The number of publicly traded companies that filed for bankruptcy protection under either Chapter 7 or Chapter 11 declined in 2011, compared to the year prior, although the 2011 bankrupt companies collectively listed greater amounts of pre-petition assets than 2010 bankrupt public companies did, according to data recently released by BankruptcyData.com (here).
According to the report, 86 publicly traded companies filed for bankruptcy protection in 2011, compared to 106 in 2010, and compared to 211 in 2009. The number of 2011 filings represents a 17% decline from the prior year, and nearly a 60% decline from 2009. Though the number of public companies filing for bankruptcy declined in 2011, the 2011 public company bankruptcies represented aggregate pre-petition assets of $104 billion, compared to $89.1 billion in assets in 2010. The 2009 public company bankruptcies represented $281 billion in assets.
The company average pre-petition assets rose to $1.2 billion in 2011 from $840 million in 2010. The increase in aggregate and average assets that the 2011 bankruptcies represent is largely a factor of two very large public company bankruptcies during the year: the $40.5 billion asset MF Global bankruptcy and the $25 billion AMR Corporation bankruptcy. Those two bankruptcies alone represented more than close to two thirds of all of the aggregate 2011 asset value. The MF Global bankruptcy represents the eighth largest U.S. bankruptcy of all times. None of the bankruptcies in 2010 are among the top ten. The two large 2011 public company bankruptcies had the effect of driving up the average bankruptcy size during the year.
The report notes that the increase in aggregate and average pre-petition asset size during 2011 is “all the more striking considering the low number of financial company bankruptcy filings” during the year. Bankruptcies in the Banking & Finance industry “typically reflect a higher pre-petition asset figure than other industries.” But there were only four public company bankruptcies in the sector during 2011, compared with 2010, when 21 of the 106 public traded bankruptcies involved companies in the Banking & Finance sector.
The sector with the largest number of 2011 bankruptcies was Health Care & Medical, which had a total of 11 bankruptcies; followed by Technology and Energy which each had nine filings each.
Though the number of public company bankruptcies has declined in each of the last two years, the public company bankruptcies remained at elevated levels. The 86 public company bankruptcies in 2011, though below the annual totals in 2010 and 2009, are above the totals in the years preceding the credit crisis and going all the way back to 2005, when there were also 86 public company bankruptcies.
In terms of what may lie ahead, the report includes the comments of one observer, George Putnam III, the founder of New Generation Research, BankruptcyData.com’s parent company, as saying that, “I expect to see an increase in bankruptcies in 2012 as some of the massive amount of debt that was issued before 2008 begins to come due.” These comments about the likely bankruptcy levels are consistent with other public commentaries (refer here) that have also suggested that 2012 could be a busy year for business bankruptcies.
A January 10, 2012 Los Angeles Times article about the public company bankruptcy data can be found here.
Bankruptcy filings overall rose by 20 percent in the twelve-month period ending on June 30, 2010, according to information released on August 17, 2010 by the Administrative Office of the U.S. Courts. Though this filing surge was largely driven by non-business filings, business related filings also remained at elevated levels during the 12 months ended June 30.
According to the Administrative Office’s data, there were 59,608 business related bankruptcy filing in the 12 months ending on June 30 this year, compared to 55,021 in the 12 months ending on June 30, 2008, which represents an increase of 8.34%. The 59,608 for the twelve months ending on June 30, 2010 is the highest number of business-related filings for that 12 month period since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 took effect.
The number of business filings for the 12 months ended June 30, 2010, though only slightly greater than the comparable period in 2009, is also over 76% greater than the number during the comparable period in 2008, and almost 150% greater than during the comparable period in 2007.
Though the number of business-related filings remained at elevated levels during the 12 month period ended June 30, the number of business-related filings declined during each of the three month periods within that 12 month period. Thus, during the first three months of the 12-month period, there were 15,303 business related filings; in the second three months, there were 15,156 business-related filings; in the third three month period, there were 14,697; and in the final three months, there were 14,452.
As reflected in an August 17, 2010 analysis of the bankruptcy filing data by the American Bankruptcy Institute, business filings decreased 4 percent for the six-month period ending June 30, 2010, to 29,059 from the first-half 2009 total of 30,333.
Despite this quarter by quarter decrease in business-related bankruptcy filings, the overall number of filings (including non-business related filings) actually increased during the three months ending June 30, 2010, to 422,061, which is the highest for any quarter during fiscal 2010 (which runs October 1, 2009 to September 30, 2010), and the highest for any April-June quarter since the 2005 third quarter filings.
Though the news about bankruptcy filings overall is discouraging, the news related to business related bankruptcy filings may be slightly encouraging as there appears to be some suggestion that the worst may be past. However, that positive note should not obscure the fact that, even if the number of filings may be declining on a quarter to quarter basis, the number of business filings still remain at elevated levels compared to periods preceding the current economic crisis.
According to statistics compiled by the American Bankruptcy Institute, over 60,000 businesses filed for bankruptcy in 2009, the highest annual number of business-related bankruptcies since 1993. By way of comparison, the 2009 business bankruptcy filing levels were nearly 200% greater than in 2006. All signs are that these bankruptcy filing levels have continued unabated this year.
One of the frequent accompaniments of a corporate bankruptcy filing is the initiation of litigation against the directors and officers of the failed company. This litigation often leads to complex questions of D&O insurance coverage. As discussed in the April 2010 paper from ACE Insurance entitled "Financial Crisis: Bankruptcy Implications for D&O Insurance" (here), "bankruptcy poses the greatest threat of personal financial risk and the most complicated [D&O Insurance] coverage issues."
Yet there may be no time when D&O insurance is more important than in bankruptcy. As Paul Ferrillo of the Weil Gotshal firm notes in his April 30, 2010 memorandum "Directors and Officers Liability Insurance in Bankruptcy Settings – What Directors and Officers Really Need to Know" (here), "when a Corporation files for bankruptcy, the D&O policy becomes one of the few protections a director or officer has against lawsuits and claims targeting his or her personal assets."
