Reed Smith LLP on Emerging Risks in Insurance: When Bankruptcy Hits, Are Directors and Officers Stuck With the Bill?

Reed Smith LLP on Emerging Risks in Insurance: When Bankruptcy Hits, Are Directors and Officers Stuck With the Bill?

 
This commentary analyzes an emerging issue of law which may become increasingly pertinent as today’s recession continues to bankrupt more and more corporations, and further, as more and more lawsuits are brought against those corporations, often as a result of activity which led those companies to declare bankruptcy in the first instance. Specifically, this commentary analyzes the legal landscape that transpires when an insured entity goes into bankruptcy, and as a result, its insurer refuses to distribute policy proceeds to insured directors and officers for fear that a court will find them to be property of the insured debtor’s estate and thus subject to the United States Bankruptcy Code’s automatic stay provision.
 
In such an event, any payments made by an insurer would violate the automatic stay and not count towards its policy’s limits. Ordinarily, when an insured entity is not in bankruptcy, an insurer’s refusal to distribute policy proceeds to insured directors and officers is not a significant problem as those directors and officers are typically indemnified by the insured entities for which they serve. But when those insured entities go into bankruptcy, they are often no longer able to indemnify their insured officers and directors, leaving those individuals responsible for defending themselves against lawsuits brought against them because of their service to a company that is now no longer able to assist them.
 
This commentary suggests such a result is wrong, both legally and for public policy reasons, and further offers various arguments for comforting a bankruptcy court in its decision to find that policy proceeds do not belong to the insured debtor’s estate. In doing so, this commentary posits that directors and officers policies are typically purchased for the primary benefit of the individual directors and officers, rather than for the benefit of the corporations for which those directors and officers serve. As a result, when an insured corporation declares bankruptcy, that should not preclude the directors and officers of that corporation from accessing the proceeds of an insurance policy purchased primarily for their benefit. Such a result would be contrary to an emerging trend of case law, as well as to the fundamental principles of fairness and public policy.
 
Moreover, even where policy proceeds are found to belong to the insured debtor, this commentary suggests that the automatic stay which would otherwise apply should be lifted to allow for the payment of proceeds to insured directors and officers. A contrary result would discourage the very best and brightest from serving as directors and officers to some of the world’s most prestigious corporations.
 
The commentary concludes, “As more and more companies continue to declare bankruptcy, and as directors and officers of those companies continue to face litigation stemming largely from those bankruptcies, courts must act swiftly and clearly in granting those directors and officers continued access to D&O insurance policy proceeds.”