Opposition Brief — Allstate Insurance v. Maleski

No. 92-873

— ve as

In The

Supreme Court of the United States

October Term, 1992

*

ALLSTATE INSURANCE COMPANY,

Petitioner,

V.

CYNTHIA M. MALESKI, Acting Insurance

Commissioner of the Commonwealth of Pennsylvania,

as Rehabilitator of the Mutual Fire, Marine and

Inland Insurance Company,

Respondent.

«

Petition For Writ Of Certiorari

To The Supreme Court Of Pennsylvania

¢

BRIEF IN OPPOSITION

¢

RicHarpD DiSa.te, Esquire

Counsel of Record

Rocer Curran, Esquire

Rose, Scumipt, 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) 342-283

COUNTERSTATEMENT OF THE

QUESTIONS PRESENTED

(1) Where Petitioner concedes that it did not argue,

in the state court proceedings, that either the Pennsylva-

nia Insurance Department Act or the Plan of Rehabilita-

tion violates the Federal Arbitration Act, and where one

of the issues in the Petition is that the Pennsylvania

Insurance Department Act-is in conflict with the Federal

Arbitration Act, should that issue be addressed?

(2) Where the specific contract provisions relied

upon by Petitioner for its Contract Clause claim were not

entered into the record below, should this Court consider

Petitioner’s claim that the Plan impairs those contract

provisions in violation of Article I, Section 10 of the

United States Constitution?

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

the Plan of Rehabilitation grants more restrictive rights of

setoff than Petitioner would receive in a liquidation and

where the Pennsylvania Supreme Court has held, based

upon its interpretation of the Pennsylvania Insurance

Department Act, that, with respect to setoff, the rights of

creditors 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?

(4) 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 Petitioner will not

ii

COUNTERSTATEMENT OF THE

QUESTIONS PRESENTED - Continued

receive the same rights in rehabilitation as it would in

liquidation, should this Court address issues involving

the state court’s interpretation of substantive state law?

TABLE OF CONTENTS

Page

COUNTERSTATEMENT OF THE QUESTIONS PRE-

8 NE eee Sore eee Tae eer eT eee

A. PETITIONER HAS WAIVED ANY CONSTITU-

TIONAL CHALLENGE TO SECTION X OF THE

B. THE PENNSYLVANIA SUPREME COURT’S

DECISION APPROVING THE PLAN DEALS

EXCLUSIVELY WITH MATTERS OF SUBSTAN-

TIVE PENNSYLVANIA LAW...................

C. THE PENNSYLVANIA SUPREME COURT

EXPRESSLY FOUND THAT THE PLAN SATIS-

FIES THE REQUIREMENTS OF NEBLETT .....

1. “MUTUAL” DEBTS/CREDITS FOR PUR-

POSES OF SETOFF DO NOT INCLUDE

CASE RESERVES AND IBNR..............