Because, as the ACE report notes, "bankruptcy has the potential to dramatically complicate D&O coverage issues," it is important at the time the D&O insurance is put in place that these potential issues are taken into account and that the insurance is structured to try to reduce the likelihood of these complications arising in the event of a later bankruptcy.
The Weil Gotshal memo outlines a number of critical steps the company can take in structuring its insurance to address these bankruptcy-related concerns, including the following.
First, in order to avoid the possibility that the insurance is unavailable to defend individuals in bankruptcy related claims due to a policy rescission based on application misrepresentations, the company should incorporate into its insurance program a provision that the Side A coverage (protecting individuals for nonindemnifiable claims) is not rescindable. This provision specifies that the Side A coverage cannot be rescinded and will require the D&O carrier to begin advancing defense costs immediately.
Second, the company’s program should incorporate a Priority of Payments provision that, as described in the Weil Gotshal memo, "created a clear path that allows for the contemporaneous payment of defense costs for directors and officers." The provision specifies that payment of individuals’ defense expense or other loss costs takes priority over those of any insured entity. As the memo notes, this provision "limits the uncertainty of whether a D&O Policy will be immediately available to fund the defense costs of directors and officers who are embroiled in litigation when a company files for bankruptcy."
Third, the policy exclusion precluding coverage for claims against insureds brought by other insureds (known as the "insured vs. insured exclusion) should be amended to carve back coverage to ensure that the policy exclusion is not applied to preclude coverage for claims brought by "a debtor in possession, chapter 11 trustee, creditors, bondholders, all committees and other bankruptcy constituencies."
The Weil Gotshal memo includes a number of other policy prescriptions which, while described within the context of bankruptcy-related concerns, actually are critically important regardless whether or not a company might eventually wind up in bankruptcy, including the following.
First the company should ensure that there is "full severability" in connection with the policy application, so that any insured person’s knowledge of application misrepresentations "should not affect coverage for directors and officers who were unaware" of the misrepresentations.
Second, with respect to the D&O policy’s conduct exclusions (excluding, for example, coverage for criminal or fraudulent misconduct) should be drafted so that they are "triggered only upon a final adjudication of the prohibited …conduct."
Third, it is critically important for companies to attend to questions of limits adequacy and policy structure. Complex claims, of the type that often arise in bankruptcy but that can also arise without regard to bankruptcy, have the dramatic potential to substantially erode or even exhaust available insurance. The amount and structure of insurance acquired should take this dramatic possibility into account.
In particular, with respect to policy structure, board members will want to determine whether the company’s insurance program includes so called Excess Side A insurance or even Excess Independent Directors Liability Insurance (IDL). As the Weil Gotshal memo notes, when D&O claims are filed, the CEOs and CFOs "generally use up most of the coverage" in the Company’s D&O insurance program, "potentially leaving the independent directors with insufficient coverage to resolve the claims against them." Even though IDL policies "are the most underutilized insurance policies," it may be in the board’s interest to purchase IDL insurance as added protection in the event of significant claims against company inside management.
All of these concerns underscore the importance of taking all of these issues into account at the time the insurance is put in place, which in turn highlights the importance of having a knowledgeable and skill insurance professional involved in the insurance acquisition process. As the Weil Gotshal memorandum notes, "a good insurance broker may be able to assist in finding alternative primary carriers or alternative coverage solutions that will better satisfy a Corporation’s needs."
The complex D&O insurance coverage issues that can arise in the event of bankruptcy related claims are a recurring concern that I have previously explored in related posts, most recently here.
Putting Options Backdating Into Perspective: In light of the vivid events in the global financial marketplace in the last couple of years, the options backdating scandal seems both distant and even trifling, at least relatively speaking. However, as Professor Peter Henning points out in an April 30 post on the Dealbook blog (here), the government’s record in prosecuting options backdating may provide important clues to the way the government may proceed in connection with the current financial crisis.
As Henning notes, the options backdating results on the criminal side "were decidedly mixed," with a few trial victories but also with "notable acquittals." In particular, Henning notes, "the cases turned out to be much more difficult to win because the conduct had neither the visceral appeal nor the impact" that prior corporate scandals had. No company’s survival was threatened and the options practices involved accounting and tax issues were murky, allowing defendants to argue successfully in some cases that they did not believe they engaged in wrongdoing.
Henning suggests that "the experience with options backdating prosecutions may be leading prosecutors to adopt a much more cautious approach to cases involving complex financial transactions in which the accounting rules are less than clear." He concludes that "the options backdating cases show how difficult it is to win convictions against senor executives, even when they are directly involved in the transactions," as a result of which "we will see few, if any, prosecutions from the recent financial turmoil when executives can point to the markets as the reason for any harm suffered by their companies."
There is Absolutely No Cause for Alarm: Tom Kirkendall on the Houston’s Clear Thinkers blog recently linked to the classic Monty Python Skit, "How to Irritate People: Airplane" which reminded me in certain air travel woes to which I have been subjected. Please remain comfortably seated while you watch this video, and be certain to reassure yourselves that no one would deliberately set out to irritate anyone like this, now would they?
According to the March 11, 2010 bankruptcy examiner’s report, the collapse of Lehman Brothers was a result of the deteriorating economic climate, exacerbated by Lehman’s executives, whose conduct ranged from "serious but non-culpable errors of business judgment to actionable balance sheet manipulation."
The Report was prepared pursuant to a January 2009 bankruptcy court order directing the trustee to appoint an examiner to investigate the events leading up to Lehman’s collapse. The examiner appointed was Anton Valukas of the Jenner & Block law firm.
The full report is nine volumes long, consisting of 2,200 pages, and can be found here. The executive summary (which alone is 239 pages long) can be found here. According to news reports, Valukas spent $38 million conducting his examination. He and his team interviewed more than 100 people and scrutinized more than 10 million documents, plus 20 million pages of e-mails from Lehman.
