As I noted in yesterday’s post, there could be a significant number of bankruptcies in coming months, and D&O claims in the bankruptcy context could give rise to insurance coverage disputes. In addition to the possible coverage issues I noted in yesterday’s post (pertaining bankruptcy exclusions, in particular), another issue that could arise is whether or not coverage for claims brought on behalf of the bankrupt debtor’s estate or on behalf of unsecured creditors is precluded by the insured vs. insured exclusion found in most policies.
Most insured vs. insured exclusions include a carve-back preserving coverage for claims brought by trustees and other estate representatives. In a recent ruling that broadly considered the scope and purpose of the insured vs. insured exclusion’s bankruptcy claim coverage carve-back, a New York intermediate appellate court concluded that the carve-back applied to preserve coverage for a claim brought by a Creditor Trust formed to pursue post-confirmation legal actions on behalf of unsecured creditors. The May 14, 2020 opinion in Westchester Fire Insurance Company v. Schorsch can be found here.
RCS Capital Corporation (RCAP) filed for Chapter 11 bankruptcy in March 2016. During the bankruptcy process, negotiations between RCAP and the company’s creditors resulted in the bankruptcy court’s approval of RCAP’s Chapter 11 reorganization plan creating a litigation trust, labeled “Creditor Trust.” The Creditor Trust was formed to pursue the bankruptcy estate’s legal claims on behalf of the unsecured creditors, after RCAP’s emergence from bankruptcy. Post-confirmation, the Creditor Trust sued RCAP’s directors and officers alleging they had breached their fiduciary duties to the company.
During the relevant period, RCAP maintained a D&O insurance program consisting of a primary layer of insurance and multiple excess layers of insurance. The primary policy and the first-through-fifth excess layers were exhausted by the defense and settlement of other claims. The sixth layer excess advanced defense expenses for the individual defendants in the Creditor Trust action. As the sixth layer neared exhaustion, the seventh level excess carrier issued a coverage denial letter, asserting that coverage under its policy for the Creditor Trust action was precluded by the Insured vs. Insured exclusion. The seventh level excess carrier then initiated a separate action seeking a judicial declaration that the exclusion precluded coverage for the Creditor Trust action. Other excess insurers whose policies in higher layers in the program joined the action. The excess carriers pursuing the coverage action are referred to below as the insurers.
The insurers and the individual defendants filed cross-motions for partial summary judgment on the question of coverage. The trial court granted the individuals’ motion for partial summary judgment, ruling that the bankruptcy carve-back applied to preserve coverage for the Creditor Trust action. The insurers appealed.
The Relevant Policy Provisions
The primary policy in the D&O insurance program, to which the excess insurers’ policies follow form, included an insured vs. insured exclusion, precluding coverage for “any Claim made against an Insured Person … by, on behalf of, or at the direction of the Company or Insured Person.” The exclusion has a bankruptcy claim carve-back, which restores coverage precluded under the exclusion for claims “brought by the Bankruptcy Trustee or Examiner of the Company or any assignee of such Trustee or Examiner, or an Receiver, Conservator, Rehabilitator, or Liquidator or comparable authority of the Company.”
The May 14, 2020 Opinion
In a May 14, 2020 opinion written by Associate Justice Dianne T. Renwick for a unanimous five-judge panel, the New York Supreme Court Appellate Division (First Judicial Department) upheld the ruling of the trial court that the bankruptcy carve-back to the policy’s Insured vs. Insured exclusion preserved coverage for the Creditor Trust action. However, the appellate court vacated the trial court’s grant of the insured defendants’ partial summary judgment motion, on the grounds that there were other alternative bases on which coverage for the Creditor Action might be precluded that had not been addressed by the trial court.
In upholding the trial court’s determinations with respect to the Insured vs. Insured exclusion, the appellate court said that “we find that the exception for ‘the Bankruptcy Trustee or…comparable authority…’ applies here to restore coverage removed by the insured vs. insured exclusion.”
