors (including Petitioners)

“at a minimum, will fare at least as well under the reha-

bilitation as they would in a liquidation proceeding, as

© In fact, the Plan, as modified by the Commonwealth

Court, specifically incorporates 40 P.S. § 221.32, removing any

doubt that setoff under the Plan is identical to setoff under the

Act.

mandated by the holding of Neblett, supra.” (A-16.) Peti-

tioners’ assertions that the Pennsylvania Supreme Court

“refused to apply” this Court’s decision in Neblett (Peti-

tion, p. 10), simply make no sense.

Petitioners do not challenge the constitutionality of

any Pennsylvania statute. Rather, they merely seek

review of the Pennsylvania Supreme Court’s decision

approving the Mutual Fire Plan of Rehabilitation. In

essence, their disagreement lies with that Court’s find-

ings and conclusions with respect to matters of substan-

tive Pennsylvania law. Petitioners would have this Court

substitute its judgment for that of the Pennsylvania

Supreme Court in matters involving the interpretation of

(1) the Pennsylvania Insurance Department Act and its

provisions regulating insolvent insurance companies; and

(2) Pennsylvania common law governing “mutual” debts

and credits, and creditor setoff rights. This Court, which

does not sit as an appellate arm of the state courts, has

consistently refused to exercise its jurisdiction over such

matters of substantive state law. Hortonville Dist. v. Hor-

tonville Ed. Assoc., 426 U.S. 482, 488 (1976); Ridgway v.

Ridgway, 454 U.S. 46, 54 (1981).

With respect to their claim under Article I, Section 10

of the United States Constitution (the “Contract Clause”),

Petitioners are asking this Court to assess the Plan’s

impact upon “explicit contractual rights,” the provisions

regarding which were never made part of the record in

the state court proceedings. (Petition, p. 2.) In any event,

the Pennsylvania Supreme Court specifically found that

(i) the Plan did not constitute a substantial impairment of

Petitioners’ contractual setoff rights; and (ii) the Plan’s

setoff provisions served a legitimate and significant pub-

lic purpose. (A-12, A-13.)

A. THE PENNSYLVANIA SUPREME COURT'S

DECISION APPROVING THE PLAN DEALS

EXCLUSIVELY WITH MATTERS OF SUB-

STANTIVE PENNSYLVANIA LAW

Behind the constitutional “labels” that Petitioners

attach to their arguments, there is only one issue raised in

the instant Petition: what constitutes a “mutual” debt,

under Pennsylvania law, for purposes of the setoff provi-

sions of 40 P.S. § 221.32. The Supreme Court specifically

found that case reserves and IBNR, which are unliqui-

dated and contingent as of the date of the filing of a

petition for rehabilitation, are not “mutual” under Penn-

sylvania law (whether in rehabilitation or liquidation)

and hence, not subject to setoff. (A-19.) Petitioners con-

tend that the Pennsylvania Supreme Court should have

ignored fundamental principles of Pennsylvania law

(A-19), and adopted the definition of “mutual” obliga-

tions set forth in In re Midland Insurance Company, 590

N.E.2d 1186 (N.Y. 1992) (applying New York law), and

Stamp v. Insurance Company of North America, 908 F.2d

1375 (7th Cir. 1990) (construing Illinois law).

This Court considers itself “bound to accept the inter-

pretation of [state] law given by the highest court of the

State,” Hortonville Dist., 426 U.S. at 488, and has empha-

sized that decisions of state courts will be subject to

disturbance only to the extent that “they incorrectly

adjudge federal rights.” Ridgway, 454 U.S. at 54 (emphasis

10

added). Petitioners here are simply challenging the Penn-

sylvania Supreme Court’s interpretation of Pennsylvania

law; this is not, and never has been, a basis for seeking

review by this Court.

Petitioners attempt to avoid the prohibition against

reviewing questions of state law by arguing that this case

involves issues of “national importance.” (Petition, pp.

