Many issues become complicated in the bankruptcy context. That is certainly true of D&O insurance coverage issues. A recent coverage decision out of the Western District of Michigan illustrates this point. In a March 31, 2016 opinion (here), Judge Janet Neff, applying Michigan law, held that the relevant D&O insurance policies’ Insured vs. Insured exclusion precluded coverage for a claim that was first transferred by a bankrupt company to a Liquidation Trust and then asserted by the Liquidation Trust against the company’s former directors and officers.
Capitol Bancorp, Ltd., a bank holding company, filed a Chapter 11 bankruptcy petition in August 2012. Negotiations between the Official Committee of Unsecured Creditors and the Debtor resulted in a settlement agreement, in which the Debtor agreed to the creation of a Liquidation Trust; agreed to transfer all causes of action belonging to the Debtor; and agreed to the limitation of any recovery on such claims to insurance proceeds. The company’s CEO signed the Liquidation Trust Agreement on behalf of the Debtor, and also signed the Liquidation Trust Agreement as a member of the Liquidating Trust Oversight Committee.
In August 2014, the Trustee of the Liquidating Trust filed a lawsuit in the Western District of Michigan against three former directors and officers of the company, including against the former CEO that had signed the Liquidation Trust agreement in her dual capacities as CEO of the debtor and a member of the Liquidation Trust oversight committee. The individuals submitted the lawsuit as a claim to the company’s D&O insurer. The insurer denied coverage for the claims and filed a lawsuit seeking a judicial declaration that coverage for the Liquidating Trustee’s lawsuit against the three individual defendants was precluded by the policies’ Insured vs. Insured Exclusion. The D&O insurer filed a motion for summary judgment in the coverage lawsuit.
The Exclusion provides that the Insurer shall not be liable to make any payment for Loss in connection with any Claim made against an Insured Person “by, on behalf of, or in the name or right of, the Company or any Insured Person,” with three exceptions, none of which, the Court later said, apply to this coverage dispute.
The March 31 Ruling
In her March 31, 2016, Judge Neff granted the insurer’s summary judgment motion, holding that the Insured vs. Insured exclusion precluded coverage for the Liquidating Trust’s action against the bankrupt company’s executives.
Judge Neff noted, at some length, the extent to which questions of the applicability of the Insured vs. Insured exclusion is unclear in the bankruptcy context. She noted that the “jurisprudential backdrop” provides the parties “with ample legal support for their opposing positions.” However, upon review of the factual circumstances leading up to the creation of the Liquidation Trust and the assignment to the Trust by the bankrupt company of the company’s claims against its former directors and officers, she concluded, while underscoring the circumstances, which she found to be “unique and significant,” that the exclusion applies to bar coverage.
In reaching the conclusion, the noted that in this case “there is a direct connection between the debtor/company/insureds and the Liquidation Trust, which was created by agreement of the Debtors and the Creditors’ Committee.” The settlement agreement “not only established the Liquidation Trust, but also transferred all causes of action belonging to the Debtors to the Liquidation Trust, including causes of action against directors and officers and Insiders, but limiting any recovery on such claims to insurance proceeds.” She also noted the fact that the debtor company’s CEO, one of the defendants in the Litigation Trust’s action against the company’s former executives, signed the Liquidation Trust Agreement on behalf of the debtor company, and also in her capacity as a member of the Liquidation Trust Oversight Committee.
The Liquidation Trust’s action is, Judge Neff said, “in effect an intracompany claim” of the type for which the Insured vs. Insured exclusion precludes coverage. Unlike the circumstances in other cases in which courts concluded that the exclusion did not bar coverage for claims brought by a bankruptcy trustee as a “genuinely adverse party,” the relationship between the parties here “cannot be considered genuinely adversarial.” Accordingly, Judge Neff concluded that the Insured vs. Insured exclusion bars coverage for the Liquidation Trust’s claims against the company’s executives.
