One of the perennial issues involving D&O insurance coverage in the bankruptcy context is the question whether the directors and officers of the corporate debtor can tap the insurance policy to pay their defense expenses in connection with claims filed against them in their capacities as executives of the corporate entity. These issues have arisen once again in the bankruptcy proceedings of the corporate parent of Silicon Valley Bank, SVB Financial Group, where the bank’s directors and officers found themselves compelled to petition the bankruptcy court to lift the stay in bankruptcy in order for the bank’s insurers to pay the individuals’ defense expenses.
While there is nothing novel about the bankruptcy court’s order granting the stay, both the high-profile nature of the proceedings and the critical importance of the issues involved warrant taking a closer look at what unfolded in that case. A copy of the bankruptcy court’s May 22, 2023, order in the case can be found here. An August 23, 2023, memo from the Foley Hoag law firm about the court’s decision can be found here.
SVB’s corporate holding company maintained a program of D&O insurance consisting of a layered tower of $150 million of traditional ABC insurance and a separate$50 million tower of Side A insurance for the benefit of the individual directors and officers. The primary policy in the ABC tower contains a “priority of payments” provision, granting the individual directors and officers priority – as the law firm memo to which I linked above puts it, “first rights” – to the policy proceeds.
SVB and certain of its directors and officers have been sued in numerous class action lawsuits arising out of SVB’s failure. The individual directors and officers are represented by 14 separate law firms. The individual officers sought to have their defense expenses paid out of the bankrupt estate, which the estate declined on the ground that the bankruptcy precluded reimbursement in the absence of court order. The individuals also sought to have the bank’s D&O insurers pay their defense fees, who similarly declined on the grounds that reimbursement would require court approval.
The individuals then petitioned the court for relief from the automatic stay to permit the use of D&O insurance policy proceeds for the payment of the individuals’ defense expenses. The Creditors’ Committee objected to modification of the stay on the grounds that the proceeds were property of the estate and that depletion of the policy proceeds would diminish the availability of policy proceeds to pay the claims asserted against SVB.
The Court’s Order
In its May 22, 2023, order, the Court declined to rule on the question of whether the insurance policy proceeds were property of the estate, holding that cause to lift the stay existed even if they were property of the estate.
In holding that the individuals had established cause to lift the stay, the court held that the priority of payments provision gave the individual directors and officers the first rights to the policy proceeds. While the payment of the individual directors and officers could deplete much or even all of the D&O policy proceeds, the Court concluded that the priority of payments provision dictated this result. The court said that even if the payment of the individuals’ defense fees would deplete the proceeds, “they are entitled to the proceeds first” and the Debtor is last in line for the insurance proceeds.” The court concluded that cause existed to lift the stay.
The outcome of this case is noteworthy primarily because of the high-profile nature of the bankruptcy proceedings involved. There arguably is nothing out of ordinary about the result. As I have noted in numerous prior posts (for example, here), the practice of bankruptcy courts granting so-called “comfort orders” to lift the stay in bankruptcy to allow D&O insurers to pay individual directors’ and officers’ defense fees is a well-established practice. (For further discussion of the use of comfort orders in the bankruptcy context to permit the payment of individuals’ defense fees, refer here.)
However, even though these practices are now well-established, and have been employed in such high profile proceedings as the Lehman Brothers bankruptcy (refer here) and the MF Global bankruptcy (refer here), participants in these kinds of bankruptcy proceedings will continue to agitate on these issues.
While the procedures employed in this case are now well-established, there nevertheless are some important takeaways from this sequence of events. First, as the authors of the law firm memo to which I linked above note, the fraught situation in which these individuals find themselves is a reminder that “it is essential for companies to maintain a robust D&O insurance program.” The most significant importance of a program of D&O insurance is to provide protection in the event of a serious claim. All too often, insurance buyers think about what is the minimum amount of insurance the company can get away with, instead of thinking about how much the company and its executives will need in order for the company and individuals to be protected adequately in the event of a serious claim.
In addition, as the memo’s authors also note, the ruling in this case underscores the importance of a clear and unambiguous priority of payments clause (also sometimes called an order of payments provision). In light of the priority of payments provision in the policy at issue here, the judge was able to agree to lift the stay without having to try to decide the issue of whether the policy proceeds were property of the estate.
I have always thought that these recurring problems are the result of a fundamental misconception of the D&O insurance policy. For obvious reasons, claimants and creditors want to establish that the D&O insurance policy exists for their protection and benefit. For less obvious reasons, some courts fall for this, which I have always found frustrating.
The fact is that insurance buyers purchase D&O insurance to protect the insured persons from liability. No one pays insurance premium as a charitable act for the benefit of prospective third-party claimants. Liability insurance exists to protect insured persons from liability, not to create a pool of money to compensate would-be claimants. The very idea that claimants who have not even established their right of recovery from the insureds should be able to deprive the insureds of their right to use their insurance to protect themselves stands the entire insurance proposition on its head.
All of that said, there are recurring issues involved with the administration of these kinds of comfort orders, particularly, as discussed here, when court insist on asserting so-called “soft caps” on the amount of defense fees that can be paid or otherwise requiring ongoing Court supervision.