8-10.) However, Petitioners’ sudden concern with the

national and international impact of the Pennsylvania

Supreme Court’s decision approving the Mutual Fire Plan

is not only suspect, but late in arriving. While Petitioners

insist that their contractual setoff provisions are “at the

heart of most reinsurance contracts” and “of critical

importance” to the reinsurance industry (Petition, p. 9),

they failed to make these “critical” contracts part of the

record in the state court proceedings. (Petition, p. 2, n.2.)7

Moreover, Petitioners’ current claims that reinsurers

may be “far less likely” to assume reinsurance from

smaller companies in Pennsylvania and that the Pennsy!-

vania Supreme Court’s decision “could result” in a fur-

ther contraction of reinsurance capacity (Petition, p. 10),

are Clearly speculative, and were not borne out by evi-

dence or testimony at the hearings on the Plan. In fact, a

reinsurance expert who appeared on behalf of various

cedents (Petitioners at Case No. 92-937), testified that his

chief concern with the Plan’s setoff provisions was that

his companies would be forced to monitor transactions

7 Petitioners’ belated attempt to modify the record by

appending to their Petition in this Court “standard” clauses,

which they claim are found in most reinsurance contracts, is no

substitute for a proper record.

11

more closely and devote more time and effort to keeping

their accounting up to date:

THE WITNESS: But more particularly, since

we are talking about offset, it’s a tool that, first

of all, saves me money.

If we would have to go ahead and carefully

monitor it, any insurance or reinsurance com-

pany in the State of Pennsylvania, | as an under-

writer would insist that my accounting

department settle immediately. If | owed them

money, pay them the money; but if they owe me

money, | would almost insist upon a simul-

taneous transfer of checks. .

. * »

THE COURT: _.... Is this the [gravamen] of the

problem; namely, that it’s going to require the

industry and particularly Mr. FitzPatrick’s cli-

ents to do a lot more than they’re customarily

doing in order to protect their interests? Is that

right?

THE WITNESS: Yes, sir.

(T. 492-493, 495.)

Mere inconvenience, the Rehabilitator respectfully

submits, does not translate into an issue of “national

importance.”

B. THE PENNSYLVANIA SUPREME COURT

EXPRESSLY FOUND THAT THE PLAN SATIS-

FIES THE REQUIREMENTS OF NEBLETT

As stated, in considering Neblett, the Pennsylvania

Supreme Court removed any need to compare setoff

12

rights under liquidation and rehabilitation when it ruled

that Section 221.32 of the Act applies to rehabilitations as

well as to liquidations. (A-16.)®§ Thus, regardless of

whether Mutual Fire is in rehabilitation or liquidation,

Petitioners would only be permitted to set off “mutual”

debts and credits as provided under Section 221.32.9

The Court then held that “mutual” debts and credits,

under Pennsvlvania law, must be present, mature obliga-

tions as of the date of the filing of the petition for reha-

bilitation. According to the Court:

[Njo right of setoft can be available against a

note or other obligation that does not mature

until after a receiver for the insolvent debtor is

appointed. Commonwealth ex rel. Bell v. Trades-

men’s Trust Company, 250 Pa. 372, 95 A. 574

(1915). Accord, Appeal of Commonwealth Trust Co.

of Pittsburgh, 324 Pa. 161, 188 A. 200 (1936).

(A-19.)

8 The Pennsylvania Supreme Court stressed that § 221.32

begins by stating that its provisions apply to any action or

proceeding “under this article.” (A-16.) The term “article” refers

to Article V of the Act, which encompasses both rehabilitations

and liquidations. Id.

° 40 P.S. § 221.32 provides, in pertinent part, that “mutual

debts or mutual credits . . . shall be set off and the balance only

shall be allowed or paid, except as provided in subsection (b).”

Subsection (b) expressly prohibits setoff where, inter alia, (1) the

obligation of the insurer to the person seeking setoff would not,

at the date of the filing of a petition for liquidation, entitle that

party to share as a claimant in the insurer’s assets and (4) the

obligation is to pay premiums, whether earned or unearned, to

the insurer.

a

13

For more than a century, Pennsylvania courts had

relied upon this basic principle:

Whatever may be the rights of a party whose

debt is due and payable to compel an insolvent

debtor to set off a claim against him not due, a

party whose debt is not due has no equitable

claim to have it set off against a debt of his own

already due in the hands of a party who is

insolvent.

Dougherty Bros. & Co. v. Central National Bank, 93 Pa. 227

(1880) (citations omitted). This view is still widely

accepted. See, e.g., Liberty Sav. Ass'n v. Sun Bank of Jackson-

ville, 572 F.2d 591, 595 (7th Cir. 1978) (” .. . a debt is not

subject to setoff unless it has matured. ... ”); In Re

Cabrillo, 101 Bankr. 443 (E.D. Pa. 1989) (setoff was denied

in a bankruptcy proceeding with respect to an installment

loan agreement, as opposed to a demand note); see also

FDIC v. Liberty Nat'l Bank & Trust Co., 806 F.2d 961, 969

(10th Cir. 1986), and Henz v. Superior Trucking Co., 96

F.R.D. 219 (M.D. Pa. 1982).

