Bankruptcy Issues Arising For Specific Kinds of Insurance – New Appleman on Insurance Law Library Edition, Chapter 110

By James M. Lawniczak

Abstract

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Chapter 110 covers insurance issues that often arise in federal bankruptcy cases.  Due to their nature, certain types of insurance policies are implicated more often in bankruptcy proceedings than others.  For example, probably the most discussed type of insurance in bankruptcy cases is Directors and Officers’ Liability Insurance (“D&O”).  This is because creditors and other parties in interest are almost certainly going to lose money in a bankruptcy proceeding, creating a focus on likely additional sources of recovery.  Officers and directors, and the insurance protecting them, are inviting targets.  Insurance is also important in professional service provider bankruptcy filings, where the malpractice insurance will certainly be impacted; in asbestos cases where the liability insurance will play a major role; and in cases where insured entities owning properties subject to environmental problems file bankruptcy proceedings.  All of these types of issues are discussed in this chapter.

Section 110.01 focuses on D&O issues.   The section begins with a description of the three types of D&O policies that are available to the officers and directors themselves and the entity.  It continues in Subsection 110.02[2] with general bankruptcy principles, including the fact that insurance policies are property of the estate so that they are subject to the automatic stay.  The discussion then turns to whether the bankruptcy proceeding of the entity might prevent the officers and directors’ access to the insurance proceeds to cover defense costs in litigation.  Even though the insurance policy is property of the estate, the proceeds might not be if they are dedicated to another party or if the estate’s interest is inchoate.  It is somewhat unclear whether D&O insurance proceeds are property of the estate and thus subject to the automatic stay; and, if the proceeds are property of the estate, whether the automatic stay should be lifted so that the officers and directors can receive reimbursement of their defense costs from insurance proceeds.  The section also addresses whether actions against officers and directors are stayed or can be enjoined.

The discussion turns to the trustee’s or debtor in possession’s right to bring causes of actions against officers and directors that belong to the estate because the claims are generic to all creditors, rather than specific to any one creditor.  There follows consideration of whether a Chapter 11 trustee or an examiner should be appointed in the Chapter 11 bankruptcy proceedings of the entity due to the existence of claims against officers and directors and the D&O coverage because of the debtor in possession’s current management’s obvious reluctance to investigate and pursue such matters.

Next discussed are some typical exclusions to D&O coverage, including the dishonesty, insured vs. insured, pollution and asbestos exclusions.  Bankruptcy implications as to severance clauses and the claims-made feature of most D&O policies are then treated.

There follows a lengthy discussion in Subsection 110.01[8] about the nature of officer and director liability, including officers and directors’ duties when the entity is insolvent or nearly so.  The discredited doctrine of director liability for deepening insolvency comes next. Criminal, employment and securities claims conclude Subsection 110.01[8].

Section 110.01 concludes with a discussion of the very important in pari delicto defense.  It applies when a plaintiff such as the business entity, or its successor, sues the officers and directors, and the plaintiff bears equal or greater fault for the wrong.  Because the claims against the officers and directors generally belong to the bankruptcy estate, they will be brought by the trustee after the entity files a bankruptcy petition.  In that case, the trustee, as successor to the debtor, will be subject to the same defenses as the debtor, including the in pari delicto defense.  The allegedly wrongful actions of the officers and directors will be imputed to the plaintiff debtor, making it “in equal fault,” unless the actions were not for the benefit of the corporation and adverse to it.  Where there is a “sole actor” in a corporation, the doctrine always applies because the actions of the sole actor are necessarily those of the corporation.

Section 110.02 discusses professional liability insurance. Addressed are the effect of the insured’s bankruptcy filing on the insurance, who has standing to bring claims after the filing, as well as implications for bankruptcy counsel and the insurer.

Section 110.03 addresses special kinds of insurance issues that commonly arise in bankruptcy cases.  First discussed are three specific types of bankruptcy cases and the insurance issues they have generated: law firm, automotive and asbestos cases.  The discussion of asbestos cases includes pre-packaged reorganization plans; the treatment of insurance in asbestos cases, particularly in the context of a Chapter 11 plan of reorganization; the shifting of the insurer insured alliance; and finally the importance of insurers closely monitoring asbestos bankruptcy cases.

Three issues that often arise in general bankruptcy cases finish the chapter: environmental, self-insurance and arbitration.  With respect to environmental matters, the general rule is that the automatic stay does not prevent enforcement of environmental laws, just the enforcement of money judgments. Additionally, the trustee cannot abandon contaminated property when to do so would cause imminent and identifiable harm. Last, the section examines when environmental issues become claims that can be discharged in a bankruptcy proceeding.  The discussion of arbitration clauses focuses on when such clauses in insurance policies and agreements are enforceable in a bankruptcy proceeding and when they are not.  The general rule is that they are enforceable in almost all bankruptcy-related proceedings, where the bankruptcy judge can only propose findings of fact and conclusions of law to the district court.  They will not, however, be enforced in most core bankruptcy proceedings where arbitration would conflict with important bankruptcy issues, so that the bankruptcy court should resolve the matter by final order.

