D&O Insurance: Advancing Defense Costs in Bankruptcy

After entity coverage began to be added to the D&O insurance policy a couple of decades ago, a recurring problem in the bankruptcy context was whether or not the D&O policy proceeds were property of the estate under Bankruptcy Code Section 541(a) and subject to the automatic stay under Bankruptcy Code Section 362. The question arose because the directors and officers of the bankrupt company wanted access to the insurance proceeds to fund defense expense or settlements, but the bankruptcy trustee wanted the proceeds preserved so they are available to satisfy the trustee's own claims, and so the trustee sought to subject payment of the proceeds to the bankruptcy stay.

As most practitioners who regularly deal with these issues know, the practical solution to these issues that seems to have been worked out is for the insured directors and officers to approach the bankruptcy court in order to try to obtain an order lifting the stay to allow the carrier to advance their costs of defense, usually subject to certain terms and conditions. These orders are often referred to as "comfort orders," since they allow the carrier to advance the defense costs without running afoul of the bankruptcy court.

Though these procedures may be well known to those who have to deal with them frequently, they may be less familiar to others in the industry who are not as frequently involved in claims presenting these issues. Recent developments in a high-profile case provide a window into these procedures. Although these case developments are not unprecedented, they still provide a useful and perhaps even interesting insight into the way these processes work, particularly for those who may be less familiar with the processes.

As was well-publicized at the time, in November 2012, the Rhode Island economic development agency sued former major league baseball star Curt Schilling and several executives at Schilling's defunct video gaming company, 38 Studios, in a civil action in Rhode Island Superior Court, alleging that Schilling and the other executives, as well as certain officials from the economic development agency, committed fraud in connection with the state's approval of a $75 million loan guarantee supposedly provided to induce the company to relocate to Rhode Island from Massachusetts.

At the time the lawsuit was filed, Schilling's company and certain related entities were in Chapter 7 bankruptcy proceedings in the District of Delaware bankruptcy court. The trustee in the bankruptcy proceeding contended that the proceeds of the company's D&O policy were subject to the automatic stay in bankruptcy. Schilling and three other executives from his company filed a motion in the bankruptcy court seeking to have the automatic stay lifted in order to permit the advancement under the D&O policy of their costs incurred in connection with the defense of the Rhode Island lawsuit. The bankruptcy trustee filed limited objections.

On February 7, 2013, Bankruptcy Court Judge Mary Walruth granted the executives' motion and entered an order (a copy of which can be found here) authorizing the D&O insurer to advance the executives defense costs, subject to certain conditions. First, the carrier was directed to provide the trustee and the trustee's counsel no more than 45 days after the close of each calendar quarter a report stating the total amount disbursed under the policy; the amount disbursed during the quarter; the amount of fee and costs requests pending for which the carrier had not yet made disbursement; and the total amount of coverage remaining under the policy. The order specified that the trustee retained the right to try to seek to have the stay reinstated. The order also specifically stated that the order did not modify the parties' various rights and obligations under the policy.

With the benefit of the order, Schilling and the other officials will now be able to rely on the D&O policy proceeds to fund their defense against the claims in the Rhode Island lawsuit. While there may be nothing remarkable about this now, for many years this relatively straightforward process was highly controversial and extensively litigated, as a result of disputes over the extent to which the policy and the policy proceeds were assets of the estate of the bankrupt company. Fortunately, the processes followed here are now better established. This case provides a good illustration of the way these things now work for those that may not be entirely familiar with these practices.

Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.

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