In conformity with this precedent, the Court simply

restated the obvious, that case reserves and IBNR!° “are

not present obligations of the reinsurer” and that:

10 The category of claims allowed to be set off under the

Plan (the “due and owing” amounts) were matured, liquidated

obligations of Mutual Fire on the date the Commissioner peti-

tioned for rehabilitation. In the context of a reinsurance agree-

ment, the due and owing amount represents the funds already

paid by the primary insurance company, which amounts are

fixed, readily ascertainable, and currently payable to the pri-

mary insurer by the reinsurance company. On the other hand,

case reserves are merely the primary insurance company’s esti-

mates of the amounts which it may expend in the future in

14

[c]Jase reserves and IBNR are at most calcula-

tions or estimates of future, potential liabilities,

which often times are contingent upon a later

development or growth of the claim or some

intervening procedure such as litigation.

(A-19.) It then reached the inevitable conclusion that the

unliquidated nature of case reserves and IBNR at the time

of the filing of the petition for rehabilitation “does not

warrant their being available for setoff....” Id. The

Pennsylvania Supreme Court’s interpretation of Pennsyl-

vania law with regard to “mutuality” is not an adjudica-

tion of “federal rights” and thus, is not a subject for

review by this Court. Ridgway, 454 U.S. at 54.

The record in this case amply supports the decision

to limit setoff to liquidated due and owing amounts, as of

December 4, 1986. At the hearings on the Plan, the

cedents’ expert testified that, even in non-insolvency situ-

ations, the industry-wide practice was to use net balance

accounting (i.e., setoff) and that it applied only to due

and owing balances, not case reserves or IBNR. (T. 489,

537-538.) If setoff as practiced within the insurance indus-

try only applies to due and owing amounts, Petitioners

can hardly complain that the same principle in the Plan

somehow violates their contract rights.

defending, settling or otherwise disposing of claims which have

been reported to it. Only future events (e.g., a jury verdict) will

determine whether additional funds will be expended on any

particular claim and, if so, in what amounts. Likewise, IBNR

amounts represent an estimate of expenses that may be incurred

on account of events that have occurred but have not yet rip-

ened into claims or been reported to the primary insurance

company.

ee

15

Not only are the Plan’s setoff provisions, as approved by

the Pennsylvania Supreme Court, consistent with well-

established Pennsylvania legal principles and the factual

record, but they also implement the important public policy

behind the Act of maximizing the protection to poli-

cyholders. (40 P.S. § 221.1(c).) Thus, the Pennsylvania

Supreme Court correctly concluded that allowing Petitioners

to set off obligations against Mutual Fire that had not

matured as of the time of filing the petition for rehabilitation

(case reserves and IBNR) would result in a “windfall” to

Petitioners not available to policyholders. (A-19 - A-20.)

In addition, the setoff demanded by Petitioners

would wreak havoc with the Act’s equitable distribution

scheme under which innocent third parties (poli-

cyholders), who are dependent upon the financial obliga-

tions of these reinsurers to Mutual Fire, have been

assigned a priority above that of cedents and reinsurers.

As the Pennsylvania Supreme Court observed:

.. . [T]he exigencies attendant to a major com-

mercial insolvency and the goals of rehabilita-

tion necessitate the reality that “individual

interests may need to be compromised in order

to avoid greater harm to a broader spectrum of

policyholders and the public.”

(A-13), citing Vickodil v. Commonwealth Insurance Dept.,

126 Pa. Commw. 390, 559 A.2d 1010, 1013 (1989).

C. THE SPECIFIC CONTRACT PROVISIONS

RELIED UPON BY PETITIONERS WERE NOT

ENTERED INTO THE RECORD BELOW; IN

ANY EVENT, THE PLAN DOES NOT VIO-

LATE THE CONTRACT CLAUSE

Petitioners have not met their threshold burden of

demonstrating that they in fact possess contractual rights

0

16

altered by the law. National Railroad Passenger Corp. v.

