bkrOn September 4, 2014, in the latest in a series of rulings on the issue of whether MF Global’s D&O insurers may pay the defense expenses the company’s former officers and directors are incurring in the various lawsuits pending against them, Southern District of New York Bankruptcy Judge Martin Glenn held that the insurers may pay the individuals’ defense expenses without restriction and he ruled further that payment of the individuals’ defense expenses should not be subject to any further bankruptcy court oversight, except with respect to $13.06 million of the D&O insurance proceeds that the bankrupt estate could claim under the policy if the estate were to pay indemnification to certain individuals. The detailed opinion makes for instructive reading for anyone interested in knowing how the issues affecting the operation of a D&O insurance policy in a bankruptcy context. A copy of Judge Glenn’s opinion can be found here.


MF Global had filed for bankruptcy in October 2011 after concerns about the company’s investments in European sovereign debt had set in motion a series of events that led to the company’s collapse. In the wake of the company’s failure, a series of claims were filed against the company’s former directors and officers. The former directors and officers sought to have the stay in bankruptcy lifted so that the company’s D&O insurer could lfund their defense in the litigation.


At the relevant time, MF Global had maintained a $225 million D&O insurance program, consisting of a primary policy of $25 million and various layers of excess insurance totaling an additional $200 million. As discussed here, in April 2012, Judge Glenn had ruled, over the objection of various claimants who had asserted claims against the individuals, that the D&O insurers could advance the individuals’ defense expenses subject to a “soft cap” of $30 million. The court did not at the time make any determination whether the policy proceeds were part of the bankrupt estate. In a subsequent ruling, Judge Glenn raised the amount of the cap to $43.8 million.


The individual defendants then filed a motion with the court seeking a ruling that the payment of their defense fees under the D&O insurance policies should no longer be subject to a cap. The defendants argued that because the bankrupt companies were unlikely to be subject to any claims that would trigger the policies’ entity coverage and and because the bankrupt entities’ indemnification obligations were unlikely to give rise to a claim under the D&O policy, the individuals should have access to the D&O insurance proceeds without further limitation.


In his September 4 opinion, Judge Glenn said that the individuals had “advanced compelling arguments that the proceeds should not be subject to further bankruptcy court oversight.” He said that “at least with respect to insurance policies to which the Debtors have no direct claims to policy proceeds, the Court has no legal basis to limit or restrict claims by the Individual Insureds that are within the coverage.”


The Court did express alarm about the rate at which the defense expenses are accumulating. He noted that “the amount of insurance proceeds expended to date for the defense of the Individual Insureds has been staggering.” He noted that more than $48 million had been incurred already “even before the first deposition has been taken,” adding that this fact “is of great concern to the Court.” But despite his alarm over the amount of the defense expenses, Judge Glenn said that “it is not the proper role of the bankruptcy court to police litigation in other courts that does not directly affect that property of the estate.” Judge Glenn said he does not believe the law “supports placing the bankruptcy court as the overseer of defense costs.”


Observing that the Debtors (that is, the bankrupt companies) had “negotiated the insurance policies that provide their former officers, directors and employees with protection against the kinds of litigation claims that have been asserted,” Judge Glenn held that the individuals were entitled to the full amount of the D&O Insurance proceeds – with the exception of $13.06 million he reserved for reimbursement of future indemnification payments by the bankruptcy estate.


This exception for future indemnification payments is interesting. The administrator of the court-approved bankruptcy plan had argued that the individual defendants should not have unrestricted access to the policy proceeds because of the possibility that the bankrupt estates could have claims under the policy for indemnification amounts it might pay to or for the benefit of the former MF Global directors and officers. Judge Glenn said that likelihood of any such indemnification is “speculative” other than with respect to specific amounts of indemnification for which certain of the individuals had filed claims in the bankrupt estate. The court had in fact entered an order in which these indemnification claims had been estimated at a total of $15.56 million.


 The bankruptcy estate has not yet provided any actual indemnification to the insureds. If the estate were to pay the indemnification and seek reimbursement out of the D&O insurance proceeds, the estate’s claim against the insurance would be subject to the applicable $2.5 million retention, meaning that the most the bankrupt estates could seek would be $13.06 million. Judge Glenn said that “it would be premature to label [an indemnification] payout as purely hypothetical.” He added that the individuals “will not be prejudiced by establishing a $13.06 million reserve in light of the substantial unused amounts available under the D&O insurance policies.”


