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Setoff involving an insolvent carrier is resisted.

In Prudential Reinsurance Company

. Superior Court of Los Angeles County, the court considered the question of setoff regarding the insolvency of an insurance company. The case arose from a petition seeking review of an order granting a summary judgment motion to the insurance commissioner of California in an action brought in her capacity as the liquidator of The Mission Group. The action compelled reinsurers to pay balances allegedly due the estate without credit for amounts owed to such reinsurers. The lower court held that the reinsurers had no right to set off reinsurance debts owed them by the insolvent insurers. The commissioner denied setoff rights on the grounds that the language in Section 1031 of the California Insurance Code makes setoff contingent on the ultimate financial ability of the liquidating estate to pay in full all claimants in a higher priority category than the setoff claimant. Also, the commissioner cited that the requirement of mutual debts to have setoff is geared to the priority classes in Section 1033 of the California code. Thus, the setoff would not be permitted if it would result in a diminution of payment to claimants against the estate for a higher priority class than a setoff claimant.

In addition, setoff rights were denied on grounds that there was no mutuality as required by Section 1031. This occurred because upon the appointment of the liquidator, there is a novation of the reinsurance contract that alters the identity and capacity of the involved parties.

In general, the court rejected all arguments advanced by the liquidator. Regarding the first two arguments, the court held that the liquidator's construction was contrary to the plain language contained in the statute. The court took the position that the Section 1031 criterion, that debts and credits must be mutual, is derived from the equitable doctrine of setoff. The right of setoff requires that subject debts and credits be mutual in three respects: the debts must be owed between the same persons or entities; these persons must owe and be owed the debts in the same legal capacities such as a distinction between an individual capacity and that as a trustee; and the debts must be owed contemporaneously. The commissioner contended that the debts were not owed at the same time because the debts owed by the claimant reinsurers to the insolvents were post-liquidation debts, while those owed to them by the insolvents were pre-liquidation debts. But the commissioner based her contention on the fact that the reinsurers' claim for proceeds did not accrue until after the liquidator approved the underlying primary policyholders' loss claims. The court concluded, however, that the rule in California is that mutual debts created by contract between two insolvents are subject to setoff upon insolvency even if they mature by virtue of the event of insolvency. Finally, the court commented that the commissioner's arguments concerning mutuality must be rejected. It reasoned that the construction would never permit an offset because appointment of a liquidator would always effect a change in the parties and transform debts owed to the insolvent insurer as the principal creditor to the debts owed the liquidator as trustee for the creditors of the insolvent. Thus, the theory produces an absurd result which would render Section 1031 nonfunctional.

Section 6114 Amendment Section 6114 of the Internal Revenue Code of 1986 as amended requires that "Each taxpayer who, with respect to any tax imposed by this title, takes the position that a treaty of the United States overrules (or otherwise modifies) an internal revenue law of the United States shall disclose ... such position on the return of tax for such tax (or statement attached to such return), or if no return is required to be filed, in such form as the Secretary may prescribe."

On Feb. 9, the Internal Revenue Service released Notice 90-19 which extended the deadline for filing disclosure statements regarding due dates after Dec. 31, 1988. The date is extended from March 10 until 90 days following the publication of final regulations in the Federal Register.

The notice is particularly important to captive insurance companies because Section 6114 applies to a Bermuda corporation that relies on the permanent establishment provision in the Bermuda treaty to support a contention that such a company is not engaged in trade or business in the United States. In addition, the notice also apparently applies to claims for a refund of excise taxes under such a treaty filed by either the foreign corporation or insureds who have paid the tax.
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Title Annotation:Prudential Reinsurance Co. v. Superior Court of Los Angeles County
Author:Wright, P. Bruce
Publication:Risk Management
Article Type:column
Date:Apr 1, 1990
Words:752
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