LOC's As Premium Collateral; It's Better Than A Cash Deposit

Rob Mosely in concert with Big Truck TV looks at escrow deposits that inhibit a trucker financially. Whether a deposit is an escrow or a working deposit, the bottom line is that it needs to be explained. What Rob's article could have added is that collateral not only protects against bankruptcy, it also protects and agent and insurance company by averting the loss or earned premium- which has been uncollected in the cancellation request. See his article below:

"Protecting a Truck Insurer from an Insured’s Potential Bankruptcy: Letter of Credit as Collateral

Too often in today's economy, insurers are getting the short-end of the stick when the motor carriers they insure file bankruptcy. By the time the insured files bankruptcy - or possibly even before any financial problems arise - it is generally too late to protect your company from the effects of the insured's bankruptcy. Therefore, safeguards must be put in place beforehand in order to insulate an insurer from bankruptcy's often harsh consequences, including harmful effects on an insurer's collateral.

Truck insurers, especially those involved with "fronting policies," captives, or high dollar deductibles necessarily insist on collateral to secure the insured's obligations. This collateral can be found in several forms, including equipment, cash, or a letter of credit. A recent opinion issued in S-Tran Holdings, Inc. v. Protective Ins. Co., Delaware Bankruptcy Court, Adversary No. 07-51341, 2009 WL 3185771 (Del. 2009), suggests that one potential safeguard against bankruptcy is to require a standby letter of credit as collateral from the insured.

What is a standby letter of credit?

A standby letter of credit is essentially a guarantee of payment by the shipper's bank. Insurer's customer, Motor Carrier, must go to its bank and apply for a standby letter of credit. Upon approval of Motor Carrier's application, Motor Carrier's bank then sends the letter of credit to Insurer as collateral for Motor Carrier's obligations under the insurance policy. Upon the occurrence of a default of Motor Carrier, Insurer may contact Motor Carrier's bank to "draw down" on the letter of credit for cash.

Why is a letter of credit better than any other collateral?

Motor Carriers might prefer to put up cash, equipment, or other property as collateral. However, from the Insurer's perspective, a letter of credit might be preferred because it lacks all of the issues associated with liquidation of equipment (e.g. valuation, finding a buyer, etc.); a letter of credit is much more easily convertible to cash than would be equipment or other tangible property. Of course, if liquidity is the primary concern, why not have Motor Carrier simply put up a cash deposit as collateral? S-Tran Holdings demonstrates why.

In S-Tran Holdings, the bankrupt debtors were related entities, S-Tran Holdings, Service Transport, Inc., and Dixie Trucking Company, Inc. (collectively "Service Transport"), which were primarily motor carriers. Prior to the bankruptcy, as a condition for issuing various insurance policies, Service Transport's insurance company had required it to put up two forms of collateral: (i) a cash deposit and (ii) a letter of credit. When Service Transport allegedly defaulted under the agreements, the insurance company drew on the letter of credit and held the proceeds. Once the bankruptcy was filed, Service Transport sued the insurance company for turnover of the proceeds of the letter of credit, as well as breach of contract. The turnover claim, in other words, meant that Service Transport wanted to require the insurance company to give the letter of credit proceeds back to the bankruptcy estate so that a determination could be made as to how the letter of credit proceeds should be distributed. The Court held, in part, in favor of the insurance company, determining that the letter of credit and the proceeds therefrom are not part of the bankruptcy estate. On the other hand, the cash deposit was part of the bankruptcy estate, and therefore, subject to turnover.

How does all of this apply to you as a Truck Insurer?

In the example laid out above, if Motor Carrier is in bankruptcy and disputes monies owed to Insurer under the policy, then depending on the collateral, Motor Carrier (or its trustee) may have a right to control the collateral (i.e. the "stake') during the litigation. If the collateral is cash, equipment, or other types of property, then Motor Carrier (or its trustee) will likely control the stake throughout the course of the litigation. However, if the collateral is proceeds from a letter of credit, then such proceeds are not property of the estate, and Insurer would likely have the right to hold the stake during the course of litigation. As an example, the S-Tran Holdings adversary case has been ongoing for over two and a half (2½) years, and is still ongoing. The party that is entitled to hold the stake throughout such a period would certainly have an advantage.

Therefore, if you are an insurer determining what you will require as collateral in order to issue a policy, consider a letter of credit rather than cash or other collateral. If the insured later files bankruptcy, you just might be glad that you did."