2. THE PLAN’S TREATMENT OF SECURED

CEDENTS IS AT LEAST AS FAVORABLE AS

IN LIQUIDATION........ Yo PETE ere ETT Te

D. THE SPECIFIC CONTRACT PROVISIONS-

RELIED UPON BY PETITIONER WERE NOT

ENTERED INTO THE RECORD BELOW; IN

ANY EVENT, THE PLAN DOES NOT VIOLATE

bo Bos Tay lo ta nner

eae hae GW hk eh '80h0 0 4CNO 664K 6

iv

11

14

15

15

iV

TABLE OF AUTHORITIES

Page

Cases

Accord, Appeal of Commonwealth Trust Co. of Pitts-

burgh, 324 Pa. 161, 188 A.200 (1936) .............. 16

Bankers Life & Casualty Co. v. Crenshaw, 486 U.S. 71

I reg eee ces ly cae ek ee oe 12, 13

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

gauy, 250 Pa. 372, 9 A. SPO (U91S). ... 225500008 8, 16

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

ef RT Peer eee ee er eee 17

Energy Reserves Group, Inc. v. Kansas Power and

Pe ES i a errr ere 8, 22, 23

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

I I crt crap deus ccsanuccenex ts < 17

Foster v. Mutual Fire, Marine & Inland Insurance

Company, 1992 W.L. 210948 (Pa. Aug. 21, 1992) ...2, 7

Grode v. Mutual Fire, Marine & Inland Insurance

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

eg ON re ca ee mre rere reapannen hae sae ora ee 6

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

it SEG own ak ok ieee atk ha SE eee Ode eR oe Ons 18

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

Ue MR a cs kW ka eek eva kaa eee ares eee cus 11, 15

In Re Cabrillo, 101 Bankr. 443 (E.D. Pa. 1989)........ 17

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

SOE SE aA Goh treks thee canes CKO Reese eee, 23

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

fe 8, 2* B., erereorerrer rey errr re 17

Vv

TABLE OF AUTHORITIES - Continued

Page

National Railroad Passenger Corp. v. Atchison, Topeka

& Santa Fe Railway Co., 470 U.S. 451 (1985)....... 21

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

Gented, 30S US. G75 (1999) ...... cn cases 7, wy, 15, 23

Prudential Reinsurance Company v. Superior Court of

Los Angeles County, 1992 W.L. 347585 (Cal.

Supreme Court, Nov. 30, 1992)................044. 14

Ridgway v. Ridgway, 454 U.S. 46 (1981)....... 11, 15, 17

Vickodil v. Commonwealth Insurance Dept., 126 Pa.

Commw. 390, 559 A.2d 1010 (1989) ............ 19, 22

Unrtep States CONSTITUTION

Ratiete 1, Section 16 .n. occ sccctenctccsdsncedas 11, 23

STATUTES

The Federal Arbitration Act

Be Sag eB ee Per rn ye etn ry 9, 12

The McCarran-Ferguson Act

eek oe ee 8 ee er er err rts 12

Pennsylvania Insurance Department Act

Oy Baee e eeE 6 ss Sine sb ence cana cle 2, 18

pe Oe a hes 5 Wk co ee we eee 19

es ee” rere rere re rrr rr” 1

OD Fim We 6 8s on eee eres eee eee 1

ee FON. rere rer rrr rrr ey tt ce > 1

ee ee | Per errr rrr rors 2

vi

TABLE OF AUTHORITIES - Continued

Page

ey ee Ps eee ren te rere herr: brent 2

i & 2 rer erry Peenere rr rere: fret se passim

oy eee)! | rrr errr errr re re er 5

Se ets. Wes 60 00 hn 0 5a eben de encssrauedsouseteks 21

a ee 7 : Pe ree ee erry etree were 21

ee SD Serer errr rrr rr rer ryt 20

Oe Fe Be Ae 0 sc csc kiviceeeseeacieetieueke tas 2

The National Association of Insurance Commis-

sioners (NAIC) Model Act..................0 eee 24

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.id(c).!

Mutual Fire is a mutusl 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.

Article V of the Act governs the rehabilitation and

liquidation of insolvent insurance companies in Pennsyl-

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

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.

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

inter alia, “equitable apportionment of any unavoidable

loss.” 40 PS. § 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. August

21, 1992) (A7),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 Petitioner, 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.

A. SECTION II OF THE PLAN PROTECTS

SECURED CREDITORS’ RIGHTS

The Plan establishes separate classes of creditors

based upon the priority of distribution set forth in 40 P.S.

§ 221.44. Pertinent classes include:

3 References to the Appendix in the Petition of Allstate are

designated as “A ___.”

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).

Petitioner Allstate both reinsured, and ceded business to,

Mutual Fire.4 To the extent that Allstate is a secured

cedent (i.e., Mutual Fire was required to pledge collateral

to secure its obligations), it qualifies as a Class 1 creditor

under the Plan.

Section II(A) of the Plan adequately protects secured

cedents’ rights by providing that they can draw upon

their collateral (whether in the form of letters of credit or

trusts) for the full amount of their approved claims.

(A91-92.) Until such claims are adjusted under the Plan,

Petitioner Allstate and the other secured cedents neces-

sarily retain their liens against the collateral which they

hold.

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, § I(4), (26) (A87, A90).

B. SECTION III OF THE PLAN PROTECTS SET-

OFF RIGHTS

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

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.

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

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

cyholders and other claimants), paid Loss Adjustment

Expenses, Claim settlements and reimbursement agreements.

Mutual Fire Plan, § I(11) (A88).

While the Plan allows setoff of mutual debts and

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

any premium obligations due to Mutual Fire. (A98.) This

provision is based upon 40 PS. § 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 P.S. § 221.32(b)(4). Section 221.32 applies both to reha-

bilitations and liquidations. (A19.)

