Insurance and bankruptcy concepts often come together in disputes involving insured entities in bankruptcy. One such issue concerns the applicability of certain exclusions to management liability coverages for the bankrupt entity or its officers and directors.
In a recent decision, the U.S. Bankruptcy Court for the Southern District of Texas was asked to determine whether a bankruptcy exception to an insured-versus-insured exclusion applied to a CEO’s claim for coverage against a claim brought by his former employer, the Debtor-in-Possession (DIP), in an adversary proceeding. In re Walker Cnty. Hosp. Corporation, No. 19-36300, 2024 WL 4394508, at *1 (Bankr. S.D. Tex. Oct. 3, 2024). The D&O policy at issue contained the following bankruptcy exception:
This Coverage Section shall not cover any Loss in connection with any Claim:
H. brought by or on behalf of any Insured, provided however, that this Exclusion shall not apply to:
(6) any Claim brought or maintained by or on behalf of a bankruptcy or insolvency trustee, examiner, receiver or similar official for the Company or any assignee of such trustee, examiner, receiver or similar official[.]
Id. at *2.
The court held that the language was ambiguous:
On the one hand, the debtor-in-possession is clearly defined by the Policy to be the Company. Under this reading, a Claim by a debtor-in-possession would fall under the Policy's insured v. insured exclusion as a Claim by the Company. On the other hand, a debtor-in-possession is a similar official to a bankruptcy trustee and is thereby authorized under the Policy's bankruptcy exception to bring a Claim on behalf of a “debtor.” By using these terms without precision, the Policy never considers what happens when a claim is brought by an entity acting for the Estate, the legal owner of the claim.
Id. at *8.
Relying on the insurance policy interpretation rule that ambiguities should be construed against the insurer as the drafter and in favor of the insured, the court held that the “more reasonable interpretation” was that the bankruptcy exception clause permits coverage for suits “by fiduciaries acting on behalf of a debtor’s estate.” The court also noted that this interpretation is supported by the Bankruptcy Code, which provides that the DIP “shall have all the rights…and powers…of a trustee serving in a case under this chapter.” 11 U.S.C. § 1107(a).
This decision is supported by other recent decisions. See, e.g., Westchester Fire Ins. Co. v. Schorsch, 186 A.D.3d 132 ( Dep’t 2020) (holding that the phrase “comparable authority” indicated an intent to allow bankruptcy-related constituents such as the Creditor Trust to assert covered claims); In re Ford City Condo. Ass'n, 653 B.R. 420 (Bankr. N.D. Ill. 2023) (finding no ambiguity where the policy expressly provided that both bankruptcy trustees and DIPs were included in the definition of “Organization” and the exclusionary language applied to actions brought by the “Insured,” which was defined, in part, as the Organization).
Taken together, the decisions send the same message: words matter. As the court noted in Walker, “using [] terms without precision can result in [policies that] may have an ambiguity.” Walker, 2024 WL 4394508, at *8.
Insurers seeking to exclude coverage should do so clearly and without ambiguity. Insureds, by contrast, should work with their insurance professionals to, where possible, negotiate narrow exclusions and broad exceptions. After all, insurance assets may be critical to a bankrupt entity and its former officers and directors, and one of the major sources of funding for the defense of claims.
