D&O Risk-Mitigation Tips
While the goal of protecting individual directors and officers is straightforward, securing adequate executive protection in a post-Purdue world can be complex. Below are several risk-mitigation considerations that can be implicated before, during, and after bankruptcy proceedings.
Evaluating Policy Exclusions
D&O policies contain several exclusions that could be implicated in insolvency situations.
The most problematic for companies facing insolvency are bankruptcy or insolvency exclusions, which may be added to policies when a company faces financial distress and can bar directors and officers from accessing D&O coverage during bankruptcy. While rare, these exclusions can significantly limit or eliminate coverage. If the exclusion cannot be avoided, insureds should attempt to limit its scope during the underwriting process.
Another exclusion implicated in bankruptcy is the “insured versus insured” exclusion, which bars coverage for claims brought by or on behalf of one insured against another insured. Issues can arise in bankruptcy when a trustee or creditor committee asserts claims against a director or officer on behalf of the debtor. Without appropriate carveouts to this exclusion, claims may be denied because these claimants are acting on behalf of the debtor company—an insured—against directors or officers, who are also insureds. Negotiating appropriate exceptions to this broad exclusion can protect coverage in the event of bankruptcy.
Insolvency-related claims against directors and officers may also implicate so-called conduct exclusions for deliberate criminal, fraudulent, or dishonest acts. Allegations of reckless or intentional conduct, even if baseless, can pose significant obstacles to advancing legal fees if the exclusion does not have appropriate “final adjudication” language, which can preserve coverage until the offending conduct is established by a final, nonappealable adjudication. As with most D&O policy provisions, exclusionary language is not one-size-fits-all and varies materially among insurers, forms, and endorsements, so policyholders must pay close attention to variations in wording that can have an outsize impact on coverage.
Understanding Runoff Coverage
The time to think about D&O insurance is before potential insolvency proceedings. One important aspect to vet in advance of bankruptcy is the availability and scope of a potential extended reporting period that may be available to the company to report claims in the event coverage is terminated during bankruptcy.
Preserving the ability to report claims—via what is often referred to as “tail” or “runoff” coverage—ensures that directors and officers are protected against claims if the company undergoes a change in ownership or management control during bankruptcy. Without runoff coverage, directors and officers would no longer have access to D&O insurance to defend against claims for actions taken during their tenure. This is important because claims might take time to surface as the bankruptcy process unfolds, or stakeholders may file claims even after the company’s operations end.
Securing Dedicated Side A Coverage
Traditional D&O policies include coverage for both the company and its directors and officers, usually subject to the same set of limits. That means that claims against the company may deplete or extinguish limits that otherwise would be available to protect directors and officers.
In most circumstances when the company is solvent, that structure is not problematic because even if the D&O insurance limits are extinguished, directors and officers can still count on the company to advance their legal fees and indemnify them in connection with claims arising from the decisions made on behalf of the company. In insolvency situations, however, that backstop of advancement and indemnity from the company is gone because the company is not able to pay, leaving D&O insurance as the sole protection for directors and officers facing personal exposure.
For that reason, policies should include dedicated Side A coverage, which sets aside separate limits available solely to protect individual directors and officers when an insolvent company is unable or unwilling to do so. Additional Side A limits are often available as part of the traditional “Side ABC” policy but can also be purchased via a stand-alone Side A–only policy, which can provide additional benefits like broader coverage and fewer exclusions. Finally, bankruptcy courts have held that Side A policy proceeds are not the property of the debtor’s estate. Therefore, the ability of directors and officers to access Side A policy proceeds is not constrained by the automatic stay, providing additional benefits to individuals who need to access that coverage quickly and efficiently to avoid being personally exposed.
Relying on Subcommittees and Outside Examiners
The formation of subcommittees chaired by independent directors or the hiring of outside examiners to evaluate potential claims is an effective strategy for proactively identifying and addressing directors’ and officers’ exposure. These pre-bankruptcy investigations can include a review of existing insurance policy provisions, decisions of directors and officers leading up to insolvency, and analysis of potential claim exposure.
By assessing the potential existence of claims at an early stage, companies can take steps to implement mitigation measures as necessary to minimize exposure to those claims. And the involvement of an outside examiner or independent board member can enhance the credibility of the investigation given their independent and unbiased position. In the event of subsequent litigation, this proactive approach can lay the groundwork for a successful defense through the documentation of key facts concerning D&O actions leading up to bankruptcy.
Implementing Consensual Release Agreements/Plans and Litigation Trusts
The above-described proactive liability-management strategies are best practices to mitigate D&O liability, but in the event of a bankruptcy, additional measures may be required to address potential D&O claims, which may require companies to navigate the issues in Purdue. For example, consensual third-party releases and litigation trusts are tools available for addressing personal liability in bankruptcy court.
Consensual Third-Party Releases: RSAs and Opt-In/Opt-Out Releases
A restructuring support agreement (“RSA”) is a prepetition agreement that a company reaches with its key stakeholders regarding restructuring terms. In exchange for stipulated economic treatment, RSAs can require the stakeholders to agree to third-party releases as part of a bankruptcy plan. These releases differ from those prohibited by Purdue because they are consensual. As a result, the utility of an RSA release turns largely on the company’s organization and the type of liability that directors and officers face.
For certain companies with a few key constituents with potential claims, an RSA that includes a third-party release provision is an effective liability-management strategy. For other companies with many third parties with potential claims, negotiating consensual releases may be untenable. And regardless of a company’s structure, RSA releases are not usually a realistic strategy for addressing mass tort liability, such as in Purdue, due to the massive number of claimants. In those instances, companies may try to obtain consensual releases through plan voting.
Since Purdue came down, litigation has ensued regarding whether “opt-in” and “opt-out” releases in bankruptcy plans constitute consent as part of the plan voting process. Opt-in releases require the releasing party to affirmatively consent to the release. Opt-out releases assume consent to the release unless the releasing party affirmatively opts out. Some courts have held that opt-out releases are acceptable in limited circumstances, depending on the specific facts and circumstances of the case. The Bankruptcy Court for the Southern District of Texas has gone further, approving a plan containing an opt-out release because opt-out consent has long been standard practice in the district. However, the U.S. trustee appealed the confirmation order in In re Container Store Group, Inc., setting the stage for the next potential Supreme Court bankruptcy release battle.
Litigation Trusts
Where consensual releases do not fully address D&O liability, litigation trusts are an additional option. Litigation trusts are created as part of a bankruptcy plan and channel claims of the estate (i.e., derivative claims of shareholders) into the hands of a litigation trustee to pursue on behalf of the estate. While this tactic does not release directors and officers from personal liability, it does make litigation and settlement negotiations efficient given that the trustee has the sole authority to pursue the channeled claims.
Conclusion
As the contours of Purdue continue to unfold, companies should proactively monitor developments in the law to avoid surprise coverage denials, large exposures, and similar issues that arise when a company enters the zone of insolvency. Engaging experienced professionals, such as insurance brokers and outside bankruptcy and coverage counsel, can help establish robust risk-mitigation measures and insulate directors and officers from personal liability.