The examiner’s report states that as conditions worsened during 2008 and in order to "buy itself time," Lehman "painted a misleading picture of its financial condition." For example, the report states, that while reporting a significant loss at the end of the second quarter 2008, Lehman "sought to cushion the bad news by trumpeting that it had significantly reduced its net leverage ratio," while failing to disclose that it had been using an "accounting device" – known as Repo 105 – that had "no substance" and whose sole purpose was to allow Lehman to "manage its balance sheet."
The report states that Lehman neither disclosed its use of nor "the significance of the use of the magnitude of its use of" Repo 105, to the Government, to rating agencies, to investors or even to its own Board. Its auditors were aware of but did not question the transaction. The Repo 105 balance sheet manipulation is summarized on the WSJ.com Deal Journal blog, here.
The examiner concluded that the business decisions that brought Lehman to a crisis "may have been in error but were largely within the business judgment rule." However, the "decision not to disclose the effects of these judgments does give rise to colorable claims against the senior officers who oversaw and certified misleading financial statements," including CEO Richard Fuld and the company’s CFOs, Christopher O’Meara, Erin Callan and Ian Lowitt.
The examiner also found that there is a "colorable claim that the "sole function" of the Repo 105 transactions was "balance sheet manipulation" that "created a misleading picture of Lehman’s true financial health."
The examiner also concluded that there are "colorable claims" against the company’s auditor, Ernst & Young, on the grounds that it "did not meet professional standards" for its "failure to question and challenge improper or inadequate as disclosures."
The examiner’s report explains that the report uses the phrase a "colorable claim" to mean one for which "there is sufficient credible evidence to support a finding by a trier of fact," without presuming the finder of fact’s ultimate conclusion.
The examiner also reviewed the actions of Lehman’s lenders, JP Morgan and Citigroup. The report concludes that "The demands for collateral by Lehman’s lenders had direct impact on Lehman’s liquidity pool," adding that "Lehman’s available liquidity is central to the question of why Lehman failed." Citigroup, which handled currency trades for Lehman, received a new guarantee from Lehman when Lehman was already insolvent and didn’t give enough value in return, the report said. The report concludes that "a colorable claim exists to avoid the Amended Guaranty as constructively fraudulent."
The examiner also reviewed the acquisition of Lehman’s North American brokerage, concluding that "a limited amount of assets" belonging to Lehman were "improperly transferred to Barclays."
The examiner recites at the outset of the report that under the relevant bankruptcy code provisions one purpose of a bankruptcy examination is to determine the existence of "a cause of action for the estate." Given the bankruptcy examiner’s conclusion that there are colorable claims against Fuld and the other former Lehman’s officials, as well as against its outside auditor, it seems reasonable to anticipate that the next step with be the bankruptcy trustee’s initiation of claims against these individuals and the auditor.
By way of comparison, after the New Century Financial bankruptcy examiner issued a report issued a report critical of company officials and the company’s auditor (about which refer here), the bankruptcy trustee filed a lawsuit (refer here) seeking to hold New Century’s auditors liable. In addition, the claimants in the New Century securities class action lawsuit relied heavily on the Examiner's findings in their amended complaint, which later suvived a motion to dismiss. I noted at the time of the dimissal that the bankruptcy examiner's findings may have strongly influenced the court in its dismissal motion ruling.
General Growth Properties Settles Credit Crisis-Related Securities Suit: According to a February 23, 2010 filing in the Northern District of Illinois, the parties to the credit crisis-related securities suit arising out of the collapse of General Growth Properties has been settled for $15.5 million, subject to court approval. The parties’ stipulation of settlement can be found here.
The General Growth Properties suit was one of the cases first filed in late 2008 as the subprime meltdown morphed into a full blown credit crisis, as I discussed in a post at the time, here.
The lead complaint, which can be found here, was filed in January 2009. The plaintiffs alleged that General Growth’s survival depended on its ability to refinance in November 2008 approximately $1.5 billion of its $27 billion of outstanding debt. Ultimately the company was unable to refinance its debt and it filed for bankruptcy in April 2009. The plaintiffs essentially alleged that the eleven individual defendants misrepresented the company’s ability to refinance its debt.
The complaint also alleged that the company’s senior executives had improperly loaned money to certain executives so that the executives did not have to sell their company shares in a margin call. The companies also allege that the company’s officials improperly sought to have the company’s shares included in the SEC’s short selling ban, so that the officials could sell their share at inflated prices.
In a September 29, 2009 opinion (here), Northern District of Illinois Milton Shadur granted in part and denied in part the defendants’ motion to dismiss. According to the settlement stipulation, in January 2010, the parties submitted the case to mediation, from which the settlement ultimately resulted.
The General Growth suit is one of only a handful of cases filed in the wake of the subprime meltdown and the ensuing credit crisis that has reached the settlement stage, and one of only a smaller handful of cases that have been settled following a dismissal motion ruling. We undoubtedly will see more settlements ahead as more cases work their way through the system.
I have in any event added the General Growth Properties settlement to my list of subprime and credit crisis-related case resolutions, which can be accessed here. My recent status update on the subprime and credit crisis related securities litigation can be found here.
Special thanks to Adam Savett of the Securities Litigation Watch blog for providing me with a copy of the stipulation of settlement.
Hello Polly: Many readers undoubtedly saw the article in yesterday’s Wall Street Journal (here) reporting that the Bank of America has apologized after its local contractor entered the home of a mortgage borrower, while she was away, and cutoff her utilities, padlocked the door and "confiscated her pet parrot, Luke." The homeowner, separated from her parrot for a week, filed a lawsuit against the bank for emotional distress.
This momentous story was deemed by the Journal’s editors to be worthy of a front page photograph of the homeowner, now fortunately reunited with her beloved parrot.
We mention this because, as was pointed out to us by a loyal reader, the Journal’s front page above- the- fold color photograph was headlined with the phrase "Hello, I Wish to Register a Complaint." We suspect that the Journal’s editors ran the picture on the front page for the sole reason that it gave them an excuse to use that headline.
