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D&O Insurance Issues in Bankruptcy
In a D&O policy, the definition of “Claim” can significantly affect the scope of coverage provided under that policy. The breadth of the definition, moreover, can differ significantly from one carrier's form to another. Forms also vary considerably with respect to the extent to which administrative or regulatory investigations are included within the definition of Claim. Unless specifically negotiated and carefully worded, many D&O policies will not automatically cover investigations, or at best, will provide very limited coverage. The insured needs to make certain that the formal triggers providing for investigative coverage are not unnecessarily restrictive. The definition of Claim must also take into account the types of litigation and investigations that may occur across a wide variety of jurisdictions, in order for coverage to apply.
For companies with U.S. securities exposures, another important issue is whether the D&O policy specifically includes coverage of damages that fall under Section 11 of the Securities Act of 1933 within the definition of “Loss.” Courts in certain jurisdictions have held that in the absence of such express language, Section 11 damages are restitutionary in nature and are therefore not “Losses” as provided for under a D&O policy. In order for coverage to apply, wording should be carefully drafted and negotiated.
Wording should also be carefully reviewed with regard to the advancement of defense expenses to determine whether such advancement is mandatory or discretionary, as written. Where the advancement of defense expenses is permitted but not required by law, D&O policies (and carriers) will presume that the company's discretion has been exercised, and that the advancement of expenses has been made pursuant to its indemnification obligations (whether it has or not). Therefore, the policy should reflect the advancement of expenses as provided for in the underlying indemnities, and further, should provide for mandatory advancement of expenses under the policy in circumstances where the company is not able to advance expenses due to, for example, legal prohibition or insolvency. If the policy is not properly drafted, a director or officer will be forced to pay his/her own expenses. In addition, the policy should provide that defense expenses will be advanced within a specified time period in order to ensure timely payment.
The Implications of Bankruptcy
Disputes under D&O policies can arise when the insured, whether voluntarily or involuntarily, files for bankruptcy or becomes insolvent. It is important to have bankruptcy provisions that adequately facilitate access to the policy proceeds in the event the scenarios above occur. The company should request specific provisions ensuring that the D&O insurance policy is available for the primary benefit of its directors and officers in the event of a company's bankruptcy. Specifically, the company should request the inclusion of the following bankruptcy protections in its policy:
Priority of Payments. In bankruptcy, the “automatic stay” prevents claims against the bankruptcy estate, including insurance policies and certain insurance policy proceeds that belong to the estate. However, the automatic stay will not prevent the assertion of claims against directors or officers, so they may be left without coverage if the proceeds of the D&O policy are deemed to belong to the estate. Proceeds of D&O policies with: 1) Side A coverage, provided for directors and officers of the company in the absence of indemnification by the company, which usually does not have a retention (deductible); and 2) Side B coverage, provided for the company for its obligation to indemnify the directors and officers in the event of claims against them, which usually has a significant retention, will not generally be deemed to belong to the bankruptcy estate and, therefore, may be distributed during bankruptcy. For policies that also provide Side C coverage (the majority of policies written since 2000), provided for liabilities of the company, which, like Side B coverage, usually has a significant retention, a properly drafted policy can ensure that certain of the proceeds of the policy are available to the directors and officers. A “priority of payments” provision provides that Side A claims have priority over Sides B and C claims and Side B claims have priority over Side C claims. Bankruptcy courts have concluded that the “priority of payments” provision has the effect of excluding from the bankruptcy estate certain of the proceeds of the policy, thereby conferring directors and officers access to those policy proceeds.
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