There are a number of interesting features of Judge Glenn’s ruling, The first is his clear sense that in allowing the individual insureds to have access to the policy proceeds to fund their defense, he was merely providing the benefit of the bargain that MF Global had struck when it purchased the policies. The policies’ inclusion of a provision that gives priority of the payment of the insurance proceeds for the protection of individual insureds in preference to the protection or reimbursement of the entity means that the policy was designed to provide the very benefits that the individual insureds were seeking. Jude Glenn noted, significantly in my view, that it “would be fundamentally unfair to allow the litigation to proceed while denying the individual insureds coverage for the defense cost.”


It is also significant that Judge Glenn mostly rejected the suggestion that he should retain control over the policy proceeds because of the possibility of future payments by the bankruptcy estate of indemnification to the individual defendants. He called this possibility “speculative” and not a valid reason for the court to retain control over the proceeds – except with respect to the specific amounts for which the individuals had actually filed a claim in the bankrupt estate and with respect to which the court had entered an order estimating a value. While indemnification claims generally were speculative, Judge Glenn was prepared to preserve a portion of the policy proceeds for which an estimated amount had been established in a court order.


But though Judge Glenn reserved this amount of the policy proceeds, his willingness to reserve these amounts was a reflection of several very specific conditions. First, he noted that any request by the bankrupt estates for reimbursement of indemnifications amounts paid would be subject to the policy’s priority of payments provision. In other words, the application of the insurance proceeds to the payment of the nsureds’ defense expenses would take priority to any reimbursement of indemnification amounts paid by the bankrupt estates. Second, his willingness to set aside the reserve was justified in part because doing so would not prejudice the individuals, due to the “substantial unused amounts” of insurance available. These determinations imply that he might not have been willing to reserve the $13.06 million if the individuals were to be prejudiced thereby or if there were not ample amounts of unused insurance proceeds. Finally, in establishing the reserve, he noted that it was “premature” to conclude that the possibility of an indemnification payout was purely hypothetical. This suggests that a time may come when the possibility of an indemnification payment may be assessed and disregarded if it appears at that time to be only hypothetical or unsubstantiated. .


I have highlighted the very specific factors surrounding the $13.06 million Judge Glenn reserved in order to emphasize the limited basis on which he made the reservation. I frankly believe the purpose of the insurance in this context is to provide defense expense protection for the individuals without limitation, and I hope it is clear that in most instances potential future claims against the bankruptcy estate for indemnification should not serve as a basis for restricting the payment of individual insureds’ defense expenses. The existence of the prior bankruptcy court order estimating the indemnification amounts and the absence of prejudice to the individuals are important factors that should limit the extent to which insurance proceeds are reserved from payment of the individuals’ defense expenses due to hypothetical future indemnification requirements.  


I also think it is interesting that Judge Glenn concluded that there was no basis for the bankruptcy court to continue to exercise oversight over the payment of the insurance proceeds, notwithstanding his concerns about the alarming rate at which the defense expenses are accumulating. The involvement of bankruptcy courts in the process of payment of individual insureds’ defense fees can be a complicating factor that sometimes muddles or unnecessarily adds expense and uncertainty to the process of claims administration in the bankruptcy context. In many instances, it would be helpful if other bankruptcy courts were to conclude that there is no basis for the court’s to maintain an oversight role.


I have often thought that the whole question of whether or not the proceeds of the D&O insurance policy should be allowed to be applied to the payment of individual insureds’ defense expenses has been belabored unnecessarily. As I have emphasized in numerous posts on this site, including even a prior post about  the payment of the individual defendants’ defense fees in the context of the MF Global bankruptcy (here), the failure to allow the individuals access to the insurance proceeds in order to be able to defend themselves would frustrate the very purpose of the insurance. Claimants often confuse the purpose of liability insurance and argue that it should be preserved for their protection or benefit. The fact is that policyholders buy insurance for their own protection not for the protection or benefit of third-parties that might file claims against them. The insurance is there to protect the insured persons from liability, not to create a pool of money for the benefit of prospective claimants. To be sure, payment of insured persons’ defense expenses reduces the amount of insurance remaining to fund any settlements or judgments, but that is in the nature of the insurance. The payment of the insurance proceeds for this purpose is merely putting into effect the benefit of the bargain the policyholder bought when it acquired the insurance.