C. SECTION X OF THE PLAN PROTECTS ARBI-

TRATION RIGHTS

In addition, the Plan (Section X) grants discretion to

the Commonwealth Court to allow court resolution of

claims otherwise subject to contractual arbitration clauses

on a case-by-case basis. Contrary to Allstate’s assertion

that “the party seeking arbitration” is required to obtain

Court approval (Petition, p. 5), Section X clearly states

that the party seeking court resolution in lieu of arbitration is

required to petition the Court. (A112.) Moreover, in order to

forego arbitration, the Court must make a determination

that court resolution “is in the best interest of the estate

and will not unduly prejudice any party to the dispute.”

(Plan, § X, A112.)

D. FINDINGS BY THE COMMONWEALTH

COURT AND THE SUPREME COURT OF

PENNSYLVANIA

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

Pennsylvania 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) (A71).

In particular, the: Commonwealth Court expressly

found that the alleged contractual impairments chal-

lenged by Petitioner and other creditors (including rights

asserted with respect to collateral, setoff and arbitration)

“are, for the most part, insubstantial and do not warrant

modification of the Plan except as hereinafter provided.”

(A52.) The Commonwealth Court then modified Section

I11(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. (A73.)

The Court also rejected the objections to Section X, and

concluded that it simply allows parties to request court

resolution in lieu of arbitration. (A66.)

Petitioner appealed this decision to the Pennsylvania

Supreme Court, arguing that Sections I!, III and X of the

Plan impermissibly impaired its contractual rights. Peti-

tioner concedes that it did not argue, either in the Com-

monwealth Court or in the Pennsylvania Supreme Court,

that Section X violated the Federal Arbitration Act. (Alls-

tate Petition, pp. 6-7.)

The Pennsylvania Supreme Court rejected the argu-

ments raised by Allstate and the other creditors on

appeal. With respect to the questions Petitioner presents

for review by this Court, the Pennsylvania 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). (A19.)

(2) 40 P.S. § 221.32, which establishes what

forms of setoff will be permitted, encompasses

both liquidation and rehabilitation in Pennsyl-

vania. (A19.)

(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. (Foster, citing

Commonwealth ex rel. Bell v. Tradesmen’s Trust

Company, 250 Pa. 372, 95 A. 574 (1915).) (A22.)

(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.”

(A22-23.)

(5) Under Pennsylvania law, setoff is an

equitable remedy and accordingly, “is permis-

sive, not mandatory.” (A22.)

(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. (A23.)

(7) Section Ill 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). (A16.)

(8) The Commonwealth Court’s approval

of Section X(A) was correct. (A36.)

The Pennsylvania Supreme Court also rejected Peti-

tioner Allstate’s argument that the Mutual Fire Plan was a

de facto liquidation which would wind up the company’s

affairs. (A13-14.) The Supreme Court fully agreed with

the Commonwealth Court’s conclusion that:

. the ultimate goal of the Plan is to have

Mutual Fire reemerge as a solvent insurer. The

Plan calls for Mutual Fire’s possible restructure

and orders that it maintain its required capital

and surplus minimums required in order to

resume operations in the future.

(A14.) Thus, Petitioner is misleading this Court with its

repeated characterizations of Mutual Fire as a “defunct”

insurance company and its descriptions of the insolvency

proceeding as a liquidation, rather than a rehabilitation.

e

REASONS FOR REFUSAL OF THE WRIT

Petitioner’s argument that the Plan abrogates its

alleged contractual arbitration rights in violation of the

Federal Arbitration Act was never raised in the state

court proceedings. Having waived any constitutional

argument on this issue, Petitioner is simply attempting to

generate a federal question in a case where none exists.

Petitioner’s remaining argument in support of review

is premised upon seriously flawed, and unsupported,

assumptions. First, Petitioner argues that it would have

been entitled to offset “significantly more” of its obliga-

tions in a liquidation proceeding. (Petition, p. 24.) This

contention is based, not upon any case or statute, but

upon Petitioner’s “belief” that mutual claims, for pur-

poses of setoff in liquidation proceedings, include case

reserves and IBNR. (Petition, p. 9, n.5.) This “belief” is

mistaken and as will be discussed, ignores completely the

Pennsylvania Supreme Court’s interpretation of 40 P.S.

§ 221.32, the statutory provision governing setoff, and

settled Pennsylvania law.®

6 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

10

Petitioner’s assertions that the Pennsylvania

Supreme Court “refus[ed] to apply” this Court’s decision

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

U.S. 675 (1939), simply make no sense. (Allstate Petition,

p. 24). The Pennsylvania Supreme Court’s determination

that the Mutual Fire Plan satisfied the requirements of

Neblett could not have been more explicit:

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. ... (A14.)

