The automatic stay in bankruptcy may be lifted to permit MF Global’s D&O and E&O insurers advance the defense expenses of individual defendants in the underlying litigation arising out of the company collapse, notwithstanding the objections of the failed company’s commodities customers, according to an April 10, 2011 ruling from Southern District of New York Bankruptcy Judge Martin Glenn. The court lifted the stay without reaching the question of whether or not the policies’ proceeds are property of the debtors’ estate. A copy of the court’s April 10 decision can be found here.


As detailed here, on October 31, 2011, MF Global filed for bankruptcy after concerns about the company’s investments in European sovereign debt set in motion a chain of events that led to the company’s collapse. Following the company’s collapse, numerous directors, officers and employees have been named as defendants in action brought by securities holders, commodities customers and others alleging a host of legal violations. In response to these lawsuits, the various defendants have submitted notices of claims under MF Global’s insurance policies. Among the many lawsuits were a number of securities class action lawsuits, which have now been consolidated. Refer here regarding the securities class action litigation.


According to the Court’s April 10 opinion, during the policy period May 31, 2011 to May 30, 2012, MF Global maintained a total of $220 million of D&O insurance and $150 million of E&O insurance. The primary insurers in this insurance program had sought relief from the stay in bankruptcy to permit the insurers to pay the defense costs of the insured individuals in the various underlying matters. During an April 2, 2012 hearing on the question of whether or not the stay should be lifted, the Court was advised that lawyers have submitted claims for reimbursement or advancement of defense expenses totaling $8.3 million.


The objectors to the motion for relief from the stay included certain commodity customers of MF Global’s broker-dealer operations. The commodity customers objected to the lifting of the stay, arguing that the use of the policy proceeds to pay the individuals’ defense expenses would diminish the funds available of funds to pay claims against the debtors. The customers further argued that payment of defense costs is premature while the issue of the ownership of the policy proceeds remains unresolved.


Notwithstanding the commodity customers’ objections, the Court granted the carriers’ motions to lift the stay, finding that the carriers’ had adequately shown “cause” to lift the stay. The Court found that because there is sufficient “cause” to grant relief from the stay, it was not necessary for the Court to determine whether the policies’ proceeds are property of the estate. In concluding that the carriers’ had sufficient shown “cause to lift the stay,” among other things, the Court concluded that the individual insureds’ needs for payment of their defense costs “far outweighs the Debtors’ hypothetical or speculative need for coverage,” and that lifting the stay “would not severely prejudice the Debtors’ estates,” while the “failure to do so would significantly injure the Individual Insureds.”


The Court considered it particularly important that the primary D&O policy had a provision giving priority to payments under the insuring provisions that protects the individuals (a so-called “Priority of Payments” provision). This provision, the Court said, provide that “coverage potentially afforded to the Individual Insureds for non-indemnifiable losses must be paid prior to any payments for matters implicating coverage potentially provided to the Debtors.” The Court rejected the objectors’ contention that these provisions run afoul of the Bankruptcy Code, noting that the Debtors’ interests in the policies are limited by their terms, including the Priority of Payments Provision. The provisions “cannot be excised” because doing so would “rewrite” the policies and “expand the Debtors’ rights under them.” The Court reached similar conclusions with respect to the E&O policy as well.


The Court further found that New York State Insurance Law Section 3420(a)(1) requires the insurers to abide by the policy provisions notwithstanding any provisions in the Bankruptcy Code. The Court also concluded that the commodity customers’ rights, if any, to the policy proceeds had not yet vested. Finally the Court concluded that the equities favored permitted the insurers to pay the defense costs, noting that while claimants can pursue their claims “without the constraints of the automatic stay,” yet they seek to enjoin the individual insureds, who are not debtors and who are not protected by the automatic stay, “from seeking coverage under valid, applicable insurance policies.”


In granting relief from the stay, the Court further imposed reporting requirements on the parties to monitor the expenditures, subject to “soft cap” of $30 million, which in turn is subject to further adjustment by agreement of the parties or further order of the Court. In a final footnote, the Court noted that the cap is intended as an aggregate limit for defense costs from the D&O and E&O policies combined. The Court observed that “as is common in such circumstances, the insurers usually agree on allocation of policy proceeds for the advancement of defense costs,” but that “nothing in this Opinion addresses the allocation issues.”


The Bankruptcy Court was of course correct in lifting the stay to permit the insurers to pay the individual insureds’ defense expenses. Failure to do so would not only have undermined the individual insureds’ ability to defend themselves in the underlying litigation, but it would have frustrated the very purpose of the insurance. Claimants often confuse the purpose of liability insurance and assume that it is there for their protection and benefit. But liability insurance exists to protect insured persons from liability, not to create a pool of money to compensate would-be claimants.


To be sure, the payment of defense fees erodes the amounts available for any later settlements or judgments. That is a feature of this insurance, and is concern that affects all claims triggering this type of insurance. This concern is a particular troublesome in catastrophic claims like this one, but that has also been true in many other recent high profile claims involving failed companies, including, for example, the Lehman Brothers claims, where the stay was also lifted to permit defense expenses to be paid and where the huge defense expense rapidly depleted the available insurance and also made settlement of the underlying claims challenging.


Bloomberg’s April 10, 2012 article regarding the ruling in the MF Global bankruptcy can be found here. Detailed background regarding the D&O insurance coverage issues in the Lehman Brothers’ bankruptcy, including the questions surrounding the advancement of defense expenses, can be found here.  A summary of the relevant issues affecting D&O insurance in the bankruptcy context can be found here.


‘Sup Hillz?:  If you somehow managed to miss the Internet vibe about "Hillary’s texts" then you need to check the April 10, 2012 Washington Post blog post here — and also be sure to click through to the "Texts from Hillary"  site (here)  for a good laugh.