3. The Automatic Stay Does Not Affect Claims Against Directors and Officers
While a company’s bankruptcy filing generally stays all claims against the company, the automatic stay does not apply to a company’s directors and officers. In certain circumstances, a debtor may seek to extend the stay to third-party claims against directors and officers if it can be shown that the continuation of such claims could impair a company’s ability to effectively reorganize. Such a situation would not include the assertion of director or officer liability claims by a Chapter 7 trustee or other estate representative, such as a creditors’ committee, if the company is not pursuing a reorganization.
An effective reorganization may include the negotiation of a release of directors and officers or limitations on pursuit of director and officer liability claims, such as limiting such claims to the proceeds of a D&O policy. Experienced bankruptcy and coverage counsel can ensure that executives navigate potential claims to minimize exposure and maximize D&O insurance protections.
4. Waiver Provisions and the Automatic Stay
While the automatic stay can protect a debtor from claims during bankruptcy, it can also pose issues to insureds in the event directors or officers need to submit their own “claim” to recover under the debtor’s D&O policies – especially since the insurer, the court, or other stakeholders may oppose the claims. With respect to the rights of the parties to the insurance contract, those risks can be mitigated in part by endorsing D&O policies with provisions clarifying, among other things:
- that bankruptcy or insolvency of the company does not relieve the insurer of its obligations under the policy;
- that the policy is intended to protect the individual director-and-officer insureds; and
- that the parties waive any automatic stay that may apply to recovery of policy proceeds.
The effectiveness of such waiver may vary from jurisdiction to jurisdiction.
5. Filing a Petition May Not Trigger Runoff in D&O Policies
Even where companies have adequate D&O insurance with runoff coverage that will continue to protect directors and officers long after the bankruptcy concludes, many executives assume that the policy’s current coverage will terminate and go into runoff automatically upon the filing of a bankruptcy petition. That is not usually the case, although there are scenarios where a bankruptcy filing and runoff trigger may occur around the same time.
Instead, policies typically contain a “change in control” provision that provides a list of enumerated events that terminate current coverage and place the policy into runoff, limiting going-forward coverage to claims noticed during the extended reporting period that allege wrongful acts by the insured occurring before the change in control. Provisions vary between policies but generally speaking, a change in control occurs if:
- the named insured consolidates with or merges into another entity;
- the named insured sells all or substantially all of its assets to another entity; or
- any person or entity acquires management control (i.e., greater than 50% of voting power to appoint board or management committee members) of the named insured.
Those kinds of acquisitions or asset sales may not occur until after a plan of reorganization is confirmed or, at a minimum, until the debtor provides notice to interested parties of its intent to sells its assets, and the bankruptcy court approves the sale process, which can occur months after the petition date. The delay between the petition date and a change in control can raise a number of D&O insurance considerations – most notably a potential lapse in coverage if the company’s policy is set to expire before a transaction or sale can be effectuated. This can be solved preemptively by negotiating an extension of the company’s current D&O policies to continue coverage beyond the expected plan confirmation or transaction effective date, although any such extension likely requires additional premium payments.
The cost of making even a seemingly simple modification to a debtor’s D&O coverage can be substantial. While bankruptcy courts generally allow debtors to maintain D&O insurance, the need for ongoing insurance funding can be cause for alarm for former directors and officers and other individuals or entities who may need to access the debtor’s D&O coverage but are not involved in the ongoing financial decisions of the company during bankruptcy.
6. Retentions and Non-indemnifiable Loss
Executives should be aware of all possible payments they may be called on to make in defending against claims in the event the company is unwilling or unable to indemnify them. Those “retention” payments – also called “deductibles” or “self-insured retentions” – are the amount of money the insured is required to pay before the D&O insurer will start paying. There are two primary issues in evaluating retentions in bankruptcy.
The first is understanding what retentions apply to each type of D&O coverage. Typically, retentions apply to claims made against officers and directors that are indemnified by the company (“Side‑B” coverage), while there is usually no retention for claims against individual officers and directors that are “non-indemnifiable” by the company (“Side‑A” coverage). Directors and officers should understand the difference between the two coverages and what, if any, retention applies to Side‑A claims where they may be personally liable in the absence of reimbursement from the insurer.
The distinction between Side‑A and Side‑B coverage raises a second issue: what constitutes “non-indemnifiable” loss sufficient to avoid a retention and make sure that the insurer is paying “first dollar” for any loss? Policy language varies greatly, but many D&O policies have presumptive indemnification, meaning that the insurer assumes that the company will indemnify executives to the fullest extent permissible under the law and, as a result, will only consider loss “non-indemnifiable” if the company is truly unable to pay. Policies may also expressly recognize that a company in bankruptcy is presumed to be insolvent and, therefore, unable to indemnify.
Issues may arise in bankruptcy, however, where a policy does not make clear that the inability to pay includes financial insolvency, allowing the insurer to argue that Side‑A coverage does not apply (and the executive is subject to a steep retention) because, even though the company has no resources to pay, it is still permitted to pay under controlling corporate governance documents and applicable law. Critical policy provisions addressing permissible, required, actual, and other variations on company indemnification can raise ambiguities impacting or even negating coverage for directors and officers during bankruptcy. These ambiguities can be avoided by adequately addressing financial insolvency and its impact on retentions during policy placement or renewal.