If the topic is parrots, the only possible reference is to the immortal Monty Python dead parrot sketch, which believe it or not has its own Wikipedia page, here. The skit begins with John Cleese entering a pet shop and stating (as reflected in this script of the sketch) "Hello, I wish to register a complaint." Cleese’s problem in the sketch is not that his parrot has been confiscated; rather, his problem is that the parrot he had just purchased is dead. Deceased. It is no more. It has ceased to exist. It has joined the choir celestial. This is an ex-parrot
We are delighted to have this pretext to be able to embed a video of the sketch below. Because we think everyone should know a dead parrot when they see one.
Bankruptcy cases filed in the U.S. federal courts continued to surge in the twelve months ended September 30, 2009, according to statistics released on November 25, 2009 by the Administrative Office of the U.S. Courts. The statistical release, which can be found here, shows that for year ending on September 30, 2009, there were 58,771 business bankruptcy filings, up 52 percent from the 38,651 business filings in the 12-month period ending September 30, 2008.
Data accompanying the release show that the number of filings has increased in the 12-month periods preceding the quarter end for each quarter since the end of the third quarter of 2006.
Though the twelve-month data show a rising number of bankruptcy filings, the quarterly data for the most recent quarter show a slightly different picture, suggesting that the number of bankruptcy filings may have peaked earlier this year, and that during the most recent months the number of business-related bankruptcy filings may even have begun to decline slightly, at least from their 2009 year-to-date highs.
Thus, according to the Administrative Office’s monthly filing data (which can be found here), there were 15,177 business-related bankruptcies in the third quarter of 2009, compared to 16,098 during 2Q08, which represents a third quarter filing decline of about 5.7%. The highest monthly total during 2009 was in April 2009, when there were 5,621 business-related bankruptcy filings, compared to 4,853 in September 2009.
But while the 3Q09 business filings were down slightly from the preceding quarter, the third quarter filings nonetheless remained at very high levels. Thus, by way of comparison, the third quarter business bankruptcy filing total of 15,177 filings is considerably higher than the quarterly totals in 4Q08, when there were 13,021 filings, and in 1Q04, when there were 14,425 filings.
Whether or not bankruptcy filing peaked earlier this year, the number of bankruptcy filings remains significant. The possibility of bankruptcy remains a significant threat for financially troubled businesses. As I have previously noted (here), among the events that often follows after the filing of a bankruptcy petition is the arrival of claims against the bankrupt firm’s directors and officers.
Bankruptcy associated-claims present a host of complications, not least of which is the intricate way that D&O insurance policies respond in the bankruptcy context. One recent development illustrating the difficulties that can arise in the bankruptcy context was the July 2009 decision in the Visitalk case (about which refer here), in which the Ninth Circuit upheld the carriers’ denial of coverage for a lawsuit brought by a company as debtor in possession against former directors and officers of the company, as a result of the policies’ insured vs. insured exclusion.
These kinds of complications underscore the need for D&O insurance policies to be closely scrutinized for their ability both to withstand and to respond to claims arising in the context of bankruptcy.
Hat tip to the SOX First blog (here) for the link to the bankruptcy statistics.
More About FCPA Enforcement and Pharmaceutical Companies: As I recently noted (here, scroll down), both the DoJ and the SEC have indicated that Foreign Corrupt Practices Act enforcement has a high priority and that FCPA enforcement in the pharmaceutical industry is a particular focus.
A November 24, 2009 memo from the Latham & Watkins law firm entitled "U.S. Department of Justice Announces Stepped-Up Criminal Enforcement of Foreign Corrupt Practices Act Against Pharmaceutical Industry" (here) takes a closer look at these prosecutorial priorities.
The memorandum explains that among other reasons for the new focus on pharmaceutical companies is that "many foreign health systems, are regulated, operated and financed by government entities, and competition is intense, which creates more opportunities to ‘pay off foreign officials for the sake of profit.’" Of particular concern is the fact that it may not always be obvious which medical functionaries are "foreign officials" within the meaning of the FCPA.
The article includes a variety of suggested practical steps that pharmaceutical companies can take in light of these concerns.
Claims arising out of corporate bankruptcy represent a significant stress test for directors’ and officers’ liability insurance coverage. Among other frequently recurring issues are questions whether post-bankruptcy claims against the bankrupt company’s directors and officers run afoul of the Insured vs. Insured (I v. I) exclusion found in most D&O insurance policies.
In a July 10, 2009 opinion (here) that highlights many of these perennial bankruptcy-related D&O insurance coverage issues, the Ninth Circuit held that a D&O policy’s Insured vs. Insured exclusion bars coverage for claims that were brought against former directors and officers of a bankrupt company by the post-bankruptcy debtor in possession and later assigned to a creditors’ trust. The decision may have important implications for the prospective wording of coverage “carve backs” from the I v. I exclusion.
Background
Visitalk, which had filed a Chapter 11 bankruptcy petition, and while acting as “debtor and debtor in possession,” sued four of its recently discharged directors and officers for breaches of their fiduciary duties. Visitalk’s D&O insurers refused coverage for the claim, in reliance on the I v. I exclusion.
Visitalk’s primary D&O insurance policy’s I v. I exclusion provided as follows:
V. EXCLUSIONS
The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against the Directors and Officers . . .:
(D) brought or maintained by or on behalf of an Insured in any capacity or by any
security holder of the company except:
(1) a Claim, including, but not limited to, a security holder class or derivative action that is instigated and continued totally independent of, and totally without the solicitation of, or assistance of, or active participation of, or intervention of an Insured;
(2) an Employment Practice Claim3 by a former Director or a present or former Officer;
(3) a claim for contribution or indemnity if the Claim directly results from another Claim that is otherwise covered under this Policy; or
(4) a claim by any employee(s) of the Company described in IV.(D)(2) of the Policy.
Visitalk filed a Chapter 11 reorganization plan that assigned its claims against the directors and officers to a trust created by the creditors. The trustee for the creditors trust (Biltmore) and the four director and officer defendants agreed to settle Visitalk’s claims for about $175 million. The four directors and officers assigned to the creditors’ trust their rights against the D&O insurers. (The record does not disclose whether or not the settlement with Biltmore also included a provision typical of these kinds of arrangements, which is a covenant by the settling claimant not to execute any judgment entered pursuant to the settlement on the assets of the settling defendants.)