As I have frequently noted in prior posts (for example, here), one of the perennial D&O insurance coverage questions is whether post-bankruptcy claims against the bankrupt company’s directors and officers run afoul of the Insured vs. Insured exclusion found in most D&O insurance policies. Among the reasons that the determination of D&O insurance coverage issues can be so challenging in the bankruptcy context is the fact that there are so many potentially interested parties whose roles and relationships to other parties are defined by operation of the laws of bankruptcy. Judge Neff cited with approval from one commentator who noted that “the constituents in the bankruptcy process, namely, the debtor in possession, Chief Restructuring Officer, plan trustee, bankruptcy trustee, and creditors’ committee, and in turn whether the ‘insured vs. insured’ exclusion applies to each, should be viewed as points on a linear continuum.”
In the end, the question whether or not coverage should exists for claims against directors and officers in the bankruptcy context will depend on the nature of the relationship between the parties, and, even more importantly, whether or not the claim is “genuinely adversarial.” Here, many of the actions the parties took in making their arrangements undermined their ability to later argue that the Liquidating Trust’s claims were genuinely adversarial. The fact that the debtor company’s CEO – later named as one of the three defendants in the Liquidating Trust’s lawsuit against the company’s former executives – signed the Liquidation Trust Agreement both in her capacity as an officer of the debtor company and as a member of the Liquidation Trust Oversight Committee substantially undermines any suggestion that there was a genuinely adversarial relationship between the parties.
One of the interesting features of this dispute is that the Insured vs. Insured Exclusion at issue in this case lacked a now fairly standard carve-back to the exclusion preserving coverage for claims in the bankruptcy context. A typical carve back of this type would specify that the Insured vs. Insured 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.” Often the list of claimants named in this coverage carve-back will include the creditors’ committee as well.
It would have been interesting to see how the Court would have addressed the issues in this case if the policies at issue had contained these now fairly standard provisions. The reference in the coverage carve back to claims by a “liquidator” might well have been relied to argue that the carve-back applied and that coverage was not precluded.
From the perspective of someone trying to maximize coverage, one possible conclusion from this case is, first, of course, that the Insured vs. Insured exclusion ought to include the bankruptcy proceedings coverage carve-back, and, second, that the carve back should expressly refer to a Liquidation Trust.
From the carrier’s perspective, the question of coverage in this context is always going to be uncomfortable, because there is always the risk of collusive claims. To be sure, Judge Neff never states that the claims here were collusive; while she refers to the risk of collusive claims, she carefully notes (in a footnote) that “the Court’s discussion of incentives for collusion … are presented only to distinguish policy concerns that arise, and are not meant to imply that the parties have engaged in any collusive activity.” However, the Ninth Circuit’s opinion in the Biltmore case (about which refer here), which Judge Neff cited throughout her opinion and on which her analysis largely relies, expressly cited the risk of collusion as one reason to enforce the Insured vs. Insured exclusion (in that case, in connection with a claim against a bankrupt firm’s former executives asserted by a creditors’ committee on assignment from the debtor-in-possession).
The question of whether or not the D&O insurance policy ought to cover these kinds of claims is an interesting one, but it is one that could be answered in a different way these days, at least within the context of the insurance structure that many companies now maintain. That is, most companies’ insurance programs now include a layer of Excess Side A DIC coverage. These policies often drop down to provide first dollar coverage when coverage is precluded under the company’s traditional D&O insurance. Many Excess Side A DIC policies these days do not have an Insured vs. Insured exclusion. The inclusion of this type of insurance in a company’s D&O insurance program could increase the likelihood that there would be at least some insurance coverage available in the event of a claim like the one asserted here.
Special thanks to a loyal reader for sending me a copy of this ruling.
Hail, Hail to Michigan: Many readers will undoubtedly have noted that Judge Neff sits in the Western District of Michigan. Some readers may also know that Western Michigan is very important to The D&O Diary. During the summer months, many of this blog’s posts are published from Western Michigan, and the rest of the year, this blog’s posts are published while the blog’s author is dreaming about Western Michigan. Some may also recall that I have written about Western Michigan on this blog; my first post about Pentwater, Michigan can be found here. My most recent post, written at the end of last summer, can be found here.