7. D&O Exclusions and “Final Adjudication”
D&O policies contain many exclusions, but the most common insolvency-related example is the “insured vs. insured” exclusion, which bars coverage for claims brought by or on behalf of one insured against another insured. The aim of these provisions is to discourage company infighting by removing it from the ambit of the company’s D&O coverage and to avoid collusion between insureds who may assert claims driven in whole or in part by a desire to recover under insurance policies.
Serious issues can arise in bankruptcy outside of these traditional examples if, for example, a bankruptcy or liquidation trustee, creditors’ committee with derivative standing, or receiver (including the FDIC) asserts a claim against directors and officers on behalf of the debtor. Absent appropriate carve-outs to the insured vs. insured exclusion, insurers may argue that coverage is negated because, as representatives of the debtor company, those bankruptcy entities are considered insureds subject to the exclusion. Executives should ensure that any D&O policy has appropriate exceptions to the otherwise broad insured-vs.-insured exclusion that protects coverage in these situations.
In addition to raising issues under the insured vs. insured exclusion, adversary proceedings brought by bankruptcy or liquidation trustees asserting claims against directors and officers can implicate D&O exclusions for deliberate criminal, fraudulent, or dishonest acts, such as allegations of reckless or intentional conduct in breaching fiduciary duties. Those allegations, even if groundless, can pose significant obstacles to advancing legal fees and expenses unless the D&O policy’s “conduct” exclusions include a “final adjudication” requirement that prevents insurers from refusing coverage under the exclusion until the criminal, fraudulent, or dishonest acts are established by a final, non-appealable adjudication.
Even if conduct exclusions contain final adjudication language, the effectiveness of those requirements can vary widely between policies. For example, is the exclusion triggered based on final adjudications in any proceeding or only the underlying proceeding, and does such adjudication need to be adverse to the insured? These and other nuances in exclusionary language can play critical roles in maximizing executive protection during bankruptcy (and other proceedings).
8. Priority of Payment Provisions
In many instances, a debtor’s insurance policies will be one of the more valuable assets of its estate. To make matters worse, as previewed throughout this article, insolvency can lead to a number of new claims against both the company and its directors and officers at a time when the company is not in a financial position to defend itself or provide indemnification. For those reasons, there often are competing claims to recover policy proceeds that involve losses far exceeding the available limits.
Claims against different insureds may proceed on different tracks. For instance, a settlement in one matter may risk exhaustion of full limits, while a separate lawsuit against only the company’s directors and officers continues to trial after incurring millions of dollars in legal fees. This risk can be mitigated in large part by purchasing the “Side‑A only” policies discussed above, which afford separate limits to executives that cannot be impaired by claims against the company (or reimbursement to the company for indemnification paid to individual insureds).
Where executives have access only to the company’s D&O policies, however, they should ensure that all policies have a “priority of payments” provision that prioritizes “Side‑A” payments to individuals before all other kinds of payments. A priority of payments provision can also clarify that the company has a right to coverage only after all claims against individual directors and officers have been satisfied or even prohibit any payments to the company absent written approval by the board.
9. Allocation Provisions
Claims during bankruptcy can involve a number of different theories of liability, different entity and individual defendants across different stages of the debtor’s corporate history, and a variety of damages, not all of which may be covered by D&O policies. In these “mixed” claim scenarios, policyholders should understand how covered and potentially uncovered losses may be treated under D&O policies or, more specifically, what grounds insurers may raise to limit coverage to something less than all claims and damages asserted in the litigation.
Policies may be silent on “allocation,” particularly with respect to defense costs incurred by a law firm representing multiple defendants, only some of whom are insureds under the D&O policy. In those instances, many courts have held that insurers must reimburse 100% of legal fees and expenses as long as they “reasonably relate” to covered claims, even if the defense benefits non-covered claims or non-insured defendants.
Other policies, however, have explicit allocation provisions that require a particular method of allocation, such as requiring the insurer and policyholder to use their “best efforts” to determine a “fair and appropriate allocation” between covered and uncovered costs based on “the relative legal and financial exposure of the parties.” Such provisions commonly provide a process for resolving allocation disputes where the insurer must advance only those defense costs it believes to be covered until a different allocation is negotiated or determined in court or arbitration.
The best approach to avoiding allocation disputes is modifying the policy to include a provision explicitly stating that the insurer will advance 100% of defense costs as long as any claim triggers the duty to pay such costs. Working with coverage counsel and insurance brokers to understand allocation and, if needed, negotiate favorable terms well in advance of any claim is key to ensuring that directors and officers receive adequate protection for covered claims during bankruptcy.
10. Avoid Cancelled Policies
In line with all of the commentary above, many directors and officers recognize the importance of placing and renewing D&O insurance protection well in advance of any insolvency, including runoff coverage to protect executives long after they have resigned. When a claim arises during bankruptcy, insureds understandably look to the debtor’s coverage as the first line of defense.
In some instances, those directors and officers may be surprised to learn that the policy they had carefully crafted was cancelled – not by the company, but by the bankruptcy trustee, who recovered the policy premium for the benefit of the estate at the expense of leaving the debtor’s officers and directors unprotected. Thus, policyholders should confirm that D&O policies have provisions stating that they cannot be cancelled for any reason except for non-payment of premium, even if the cancellation is being requested by the insured (including a bankruptcy trustee or other entity acting in the capacity of the insured).