Biltmore, as trustee for the creditors’ trust, then sued the D&O insurers in reliance on the individuals’ assignment to Biltmore of their rights under the D&O policies. The District Court dismissed Biltmore’s complaint on narrow grounds relating to the relation between Visitalk’s primary D&O insurer and the primary insurer’s successor in interest. The Ninth Circuit did not reach the successor in interest issue but nevertheless affirmed the District Court’s dismissal of the case on the grounds that the I v. I exclusion applies.
The Ninth Circuit’s Opinion
The Ninth Circuit’s July 10, 2009 opinion (here) written by Judge Andrew J. Kleinfeld opens with a review of the reasons for the inclusion of an insured vs. insured exclusion in D&O insurance policies, noting that “because risks such as collusion and moral hazard are much greater for claims by one insured against another insured … than for claims by strangers, liability policies typically exclude them from coverage.”
The Court then noted that because none of the exceptions to the policy’s I v. I exclusion apply, the only question was whether the underlying suit was “brought or maintained on behalf of an Insured in any capacity.”
The Court found that the underlying claim had been “instigated and continued” by Visitalk as Chapter 11 “debtor and debtor in possession.” Though coverage was now being sought by the trustee of the creditor’s trust, it was doing so merely as an assignee. The court noted that “an assignee of a claim against an insurance company can have no stronger claim than the assignor who assigned the claim.”
The question then is whether Visitalk’s status as debtor in possession at the time it initiated the claim triggered the I v I exclusion.
Biltmore argued that Visitalk, the chapter 11 debtor in possession that brought the underlying suit, is not the same entity as Visitalk, the insured corporation. However, the Ninth Circuit concluded after a review of authorities that “for purposes of the insured versus insured exclusion, the prefiling company and the company as debtor in possession in chapter 11 are the same entity.”
The Ninth Circuit acknowledged that “it is certainly true that interests differ once a debtor goes into bankruptcy.” Among other things, due to the bankruptcy “ownership of the cause of action fell into the bankruptcy estate” and Visitalk as debtor in possession of the bankrupt estate was “empowered to act as fiduciary for its creditors and shareholders.”
Biltmore argued that because Visitalk as debtor in possession was acting as representative for the estate’s creditors in bringing the suit, the I v. I exclusion does not apply. The Ninth Circuit reasoned that while suit might be brought for the benefit of creditors, it was not brought “on behalf of” the creditors. The Ninth Circuit said that the suit is “for the benefit of the creditors, but on behalf of the pre-bankruptcy corporation.”
The Court said that the question was not whether the creditors might benefit from any recovery. The court said that the insurance “cannot be turned into an available pot for the corporation’s creditors by enforcing the insurance obligations while disregarding the parties’ agreement to limit those obligations to exclude insured versus insured claims.”
The Ninth Circuit concluded its analysis of the I v. I exclusion issues by noting that a contrary holding would
create a perverse incentive for the principals of a failing business to bet the dwindling treasury on a lawsuit against themselves and a coverage action against their insurers, bailing the company out with the money from the D & O policy if they win and giving themselves covenants not to execute if they lose. That is among the kinds of moral hazard that the insured versus insured exclusion is intended to avoid.
Discussion
As I have previously noted (here), the insured vs. insured exclusion is heavily litigated and continues to be at the heart of many D&O coverage disputes, particularly in the bankruptcy context, as this case demonstrates. In response to these many continuing disputes, the exclusion itself has continued to evolve, and the I v. I exclusion in the typical D&O policy in today’s marketplace is quite a bit different than the exclusion at issue in the Visitalk case.
Among other things, the I v. I exclusion in most D&O policies today contain additional exceptions to the exclusion, or coverage “carve banks” as they are usually called. Among other provisions now more or less standard is a carve back to the I v. I exclusion specifically relating to the bankruptcy context. A typical carve back of this type would specify that the I v. I exclusion would not apply “in any bankruptcy proceeding by or against an Organization” to “any claim brought by an examiner, trustee, receiver, liquidator or rehabilitator (or any assignee thereof) of such Organization.”
It would have been interesting to see how the Ninth Circuit would have addressed the issues in the Visitalk case if the policy as issue had contained these now fairly standard provisions. However, even if Visitalk’s policy had contained a carve back of this kind, it likely would not have altered the outcome, because the underlying action in the Visitalk claim had not been brought by any of the creditors’ representatives referenced in the carve back, but rather had been brought by Visitalk as debtor in possession.
The solution to this coverage problem would seem to be simply to include the debtor-in-possession in the list of bankruptcy-related claimants for whose claims coverage is carved back as an exception to the exclusion. Indeed, parts of the Ninth Circuit’s opinion in the Visitalk case suggest that this would be appropriate, particularly the Court’s comments about how a debtor’s status changes upon becoming a debtor in possession, and how an action by a debtor in possession as representative of the estate is for the benefit of creditors.
However, throughout the Ninth Circuit’s opinion is a pervasive concern with the possibility of collusive litigation. The Court clearly was concerned that if there were coverage, a debtor in possession action might represent a collusive attempt by a debtor company to use the cover of a bankruptcy filing and the ruse of a supposed claim as a way to access insurance proceeds to pay off the company’s debts.
Without minimizing the collusive possibilities to which the Ninth Circuit refers, I believe there is also a legitimate concern that without policy recognition in some way for debtor in possession claims, individuals could be left without insurance for claims of a kind for which D&O policies are intended to provide coverage.A debtor in possession claim is not inevitably collusive, and in that regard I note that the individuals named as defendants in the underlying suit in the Visitalk claim were former directors and officers, targeted post-bankruptcy on behalf of the bankrupt estate.
