How many of your business and corporate customers carry business interruption insurance? For those that do, what steps, if any, have you taken when extending credit to obtain a security interest in the borrower’s business interruption insurance policy or its property insurance?

A recent bankruptcy case, In re Montreal Main & Atlantic Railway Ltd., Debtor¹ underscores the importance of understanding the requirements of obtaining a security interest in an insurance policy. The Debtor had a $7.5 million business interruption policy. It sought a payment under the policy occasioned by a covered disaster. After reaching an accord with the trustee in bankruptcy, the insurance carrier agreed that 35% of the settlement amount would be paid to the Debtor with the remaining 65% going to the Debtor’s subsidiary.

Wheeling & Lake Erie Railway Company (“Wheeling”) had extended credit to the Debtor and had perfected a security interest in certain property of the Debtor. Wheeling claimed that under Maine law the policy proceeds came within the definition of an “account.”

After addressing Wheeling’s arguments and noting that there was no specific assignment of the insurance policy or its proceeds, the court held against Wheeling, stating that the assignment of an insurance policy and its proceeds is outside the provisions of Article 9 of the Uniform Commercial Code (“UCC”).

Section 4-9-109(d)(8) of the Colorado UCC provides that Article 9 does not apply to “a transfer of an interest in or an assignment of a claim under a policy of insurance other than an assignment by or to a health-care provider of a health-care insurance receivable and any subsequent assignment of the right to payment, but Sections 4-9-315 and 4-9-322 apply with respect to the proceeds and priorities in proceeds.” (Emphasis supplied.)

This case underscores the importance of understanding that generally one cannot perfect a security interest in an insurance policy or its proceeds by complying with the requirements of Article 9 of the UCC. When an insurance policy is part of your loan collateral, separate steps must be taken to perfect a security interest in the insurance policy. This may require a careful review of the policy’s terms and conditions.

¹59 Bankr. Ct. Dec. 101, 63 UCC Rep. Serv. 2nd 461.

Sherman & Howard L.L.C. has prepared this advisory to provide general information on recent legal developments that may be of interest. This advisory does not provide legal advice for any specific situation and does not create an attorney-client relationship between any reader and the Firm.

©2015 Sherman & Howard L.L.C.                                                                                     November 6, 2015