Bankruptcy and D&O Insurance: Top Tips and Reminders

[co-author: Andrew Solyntjes, Markel Bermuda Limited]

The effects of the COVID-19 pandemic on businesses in all sectors have been profound to say the least. One need only look at recent reports showing an over 30% drop in U.S. GDP between Q1 and Q2 to get a sense of the economic impact of our times on large businesses. While some sectors have fared well, many others have not. As the economy weathers these times, it is safe to predict that large bankruptcy filings will continue through at least the remainder of 2020.

As bankruptcy risk increases, the overall size and structure of a company’s directors and officers (D&O) insurance program becomes crucial. Companies of all sizes purchase D&O insurance to protect their corporate directors and officers, and insure against risks which may threaten the viability of the company itself. In a potential bankruptcy scenario, the availability of “Side-A” coverage under a D&O policy becomes vitally important, as Side-A limits are triggered when a company cannot indemnify its directors and officers due to, among other things, insolvency.

D&O bankruptcy claims pose unique risks and challenges to D&O professionals for several reasons, not the least of which is that the interplay between bankruptcy law and procedure, on the one hand, and D&O coverage obligations, on the other, can become confusing. Here are some of the top tips and reminders we think about when we are dealing with bankruptcy filings by insureds:

• Side-B and Side-C Coverage Under D&O Policies is Typically Deemed Property of the Debtor’s Estate

  • Section 362(a)(3) of the Bankruptcy Code stays “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” 11 U.S.C. § 362(a)(3).
  • Because Side-B and Side-C insuring agreements under a D&O policy provide coverage for costs directly incurred by the corporation, and because insurance policy payments can reduce the available coverage for the debtor on a dollar-for-dollar basis, bankruptcy courts have deemed these portions of the D&O policy to be property of the debtor’s estate, and therefore come within the purview of the automatic stay. This means that D&O insurers are not allowed to pay any insurance proceeds to any insureds without prior authorization from the bankruptcy court.
  • Practice Tip: When the insured files for bankruptcy during the pendency of a claim, coordinate with defense counsel for the insureds to prepare a motion for a “comfort order” with the bankruptcy court to partially lift the automatic stay to allow for the payment of D&O insurance proceeds towards covered defense costs in that claim.

• Side-A Coverage Under D&O Policies is Typically Not Deemed Property of the Debtor’s Estate

  • Many bankruptcy courts have held that D&O insurance policy proceeds available under Side-A coverage, i.e., coverage for amounts incurred by insured persons that is not indemnified by the company, are not property of a bankruptcy estate, and therefore not subject to the automatic stay. This makes sense considering that one of the major reasons Side-A coverage under a D&O policy was created in the first place was to provide a backstop to corporate directors and officers in the event that a corporation was unable to indemnify them due to insolvency.
  • However, this is subject to a fact-intensive analysis by the court. Often, when a policy includes Side-A, Side-B, and Side-C coverage, courts will find that depletion of the policy proceeds to indemnify individual directors and officers would harm the debtors by decreasing the funds available to settle outstanding claims against the corporation. In this scenario, a separate Side-A policy, known as a Side-A DIC (Difference in Conditions) policy, would “drop down” to indemnify the individual directors and officers.
  • Some D&O policies contain an “order of payments” provision which prioritizes indemnification of claims against the corporation’s directors and officers over other claims. These provisions require that proceeds of the policy must first be paid to directors and officers, regardless of the severity of any other claims against the corporation. Insurers should be mindful of limits available when using policy proceeds to settle a claim if such a provision exists. If a corporation’s D&O insurance program is depleted by the time individual directors and officers seek indemnification, the insurers may be subject to extra-contractual liability above policy limits.
  • Practice Tip: In any motion for a “comfort order” with the bankruptcy court to partially lift the automatic stay as to proceeds under Side-B and Side-C coverage, it is also important to note that bankruptcy courts have frequently held that Side-A coverage is typically not subject to the automatic stay. However, it is important to note in the motion that even if the court were to find that Side-A coverage is subject to the automatic stay, the court should nevertheless lift the stay for the purpose of paying policy proceeds under Side-A coverage in addition to Side-B and Side-C.

• The “Automatic Stay” Applies to Suits Maintained Against the Corporation, but Typically not Against the Corporation’s individual Directors and Officers

  • When an insured corporation files for bankruptcy, the court’s “Automatic Stay” will act to halt any pending litigation against the corporation. However, the Automatic Stay does not typically act to pause any litigation against the individual directors and officers.
  • While D&O policy proceeds that inure to the benefit of the corporation are generally property of the bankruptcy estate, individual directors and officers often still have access to policy proceeds to fund defense costs and indemnify settlements.
  • Practice tip: Identify which lawsuits pending against the directors and officers (which, in many cases, will be cases pending against both the corporation and the directors and officers) will continue despite the corporation’s bankruptcy filing, and assess whether policy proceeds can be paid to defend those individuals with or without a comfort order from the court.

• Be Mindful of D&O Policy Exclusions That Apply (and Don’t Apply) to Bankruptcy-Related D&O Claims

  • In many situations where the insured has filed for bankruptcy, the court will appoint a trustee to represent the insured-debtor’s interests, and pursue any outstanding claims that the debtor may have against third parties. Frequently, the trustee will assert these claims against the debtor’s current or former directors and/or officers, alleging that these individuals (insured persons under a D&O policy) breached their fiduciary duties to the corporation by engaging in activities that hastened the insolvency of the corporation. Additionally, the insured-debtor’s unsecured creditors may establish a committee in the bankruptcy proceeding for the purpose of pursuing claims of their own.
  • Because a trustee asserts these claims on behalf of the insured-debtor against insured persons, many will look to whether the D&O policy in question contains an “insured versus insured” exclusion. However, insured versus insured exclusions typically contain a carve-back for any claims brought in any bankruptcy or insolvency proceeding, and therefore typically does not preclude coverage for trustee claims. However, some D&O policies do contain exclusions for creditor claims.
  • Practice Tip: Review the D&O policy for any potentially applicable exclusions, but bear in mind that insured versus insured exclusions will likely not apply to trustee claims even though they are technically brought on behalf of the company.

The intersection of D&O insurance and bankruptcy law is nuanced but relatively predictable; the same issues tend to come up again and again. Keeping these notes and practice tips in mind as bankruptcy claims start rolling in should keep D&O professionals ahead of the curve.

[View source.]