There are, in fact, D&O insurance policies available in the current marketplace that attempt to address the problem of debtor in possession claims. For example, one policy’s list of the bankruptcy-related claimants for whose claims coverage is carved back include “a Claim by the Entity as Debtor-in-Possession after such Examiner, Trustee, Receiver has been appointed.” The prerequisite for the availability of coverage under this carve back for the appointment of an examiner or trustee does represent some check against the collusive possibilities about which the Ninth Circuit was concerned.
Whether or not this particular formulation is sufficient to preclude the possibility of collusive claims, it strikes me as a step in the right direction toward protecting against the possibility that individuals could otherwise be left without coverage for claims of a kind for which these policies were intended to provide protection.
To be sure, the individual defendants in the Visitalk claim were not left to defend themselves without coverage; they entered into the settlement and assignment of rights with the trustee to the creditors’ trust. The parties’ entry into this settlement arrangement clearly troubled the Ninth Circuit, and the Court’s concerns about these kinds of settlement and assignment of rights deals clearly affected the court’s analysis. However, it should be noted that there is nothing about the debtor in possession claim context that uniquely encourages this kind of settlement, and litigants in many other contexts enter similar arrangements. Indeed, if the individuals were clearly covered and thus able to defend themselves, they would have far less incentive to enter these kinds of arrangements.
While I don’t mean to trivialize concerns about the possibility of collusive claims, for me the most important message from the Ninth Circuit’s decision in the Visitalk case is not necessarily the threat of collusive claims but rather then need to address in the policy the possibility of debtor in possession claims against individual directors and officers. The clear implication seems to be that the now fairly typical bankruptcy-related coverage carve back to the I v I exclusion should be modified to preserve coverage for debtor in possession claims.
One final observation about this particular coverage problem is that whether or not the primary D&O insurer will agree to provide a coverage carve back in the I v I exclusion for debtor in possession claims, an insured company may be able to purchase an excess Side A policy providing “difference in condition” protection and that either does not contain an I v. I exclusion or has one that is very narrowly circumscribed.
Because of the issues raised in the Ninth Circuit’s opinion, particularly the court’s concerns about the possibility of collusive claims, I would like to hear readers’ views about these issues, and I encourage everyone to post their thoughts for others using this blog’s “Comment” feature.
Very special thanks to Mike Early of the Chicago Underwriting Group for providing me with a copy of the Visitalk opinion. I hasten to add that the views expressed in the blog post are exclusively my own.
2009 Failed Banks – The Slideshow: This past Friday night, the Bank of Wyoming of Thermopolis, Wyoming, became the fifty-third bank to fail this year (refer here for more details). Regular readers know that the FDIC maintains a detailed list of failed banks (here). But who needs a list when you can see a slideshow, including pictures of all of the banks that failed this year? Check out Clusterstock’s failed bank slideshow, which is complete prior to the closure of the Bank of Wyoming, and can be accessed here.
Mid-Year Review: Securities Litigation and Enforcement: On July 9, 2009, I participated in a Securities Docket webinar entitled “Mid-Year Review: Securities Litigation and Enforcement” that included as panelists Lyle Roberts of the 10b5-Daily blog, Francine McKenna of the Re: The Auditors blog, Tom Gorman of the SEC Actions blog, as well as Bruce Carton of Securities Docket. Carton has posted a brief summary of the topics discussed in the webinar in a July 10, 2009 Compliance Week column entitled “Bloggers Offer 2009 Mid-Year Review” (here).
The webinar itself is available to be viewed online and can be accessed below:
The high-profile bankruptcies of two of the country’s leading auto companies have dominated recent headlines, but for all their size, complexity and notoriety, the GM and Chrysler bankruptcies are only part of the recent wave of bankruptcies that have swept through economy. Numerous other companies have also found themselves in bankruptcy court. As these bankruptcies have spread, bankruptcy-related securities lawsuits against the bankrupt companies’ directors and officers have followed. Unlike much of the credit crisis-related litigation thus far, these latest bankruptcy-related securities lawsuits are not concentrated in the financial sector.
The most recent example of bankruptcy-related securities litigation is the securities class action lawsuit that was filed on June 1, 2009 in the Eastern District of Arkansas against the CEO, CFO and Chairman of Charter Communications. Charter, which filed for bankruptcy on Marsh 27, 2009, was not named as a defendant. The complaint, which can be found here, purports to be filed on behalf of all persons who acquired Charter shares between October 23, 2006 and February 12, 2009.
The complaint alleges that during the class period the defendants made a series of statements that misled the investing public about the company’s ability to service its debt, about its need to refinance or recapitalize, and about its cash resources. As reflected in plaintiff’s counsel’s June 1 press release (here), the plaintiff contends that "defendants failed to disclose, among other things, that Charter would not be able service its debt to September 2010, but rather Charter would file bankruptcy in March of 2009. Also, the Defendants issued misleading statements about Charter’s potential for mergers. As a result of defendants’ false and misleading statements, Charter’s securities traded at artificially inflated prices during the Class Period."
A second recently filed bankruptcy-related securities lawsuit is the action filed on May 18, 2009 in the Southern District of New York against the former CEO and former CFO of Nortel Networks. Nortel, which filed for bankruptcy on January 14, 2009, is not named as a defendant. The complaint, which can be found here, purports to be brought on behalf of persons who acquired Nortel shares between May 2, 2008 and September 17, 2008.
According the plaintiffs’ counsel’s May 19, 2008 press release (here), the complaint alleges that the defendants "failed to disclose material adverse facts about the Company’s true financial condition, business and prospects." Specifically, the complaint alleges that the defendants failed to disclose that
(i) that demand for the Company’s products was declining as carriers cut back their capital expenditures and other customers deferred purchase decisions; (ii) that the Company’s financial results were materially overstated as the Company was failing to properly write-down its goodwill; (iii) that the Company’s restructuring was not meeting with success as the Company was struggling to cut costs and improve profitability; (iv) and as a result of the foregoing, defendants lacked a reasonable basis for their positive statements about the Company, its business, operations, earnings and prospects.
These two actions join the bankruptcy-related securities lawsuits recently also recently filed against the directors and officers of Idearc (about which I previously wrote here) and MRU Holdings (about which I wrote here).