The Court also found that Section III of the Plan complied

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

§ 221.32), which applies to rehabilitations as well as liq-

uidations. (A19.)” Thus, the Court found that, under the

Plan’s setoff provisions, creditors “at a minimum, will

fare at least as well under the rehabilitation as they

would in a liquidation proceeding, as mandated by the

holding of Neblett, supra.” (A19.)

Petitioner seeks review of the Pennsylvania Supreme

Court’s decision approving the Mutual Fire Plan of Reha-

bilitation because it is dissatisfied with that Court’s find-

ings and conclusions with respect to matters of

substantive Pennsylvania law. Petitioner would have this

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

the insurer.

7 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.

11

Court substitute its judgment for that of the Pennsyivania

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. This Court, which does not sit in appellate

review of state court judgments, has consistently refused

to exercise its jurisdiction over such matters of substan-

tive state law. Ridgway v. Ridgway, 454 U.S. 46, 54 (1981);

Hortonville Dist. v. Hortonville Ed. Assoc., 426 U.S. 482, 488

(1976).

With respect to its claim under Article I, Section 10 of

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

Petitioner is asking this Court to assess the Plan’s impact

upon specific contract provisions (relating to collateral,

setoff and arbitration) which are not before the Court and

were never made part of the record in the state court

proceedings. In any event, the Pennsylvania Supreme

Court specifically found that (i) the Plan did not consti-

tute a substantial impairment of Petitioner’s contractual

rights; and (ii) the Plan (including its provisions relating

to secured creditors. setoff and arbitration) served a legit-

imate and significant public purpose, and was “legit-

imately designed to ameliorate a financial hazard for the

good of ali involved.” (A17.)

A. PETITIONER HAS WAIVED ANY CONSTITU-

TIONAL CHALLENGE TO SECTION X OF

THE PLAN

In presenting its questions for review, Petitioner con-

tends that Section X of the Plan, which grants the

12

Commonwealth Court of Pennsylvania the discretion to

allow court resolution in lieu of arbitration on a case-by-

case basis, abrogates its rights to arbitrate under rein-

surance contracts with Mutual Fire, and therefore, vio-

lates the Federal Arbitration Act, 9 U.S.C. § 1 et seq.

However, Petitioner eventually concedes that “[its] brief

and oral statement in the Commonwealth Court did not

specifically mention the Federal Arbitration Act and its

conflict with the McCarran-Ferguson Act... .” (Allstate

Petition, pp. 6-7.) Likewise, Petitioner admits that it failed

to raise this issue before the Pennsylvania Supreme

Court:

Petitioner’s brief to the Supreme Court of Penn-

sylvania restated its objection to the Plan’s abro-

gation of its contractual right to arbitration, but

did not specifically reference the Federal Arbitration

Act. (emphasis added.)

(Allstate Petition, p. 7.)

Obviously, Petitioner Allstate is attempting to fashion

a federal question for review by this Court where none

exists. As a result of Petitioner’s failure to raise these

issues, the Pennsylvania courts had no opportunity to

pass on the applicability of the Federal Arbitration Act to

the provisions of the Plan. Bankers Life & Casualty Co. v.

Crenshaw, 486 U.S. 71, 76 (1988). Petitioner has clearly

waived the argument which it seeks to present concern-

ing a “conflict” between the Federal Arbitration Act and

the McCarran-Ferguson Act. (Allstate Petition, pp. 13-22.)

As this Court has stated:

. at the minimum .. . there should be no

doubt from the record that a claim under a

13

federal statute or the Federal Constitution was

presented in the state courts... .

Bankers Life, 486 U.S. at 77-78.

In any event, the Plan does not abrogate arbitration

rights of Petitioner and other creditors, but simply grants

the Commonwealth Court the discretion to allow court

resolution in lieu of arbitration on a case-by-case basis.

Under Section X of the Plan, arbitration will be sup-

planted only where court resolution is: (1) requested by at

least one party; and (2) granted by the court upon a

finding that it is in the best interest of the estate, without

undue prejudice to any party. (A112.) In approving Sec-

tion X(A) of the Plan, the Commonwealth Court explicitly

stated: “We construe this section as permitting parties to

a dispute to request Commonwealth Court resolution in

lieu of arbitration.” (A66.) The Pennsylvania Supreme

Court agreed. (A36.)

