It is generally said of protected cell companies and their protected cells that statutorily, no protected cell’s assets may be used to satisfy the liabilities of any other protected cell, and further, that no protected cell’s assets may be used to satisfy liabilities of the protected cell company itself (the core). But is the reverse true? Can the assets of the core company itself be used to satisfy liabilities of one or more of the protected cells?
In some cases, it appears that–at least as the applicable statutes are currently written –the answer may be no. That is, the assets of the core may be susceptible to claims of the protected cells. If true, protected cell company owners should make sure that their participation agreements are well drafted to cover such contingencies.
During a discussion of protected cell companies at the 2016 North Carolina Captive Insurance Association, someone in attendance posed this very question. Nobody in attendance had the opportunity to research the question, but someone very reasonably posited that N.C.G.S. 58-10-512(f) provided the needed core protection. That statutory section provides, in relevant part, as follows:
In the case of a contract or obligation to which the protected cell captive insurance company is not a party, either in its own name and for its own account or on behalf of a protected cell, the counterparty to the contract or obligation shall have no right or recourse against the protected cell captive insurance company and its assets other than against assets properly attributable to the incorporated protected cell that is a party to the contract or obligation.
At first blush, this seems to provide the answer. However, this section is part of a larger statute entitled Incorporated Protected Cells. Further, the section itself, though it initially refers to a protected cell (a generic term that could mean either a protected cell or incorporated cell), then states that the right of recourse is only against the incorporated protected cell. It is easy to understand the logic providing that the liabilities of one entity (the incorporated protected cell) are not attributable to the larger entity (the protected cell company). However, whether intentionally or not, the language does not appear to apply to all protected cells because it refers only to incorporated cells and is placed in the statute legislating incorporated cells.
By contrast, the statute immediately prior (58-10-511, entitled Establishment of Protected Cells), provides no similar language, though it would have been quite easy for the legislature to provide mirrored language that there is no right of recourse against a protected cell captive insurance company and its assets other than against assets properly attributed to the protected cell itself for whom the contract or obligation was entered.
The closest the protected cell statute comes to segregating liabilities away from the core is in subsection (k), when it provides:
(k) In connection with the rehabilitation or liquidation of a protected cell or a protected cell captive insurance company, the assets and liabilities of a protected cell shall, to the extent the Commissioner determines they are separable, at all times be kept separate from and shall not be commingled with those of other protected cells and the protected cell captive insurance company’s general account.
But this appears to be simply on paper ringfencing the separate cells and the core when one or more of them is in financial difficulty, which is not the same thing as providing that the core is not liable for the liabilities of the various protected cells.
As a practical matter, for captive clients who participate in a cell structure, this would likely have no import. It is the owner of the core company itself, and that company’s captive manager, who should take proactive steps to protect the core from liabilities of the protected cells.
First, the most optimum resolution would be a legislative clarification of the protected cell statute to make clear that the liabilities of any one or more protected cells should not be attributable to the core.
Second, until there is a change or clarification of the law, owners should review their company’s participation agreement with their captive manager. Most standard participation agreements I have read provide general language that any cost, taxes and fees paid by the core on behalf of a cell shall then be the ultimate liability of the participant cell owner. Review your participation agreement to see if the right to reimbursement and indemnity should be clarified to cover any liabilities of the cell that might become a liability of the core.
If you have need assistance with reviewing a participation agreement, or have questions about protected cell companies, or captive insurance legal matters in general, please contact me at info@captivelegal.com.