In addition to the common element of bankruptcy, and the fact that as a result of the bankruptcy in each of the cases the company was not names as a defendant in the lawsuits, the recent actions against Charter, Nortel and Idearc also share something else in common, which is that each of these companies is outside the financial sector.
As has been well-documented elsewhere (refer, for example, here), the securities litigation arising out of the credit crisis has to this point largely been concentrated in the financial sector. However, these recent actions suggest that the spread of adverse financial consequences from the current economic crisis will not only result in an increasing number of bankruptcies but also in an increasing number of bankruptcy-related securities lawsuits.
These bankruptcy-related securities lawsuits, like the ones described above, are likely to arise in a wide variety of business sectors, not just in the financial sector. Indeed, because the bankruptcies are and are likely to continue to be spread throughout the larger economy, it seems increasingly likely that going forward the litigation arising from the current economic crisis will not be concentrated just in the financial sector.
Whether or not these most recent lawsuits will be successful of course remains to be seen. The scienter allegations in the Charter and Nortel complaints are not overwhelmingly detailed. Neither complaint contains insider trading allegations; rather, the scienter allegations depend on assertions about what the defendants knew or must have known, without further elaboration showing that the defendants had contrary knowledge at the time of the allegedly misleading statements.
The other interesting detail about the Charter complaint is that a number of the allegedly misleading statements on which the plaintiff relies were actually made by a UBS media analyst. Neither UBS nor the analyst is named as a defendant; rather, the plaintiff alleges that the analyst was "directed" to make "statements related to Charter by the Defendants." The complaint further alleges that after making these statements and recommending Charter’s stock, the analyst "became Charter’s primary banker."
Allegations that securities litigation defendants misled the investing public through statements by third party analysts are certainly not unprecedented, but as a result of Regulation FD and other developments, these kinds of allegations have become relatively rare, particularly in private securities lawsuits. Whether and to what extend these allegations in the Charter case serves as the basis of liability will be interesting to monitor.
In a recent issue of Insights (here), I discuss at greater length the likelihood that more bankruptcies could result in increased securities litigation, and the D&O insurance issues that bankruptcy-related securities lawsuits could present.
Deteriorating economic conditions threaten a massive wave of corporate defaults. Corporate borrowers’ inability to fulfill debt obligations could not only prompt a bankruptcy filing surge, but could also result in a flood of lawsuits and claims as creditors and shareholders seek to recoup their losses. These claims could present a host of challenging D&O coverage issues.
In the latest issue of InSights (here), I take a look at the conditions that could contribute to an increase in corporate bankruptcies, the likelihood that more bankruptcies could translate to increased litigation, and the D&O insurance issues that bankruptcy litigation could present.
Deteriorating economic conditions threaten a massive wave of corporate defaults. Corporate borrowers’ inability to fulfill debt obligations not only could prompt a bankruptcy filing surge, but also could result in a flood of ensuing lawsuits and claims as creditors and shareholders seek to recoup their losses. These claims could present a host of challenging D&O coverage issues.
The Growing Default Threat
According to a February 13, 2009 Wall Street Journal article entitled "Wave of Bad Debt Swamps Companies" (here), "the U.S. is entering a period likely to feature the most corporate-debt defaults, by dollar amount, in history." The article reports estimates that "U.S. companies are poised to default on $450 billion to $500 billion in corporate bonds and bank loans over the next two years."
In percentage terms, the default rate could "approach levels last seen in 1933." High yield default rates peaked around 15% in 1930. The Journal reports that S&P estimates that default rates will hit 13.9% this year "but could go as high as 18.5% if the downturn is worse than expected."
The "growing wave of souring debt" has already resulting in rising numbers of bankruptcies, including, just in the last few days, Muzak Holdings LLC; Pliant Corp.; Aleris International; and Midway Games.
However, as the Journal article observes, corporate defaults do not always result in Chapter 11 filings. Borrowers are sometimes able to restructure their debt outside of bankruptcy, and sometimes give creditors ownership stakes in exchange for reducing or elimination debt.
The Risk of Increased Numbers of Claims
In addition to the possibility of a growing number of bankruptcies, the prospect of surging corporate defaults also raises the possibility of an upsurge in claims against the directors and officers of the struggling or bankrupt companies.
Companies whose financial stability is deteriorating may as one consequence of their struggles get hit with a "going concern" opinion from their auditor. As the securities lawsuit filed against NextWave Wireless illustrates, the question whether a company can continue as a going concern alone can become an allegation in a shareholders’ class action complaint.
Claims may arise even when companies attempt a work out to try to avoid bankruptcy. These claims can come from shareholders, who may content that the workout resulted in a dilution of their interests, or it can even come from other bondholders, who may claim that their interests have been harmed or improperly subordinated, as demonstrated in the recent Station Casino bondholder claim (complaint here). Bondholders also recently filed a similar lawsuit against Harrah's Entertainment and certain of its directors and officers (refer here).
But a bankruptcy filing is particularly likely to be followed by claims against the bankrupt company’s directors and officers. These claims can come in the form of securities lawsuits brought against the individuals by the bankrupt company’s shareholders, as reflected for example in the recent cases filed against Pilgrim Pride’s corporate officials (refer here); against Britannia Bulk’s senior officers (here); or against the directors and officers of Charys Holding Company (here).
In addition, the Trustee in bankruptcy may also assert claims against the company’s directors and officers, as evidenced in the now infamous Just for Feet claim (about which refer here). As the Just for Feet bankruptcy also demonstrates, these various claims can arise simultaneously, which presents its own set of issues.
The Potential Coverage Issues
The advent of claims following bankruptcy presents a number of challenges in the context of any potentially applicable directors and officers’ liability insurance. Some of these challenges are a reflection of the size and structure of the insurance program; other challenges arise from the nature and extent of the coverage afforded.