Moreover, even if Petitioner had properly raised and

preserved a challenge to Section X, the issues presented

in the Petition are not ripe for review. There has been no

suggestion by Petitioner that the Commonwealth Court

abused its discretion by denying arbitration in any case,

nor has any factual record been developed which couid

be presented to this Court for review. On the contrary,

acknowledging that there is no case or controversy with

regard to Section X, Petitioner simply suggests that this

issue “needs further refinement” (Petition, p. 12) and in

8 In fact, the Rehabilitator filed petitions under Section X

seeking court resolution to resolve contract disputes with sev-

eral reinsurers. These petitions were denied by the Common-

wealth Court. -

14

effect, is seeking an advisory opinion. Above all, it is

properly within the discretion of the Commonwealth

Court and within the realm of its jurisdiction, to decide

whether court resolution is preferable in any specific

instance based upon the best interest of the estate.

B. THE PENNSYLVANIA SUPREME COURT’S

DECISION APPROVING THE PLAN DEALS

EXCLUSIVELY WITH MATTERS OF SUB-

STANTIVE PENNSYLVANIA LAW

The Pennsylvania Supreme Court specifically found

that case reserves and IBNR, which are unliquidated and

contingent as of the date of the filing of a petition for

rehabilitation or liquidation, are not “mutual” under

Pennsylvania law and hence, not subject to setoff.

(A22-23.)? That Court also found that any actual contrac-

tual impairments arising out of the Plan (including the

alleged effects upon security interests, setoff and arbitra-

tion claims) were “insubstantial” and, in any event, such

Plan provisions were “legitimately designed to amelio-

rate a financial hazard for the good of all involved.”

(A15-17.)

Petitioner is simply challenging the Pennsylvania

Supreme Court’s interpretation of Pennsylvania law with

9 By letter dated December 17, 1992, counsel was advised

that Allstate intends to file a supplemental brief presenting the

case of Prudential Reinsurance Company v. Superior Court of Los

Angeles County, 1992 W.L. 347585 (Cal. Supreme Court, Nov. 30,

1992). As of this printing, no supplemental brief has been

received. If such a brief is filed in this case; Respondent reserves

the right to file a supplemental brief in response thereto.

15

regard to the purpose of the Insurance Department Act

and the meaning of “mutuality.” This type of challenge is

not, and never has been, a basis for seeking review by

this Court. In fact, this Court considers itself “bound to

accept the interpretation of [state] law given by the high-

est court of the state,” Hortonville Dist., 426 U.S. at 488,

and has emphasized that decisions of state courts will be

subject to disturbance only to the extent that “they incor-

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

(emphasis added).

C. THE PENNSYLVANIA SUPREME COURT

EXPRESSLY FOUND THAT THE PLAN SATIS-

FIES THE REQUIREMENTS OF NEBLETT

1. “MUTUAL” DEBTS/CREDITS FOR PUR-

POSES OF SETOFF DO NOT INCLUDE

CASE RESERVES AND IBNR

As stated, in considering Neblett, the Pennsylvania

Supreme Court removed any need to compare setoff

rights under liquidation and rehabilitation when it ruled

that 40 P.S. § 221.32, which is set forth under the Act’s

liquidation section, also applies to rehabilitations.

(A18-19.)!° Thus, regardless of whether Mutual Fire is in

rehabilitation or liquidation, Petitioner would only be

permitted to set off “mutual” debts and credits as pro-

vided under 40 PS. § 221.32.

10 The Pennsylvania Supreme Court stressed that § 221.32

begins by stating that its provisions apply to any action or

proceeding “under this article.” (A19.) The term “article” refers

to Article V of the Act, which encompasses both rehabilitations

and liquidations. Id.

16

Notwithstanding Petitioner-Allstate’s belief that Sec-

tion 221.32 would permit setoff of case reserves and IBNR

(Petition, p. 9, n.5), the Pennsylvania Supreme Court

specifically found that a “mutual” debt must be a present,

mature obligation as of the date of the filing of the

petition for rehabilitation. According to the Court:

[No right of setoff 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).

(A22.) The Pennsylvania Supreme Court further con-

cluded that case reserves and IBNR “are not preseni

obligations of the reinsurer”:

Case reserves and IBNR are at most calculations

or estimates of future, potential liabilities, which

often times are contingent upon a later develop-

ment or growth of the claim or some intervening

procedure such as litigation.