In reaching this conclusion, the appellate court said that “the pertinent clauses of the insured vs. insured exclusion and the bankruptcy exception, when read together, are unambiguous.” Their “plain language” indicates “no intent to bar coverage for D&O Claims brought by the Creditor Trust, as a post-confirmation litigation trust.”
What makes the Creditor Trust “comparable” to a bankruptcy-related entity seeking to recover funds for the creditors, is that “the Trust is not merely a creditor.” Rather, “it is an entity and authority created as part and parcel of the bankruptcy reorganization proceeding, empowered by the bankruptcy court’s order of confirmation to file D&O Claims.”
The appellate court went on to note that “we perceive no valid rationale for excluding D&O claims from D&O coverage when asserted by a post-confirmation litigation trust where coverage would otherwise exist for identical claims asserted by a Chapter 11 trustee, liquidator or creditors’ committee.”
By including “the undefined and open-ended phrase ‘comparable authority’ into the D&O policy’s bankruptcy exception, the parties created a broadly applicable exception with no clear limiting principles other than there should be no coverage where the D&O claims are prosecuted by the [debtor-in-possession] or by individuals acting as proxies for the board or the company.”
In order to try to determine how the bankruptcy carve-back to the insured vs. insured exclusion applied to the circumstances of this case, the appellate court took a detailed look at the function, authorities, and relation to the bankrupt debtor of various kinds of bankruptcy-related entities and operatives, including also the specfic Creditor Trust at issue here. The court’s analysis will make compelling reading for anyone interested in thinking about the relation between these entities and authorities and the pertinent D&O policy provisions.
What makes the opinion interesting is the appellate court’s analysis of the purposes of the exclusion and of the coverage carve-back. The court’s analysis of these issues provides a sort of road map for others in trying to think about what kinds of claims the exclusion intended exclude and the kinds of claims for which the carve back was intended to preserve coverage.
From my perspective, the court’s most important observation is its recognition that the coverage carve-back expressly included a broad open-ended catch-all provision preserving coverage for “comparable authorities.” Of course reasonable minds may differ about what might make an entity or operative “comparable.” But the inclusion of this type of open-ended provision evidences a recognition that there a host of entities, vehicles, and authorities that might bring claims against insured persons in the bankruptcy context – particularly in the context of a Chapter 11 reorganization. The open-ended provision is a flexible extension of the carve-back’s coverage-preserving effect to these other entities, vehicles, and authorities, without the need for a specific policy reference to each one of these in order for coverage to be preserved. The phrase “comparable authority” is a “catch-all” provision, and it should be read that way.
As I noted at the outset, it seems likely that we are headed into a prolonged period in which significant numbers of companies will be seeking the protection of the bankruptcy courts. Historically, bankruptcy proceedings have been a fruitful source of D&O claims, and there is no reason to expect that that pattern will be any different in the context of the bankruptcies filed in the wake of the pandemic. In many instances, the bankrupt companies D&O insurers may seek to dispute coverage, among other grounds in reliance on the insured vs. insured exclusion. These kinds of coverage disputes will likely raise the question of the applicability of the bankruptcy carve-back in order to preserve coverage for the claims. The New York appellate court’s recent opinion provides a detailed example of the kinds of issues these disputes will involve.
Of course, whether or to what extent there will be insurance coverage for these claims will depend on the precise policy wordings at issue as well as the specific circumstances involved. But regardless of the specific circumstances, one point that any court considering these issues should keep in mind is this court’s pragmatic observation that there is “no valid rationale” for precluding coverage for claims where coverage would otherwise exist for identical claims asserted by a trustee or liquidator.
Compare and Contrast: In an earlier post (here), I discussed a 2017 opinion of the Sixth Circuit (applying Michigan law) in which the court held that the insured vs. insured exclusion precluded coverage for a claim that had been assigned to a litigation trustee by the debtor-in-possession. Significantly, the exclusion at issue in that case did not contain a bankruptcy claim carve-back provision.