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James M. Lawniczak is a partner at Calfee, Halter & Griswold LLP, Cleveland Ohio, and chair of the firm’s Bankruptcy Litigation practice.  He has more than 30-years’ experience in insolvency matters, including handling insurance issues in federal bankruptcy proceedings and also several large state insurance insolvency matters.  He is a frequent writer and speaker on insolvency matters.

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Table of Contents

§110.01 Directors and Officers Liability Insurance

[1] Considerations at Policy Issuance

[a] General Bankruptcy Considerations

[b] Who Is Covered by D&O Policies

[i] Directors and Officers

[ii] Entity Coverage

[iii] Problems When One Pool of Coverage Is Available Both to Officers and Directors and the Entity

[c] Differences in Coverage Between Public And Private Companies

[2] Bankruptcy Issues of Property of the Estate and Automatic Stay

[a] Overview

[b] Insurance Policies as Property of the Estate

[c] Are Insurance Proceeds Property of the Estate as Well?

[d] Relief From the Automatic Stay

[e] Claims Against Officers And Directors Are Property of the Estate of the Claimant

[3] Right of a Trustee to Pursue Estate Claims Against Officers and Directors Including Proceeding Against Insurance

[a] Chapter 7 And 11 Trustees and the Debtor in Possession

[b] General Claims Against Officers and Directors Are Property of the Estate to Be Pursued by the Trustee

[c] Rule Generally Prohibiting Direct Actions Against Insurance Applies

[d] Confession of Judgment, Assignment of Rights, Covenant Not to Execute Technique

[4] Appointment of a Chapter 11 Trustee or an Examiner Due to Mismanagement or Conflicts Arising From Claims Against Officers and Directors

[5] Bankruptcy Implications of Exclusions in D&O Coverage

[a] Overview

[b] Dishonesty Exclusion

[c] Insured vs. Insured Exclusion

[d] Pollution and Asbestos Exclusions

[6] Bankruptcy Implications Related to Severance Clauses

[7] Bankruptcy Implications Related to the Claims-Made Features of Policies

[8] Types of Claims Brought Against Officers and Directors in Insolvency Situations

[a] Discussion of Officers’ and Directors’ Fiduciary Duties in General

[i] Directors’ Duties

[ii] Officers’ Duties

[iii] Protecting Officers and Directors Through Insurance and Indemnities

[b] Litigation Against Officers and Directors After Bankruptcy

[c] Duties Upon Insolvency

[d] Zone of Insolvency

[i] The Shift of Fiduciary Duty to Creditors When in Zone of Insolvency Develops

[ii] The Demise of the Shift of Fiduciary Duty to Creditors When in the Zone of Insolvency

[e] Deepening Insolvency

[i] Introduction to the Concept of Deepening Insolvency

[ii] Deepening Insolvency as a Cause of Action

[iii] Deepening Insolvency as a Measure of Damages

[f] Bankruptcy Implications When Coverage for Criminal Acts Is Sought

[g] Bankruptcy Implications When Coverage for Nonpayment of Employees or Other Employment Claims Is Sought

[h] Securities Claims

[i] Securities Fraud Litigation

[ii] SEC and Other Governmental Investigations

[9] Implications of the Fact That Liability Limits Are Eroded by Defense Costs

[10] Implications Arising out of the Insurance Company’s Duty to Defend or Lack Thereof

[11] In Pari Delicto (In Equal Fault) Defense

§110.02 Professional Liability Insurance

[1] Effect of Insured’s Bankruptcy

[2] Who Has Standing to Bring Claims After a Bankruptcy of the Insured

[3] Implications for Bankruptcy Counsel

[4] Implications for the Insurer

§110.03 Special Kinds of Insurance Issues Arising in Bankruptcy Cases

[1] Law Firm Bankruptcies

[2] Automotive Company Bankruptcies

[3] Asbestos Bankruptcy Cases

[a] Overview and Bankruptcy Asbestos Trusts

[b] Pre-packaged Reorganization Plans

[c] Treatment of Insurance in Asbestos Cases

[d] Altering the Insurer Insured Alliance

[e] Importance of Insurance Representatives Monitoring Bankruptcy Proceedings

[f] Standing of Insurer

[4] Environmental Issues

[a] Overview

[b] Automatic Stay Does Not Prevent Enforcement of Environmental Laws

[c] Ability of Debtor to Abandon Property

[d] Claims and Discharge

[5] Debtors With Large Self Insurance, Fronting Policies

[6] Enforceability of Arbitration Clauses in Bankruptcy Proceedings

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