(A22.) According to the Court, 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

11 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 are currently

payable to the primary insurer by the reinsurance company. On

17

Court’s interpretation of Pennsylvania law with regard to

“mutuality” is not an adjudication of “federal rights” and

thus, is not a subject for review by this Court. Kidgway,

454 U.S. at 54.

For more than a century, Pennsylvania Courts had

relied upon this 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,

231 (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

the other hand, case reserves are merely the primary insurance

company’s estimates of the amounts which it may expend in the

future in 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 ripened into claims or been reported to the primary

insurance company.

18

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

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

The record in this case amply supports the decision

to limit setoff to liquidated due and owing amounts, not

loss reserves or IBNR, as of December 4, 1986. At the

hearings on the Plan, an expert on behalf of the cedents

group (some of whom are Petitioners at Case No. 92-937)

testified that, even in non-insolvency situations, 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 industry applies

only to due and owing amounts, Petitioner can hardly

complain that the same principle in the Plan somehow

violates its contract rights.

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 protection to

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

Supreme Court correctly concluded that allowing Peti-

tioner and other creditors 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 Petitioner not available to

policyholders. (A23.)

In addition, the setoff demanded by Petitioner would

wreak havoc with the Act’s equitable distribution scheme

under which innocent third parties (policyholders), who

are dependent upon the financial obligations of these

19

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.”

(A15-16), citing Vickodil v. Commonwealth Insurance Dept.,

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

2. THE PLAN’S TREATMENT OF SECURED

CEDENTS IS AT LEAST AS FAVORABLE

AS IN LIQUIDATION

Contrary to Allstate’s assertions, the Plan’s treatment

of secured cedents’ claims and collateral is perfectly clear.

Section II(A) of the Plan provides that secured cedents

can draw upon their collateral for the full amount of their

approved claims. The procedure for claims adjustment

and approval is clearly set forth in Section VII of the Plan.

(A108.)

Should the value of the collateral exceed the amount

of the secured cedents’ allowed claims, that excess is to

be paid to the Rehabilitator. Section II(A) (A91). The term

“excess collateral” is clearly defined in the first para-

graph of Section II(A) dealing with secured claims gener-

ally, to be “any collateral . . . in excess of the amount to

which said Secured Creditor is entitled pursuant to this

Plan. ...” (A91.) See also 40 P.S. § 221.3. Should the value

of the allowed claims exceed the value of the collateral,

20

the amount of any deficiency will be treated as a Class 6,

unsecured claim. Section II(A)(l) (A91).

Until such time as the secured cedents’ claims are

fully adjusted pursuant to Section VII, the secured

cedents necessarily retain their liens against the collat-

eral. Nothing in the Plan abrogates the cedents’ security

interests.

Thus, the Plan merely provides that the payment to

secured cedents from their collateral shall be made by

drawing down against that collateral once their claims

are finally approved. Through this orderly adjustment of

claims, the Rehabilitator can determine her interest in any

excess collateral.

Petitioner’s argument that the Plan somehow uncon-

Stitutionally impairs its rights vis-a-vis its collateral is

absurd. The requirements for court approval before Alls-

tate can draw against its collateral and that Allstate be

permitted to draw against its collateral those amounts

due and owing from Mutual Fire, without acceleration,

for paid losses and loss adjustment expenses hardly rise

to the level of “impairment.” (Petition, pp. 9-10.) In any

event, Petitioner fails to cite any case or Insurance Act

provision to support its contention that its collateral

rights are “significantly less favorable” under this Plan

than under liquidation. (Petition, p. 24.)

In a liquidation, the Insurance Act (40 P.S. § 221.43)

requires that the secured creditors’ collateral be valued

by conversion into money or by agreement, compromise

or litigation. Such a valuation prior to the release or

payment of collateral to the secured creditor is obviously

necessary to determine the estate’s interest in any excess

21

collateral. Further, the secured creditors’ claim or claims

must also be determined, as provided in the liquidation

sections of the Insurance Act, 40 P.S. §§ 221.38 and 221.41.

Only after both the value of the collateral and the amount

of the secured creditors’ claims have been determined can

the rehabilitator or liquidator know the value of the

estate’s interest and take appropriate steps to marshal

that value for the benefit of the estate.