Atchison, Topeka & Santa Fe Railway Co., 470 U.S. 451, 472

(1985). While Petitioners argue that the Plan impairs their

“explicit contractual rights” (Petition, p. 2) and “largely

overrides” the setoff provisions of their reinsurance con-

tracts (Petition, p. 14), they concede that these very rein-

surance contracts, which allegedly have been rendered

“null and void,” were never made part of the record in

the state court proceedings. (Petition, pp. 2, 4.) Petitioners

certainly should not be permitted to ask this Court to

pass upon “standard” clauses, which they claim are

found “in most reinsurance contracts.” (Petition, p. 2.)

Even more egregious, however, is Petitioners’

selected editing of the “standard” clause from which they

quote at p. 2 of their Petition. Petitioners fail to include

the following provision, which modifies setoff in the

event of insolvency of either party:

... provided, however, that in the event of the

insolvency of a party hereto, offsets shall only

be allowed in accordance with the provisions of

Section 538 of the Insurance Law of the State of

New York.

~

(G-4 - G-5.)!1 If this “standard” contract is truly represen-

tative of Petitioners’ reinsurance contracts with Mutual

Fire, Petitioners should not be heard to argue, 15 pages

later in their Petition, that the setoff provisions in Mutual

Fire’s Plan were “sudden” or “totally unanticipated.”

(Petition, p. 17.) Nor is it conceivable that Petitioners had

11 Section 538 of the Insurance Law of the State of New

York (NY Law § 7427° is similar to 40 P.S. § 221.32, with the

exception of the prohibition against premium setoff.

aii

17

no reason to expect that a rehabilitator in Pennsylvania could

regulate setoff when one of the parties to a reinsurance

contract becomes insolvent. The Pennsylvania Supreme

Court, in fact, specifically found that Petitic ers “are mem-

bers of a highly regulated industry and as such were well

aware of the powers of a rehabilitator.” (A-14, n.4.)

In any event, the Pennsylvania Supreme Court

addressed the Contract Clause challenge raised by Peti-

tioners (A-14, n.4) and properly found that the Plan’s

setoff provisions satisfied the three-part test set forth by

this Court in Energy Reserves Group, Inc. v. Kansas Power

and Light, 459 U.S. 400 (1983). Additionally, it is well

settled that the prohibition in Article I, Section 10 of the

United States Constitution against impairing the obliga-

tions of contracts “is not to be read literally,” Keystone

Coal Assoc. v. DeBenedictis, 480 U.S. 470, 502, (1987), but

must be accommodated to the inherent power of the state

“to safeguard the vital interests of its people.” Energy

Reserves, 459 U.S. at 410. The Pennsylvania Supreme

Court’s decision approving the Plan leaves absolutely no

doubt that the Plan, including its setoff provisions, is

necessary for the public good as it legitimately and rea-

sonably fosters the goals of rehabilitation announced by the

- Legislature, i.e., “equitable apportionment of any unavoid-

able loss.” (A-14 - A-17.)

Moreover, the Plan’s setoff provisions hardly consti-

tute “special interest” regulation favoring policyholders,

as Petitioners suggest. After all, the Pennsylvania Legisla-

ture has established the priority of distribution for credi-

tors of an insolvent insurance company, and has elevated

policyholder claims above those of reinsurers/cedents.

Allowing the unlimited setoff which Petitioners seek

18

would make a mockery of that priority scheme by raising

Petitioners to the level of secured creditors. If Petitioners

had wanted security for Mutual Fire’s reinsurance obliga-

tions, they certainly could have demanded it, as other

secured creditors had done. Instead, Petitioners chose to

rely upon their alleged setoff clauses. Having done so,

their vague and nebulous Constitutional assertions

should not be considered by this Court.

¢

CONCLUSION

For the foregoing reasons, it is submitted that the

Petition for Writ of Certiorari should be denied.

Respectfully submitted,

RicHARD DISALLeE, EsQuire

Counsel of Record

RocerR CuRRAN, EsQuirRE

Rose, SCHMIDT, HaAsLey &

DiSatte, P.C.

900 Oliver Building

Pittsburgh, PA 15222-5369

(412) 434-8600

Attorneys for Respondent,

Cynthia M. Maleski,

Acting Insurance Commissioner

of the Commonwealth of

Pennsylvania, as Rehabilitator

of The Mutual Fire, Marine

and Inland Insurance Company

is

-

a:

F