With respect to the overall program, one critically important issue may simply be the amount of insurance available. The prospect for multiple simultaneous claims is increased dramatically when a company files for bankruptcy. The simultaneous prosecution of multiple claims presents the very real possibility that the insurance could be substantially depleted or even entirely exhausted. As demonstrated in the claims surrounding the Collins & Aikman bankruptcy (about which refer here), defense costs alone potentially could deplete the available limits.
And as demonstrated in connection with the multiple claims filed against the directors and officers of Just for Feet following that company’s bankruptcy, the proceeds of a traditional D&O insurance program alone may be insufficient to resolve all claims that can arise in the bankruptcy context. Both the Collins & Aikman and the Just for Feet examples have important implications for policy structure, as discussed below.
The interplay between the provisions of the Bankruptcy Code and the terms and conditions of the D&O policy may present certain specific challenges. As I discussed at greater length in a prior post (here), a recurring issue since so-called "entity coverage" has become a standard part of the D&O policy has been whether or not the D&O policy proceeds are property of the bankrupt estate under Bankruptcy Code Section 541(a) and subject to the automatic stay in bankruptcy under Bankruptcy Code Section 362.
A particularly good article discussing these questions regarding the D&O policy proceeds and the operation of the bankruptcy stay written by my good friend Kim Melvin of the Wiley Rein law firm can be found here.
Another frequently recurring D&O insurance coverage issue arising in the bankruptcy context is whether claims asserted by the Trustee or other receivers or liquidators against the company’s directors or officers funs afoul of the policy’s exclusion for claims brought by one insured against another insured. The "insured vs. insured" issue arises because of the concern that the Trustee or other claimant is "standing in the shoes" of a policy insured, the company itself.
Addressing the Insurance Concerns
A number of policy solutions to these recurring bankruptcy issues have developed in recent years. For example, a coverage carve-back to the insured vs. insured exclusion, now a standard provision in most policies, has continued to evolve over the years to address concerns about coverage for claims brought by Trustees and others.
In addition, many policies now contain "priority of payments" provisions as a way to try to address questions surrounding the availability of the D&O policy’s proceeds for the payment of defense expense or the resolution of claims notwithstanding the bankruptcy stay.
Perhaps even more importantly, to address concerns about the susceptibility of the policy proceeds to depletion or exhaustion from multiple simultaneous claims, particularly in the bankruptcy context, the D&O industry has developed a number of structural solutions designed to ensure that whatever may happen, a fund of money will remain available for specified individuals so they can defend and resolve claims against them. These structures might take any one of a number of forms, including a so-called Side A/DIC policy, or even an individual director liability (IDL) policy.
The complexity of these coverage and structural issues underscores the need to involve a skilled insurance professional in the D&O insurance acquisition process. Financial troubled companies in particular require the contributions of an informed and experienced advocate in structuring their coverage. The structure and the terms and conditions of a company’s insurance program could determine whether or not insurance coverage is available for individual directors and officers in the event of bankruptcy and related claims.
One final note about the likelihood of increasing corporate defaults. That is, the current deteriorating economic conditions not only present challenges for insurance buyers, they also present serious concerns for D&O underwriters. As the Journal article cited above notes, the defaults "will likely spread across many industries." Among the industries the article specifically mentions are "media, entertainment, casino and hotel companies, car makers and retailers."
Up to this point, the most significant consequences of the credit crisis have been concentrated in the financial sector. D&O underwriters have had the ability to segment risk arising from the credit crisis according to whether or not companies were financially related. However, with the growing threat of corporate defaults across many industry sectors, risk segmentation will be much more challenging. At a minimum, it will no longer be sufficient for underwriters to presume that risk is limited to the financial sector alone.
Kevin M. LaCroix is an attorney and Executive Vice President, OakBridge Insurance Services, Beachwood,Ohio, a division of R-T Specialty, LLC. OakBridge is an insurance intermediary focused exclusively on management liability issues.More...
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The number of publicly traded companies that filed for bankruptcy protection under either Chapter 7 or Chapter 11 declined in 2011, compared to the year prior, although the 2011 bankrupt companies collectively listed greater amounts of pre-petition assets than 2010 bankrupt public companies did, according to data recently released by BankruptcyData.com (here).
Bankruptcy filings overall rose by 20 percent in the twelve-month period ending on June 30, 2010, according to 
According to 
According to the March 11, 2010 bankruptcy examiner’s report, the collapse of Lehman Brothers was a result of the deteriorating economic climate, exacerbated by Lehman’s executives, whose conduct ranged from "serious but non-culpable errors of business judgment to actionable balance sheet manipulation."
Bankruptcy cases filed in the U.S. federal courts continued to surge in the twelve months ended September 30, 2009, according to statistics released on November 25, 2009 by the 
Claims arising out of corporate bankruptcy represent a significant stress test for directors’ and officers’ liability insurance coverage. Among other frequently recurring issues are questions whether post-bankruptcy claims against the bankrupt company’s directors and officers run afoul of the Insured vs. Insured (I v. I) exclusion found in most D&O insurance policies..jpg)
The high-profile bankruptcies of two of the country’s leading auto companies have dominated recent headlines, but for all their size, complexity and notoriety, the GM and Chrysler bankruptcies are only part of the recent wave of bankruptcies that have swept through economy. Numerous other companies have also found themselves in bankruptcy court. As these bankruptcies have spread, bankruptcy-related securities lawsuits against the bankrupt companies’ directors and officers have followed. Unlike much of the credit crisis-related litigation thus far, these latest bankruptcy-related securities lawsuits are not concentrated in the financial sector.
Deteriorating economic conditions threaten a massive wave of corporate defaults. Corporate borrowers’ inability to fulfill debt obligations could not only prompt a bankruptcy filing surge, but could also result in a flood of lawsuits and claims as creditors and shareholders seek to recoup their losses. These claims could present a host of challenging D&O coverage issues. 
Deteriorating economic conditions threaten a massive wave of corporate defaults. Corporate borrowers’ inability to fulfill debt obligations not only could prompt a bankruptcy filing surge, but also could result in a flood of ensuing lawsuits and claims as creditors and shareholders seek to recoup their losses. These claims could present a host of challenging D&O coverage issues.