The process provided in the Plan for determining the

secured cedents’ claims and paying them from their col-

lateral is nothing more than a method of valuing the

estate’s interest and providing for its realization by the

estate. Since a secured cedent’s full rights in the collateral

are maintained by the Plan, Petitioner Allstate cannot be

heard to complain about its treatment. Clearly, a slight

modification in the procedure for payment from collateral!

does not amount to a deprivation of due process rights

under the rule in Neblett.

D. THE SPECIFIC CONTRACT PROVISIONS

RELIED UPON BY PETITIONER WERE NOT

ENTERED INTO THE RECORD BELOW; IN

ANY EVENT, THE PLAN DOES NOT VIOLATE

THE CONTRACT CLAUSE

Petitioner has not even attempted to meet its thresh-

old burden of demonstrating that it in fact possesses

contractual rights altered by the law. National Railroad

Passenger Corp. v. Atchison, Topeka & Santa Fe Railway Co.,

470 U.S. 451, 472 (1985). Petitioner claims that it was a

party to various reinsurance contracts with Mutual Fire,

22

which contained provisions concerning security /collat-

eral, arbitration and setoff. (Petition, p. 4.) Then, Peti-

tioner argues that the Plan “severely restricts” each of

these provisions. (Petition, pp. 5, 9-10.) However, these

crucial reinsurance contracts, which Petitioner insists

have been abrogated by the Plan, were never made part

of the record in the state court proceedings. These absent

contracts, which now are at the very heart of Allstate’s

request that this Court review the Peansylvania Supreme

Court’s decision on the Mutual Fire Plan, were obviously

not important enough to warrant their admission as evi-

dence during the course of four days of hearings.

In any event, the Pennsylvania Supreme Court

addressed the Contract Clause challenge raised by Peti-

tioner (A15-16) and properly found that the Plan satisfied

the three-part test set forth by this Court in Energy

Reserves. The Pennsylvania Supreme Court found that

any actual contractual impairments as a result of the Plan

“are insubstantial.” (A15.) The Court also concluded, cit-

ing the decision of the Pennsylvania Commonwealth

Court in Vickodil, supra, that the exigencies associated

with a major insurance insolvency and the goals of reha-

bilitation (minimizing the harm to all affected parties)

“necessitate the reality” that individual interests may

have to be compromised “to avoid greater harm to a

broader spectrum of policyholders and the public.” (A15.)

Inexplicably, Petitioner suggests that the foregoing

analysis by the Pennsylvania Supreme Court is faulty

because this Court’s requirement in Energy Reserves that a

statute (which substantially impairs contractual rights)

serve “a legitimate and significant purpose,” is only dicta.

(Petition, pp. 25-26.) Quite the contrary, it is well settled

23

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

States Constitution against impairing the obligations 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 provisions being challenged by Peti-

tioner are reasonable and legitimately designed to foster

the goals of rehabilitation in Pennsylvania.

Likewise, Petitioner’s attempt to separate itself from

the gas suppliers in Energy Reserves strains credulity. All-

state’s argument that the Plan constituted “a sudden and

unanticipated retroactive modification” to the commer-

cial expectations of major reinsurers in the United States

is difficult to accept. (Petition, p. 25.) The Pennsylvania

Supreme Court specifically noted that:

.. . the objectors to the Plan are members of a

highly regulated industry and as such were well

aware of the powers of the Rehabilitator. (emphasis

added.)

(A16, n.4.)

Indeed, the current Pennsylvania Insurance Depart-

ment Act, in effect since 1977, and decisions issued there-

under, place substantial emphasis upon the broad powers

of the Insurance Commissioner, as rehabilitator, “to effec-

tuate equitably the intent of the Rehabilitation statutes,

i.e., to minimize the harm to all affected parties.” (A15.)

24

Moreover, the National Association of Insurance Com-

missioners (NAIC) Model Act, upon which the Pennsyl-

vania Insurance Department Act is based, has been in

existence for almost 25 years (with the Wisconsin Insur-

ance Law serving as the original model legislation) and is

well known to members of the reinsurance industry.

Therefore, it is difficult to believe that Petitioner Allstate

was surprised in this case.

CONCLUSION

For the foregoing reasons, it is submitted that the

Petition for Writ of Certiorari should be denied.

Respectfully submitted,

RICHARD DISALLE, EsQuirE

Counsel of Record

ROGER CURRAN, ESQUIRE

Rose, ScHmMipT, HaAsLey &

DiSAaLte, 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