During bankruptcy, trustees, creditors and shareholders will often advance arguments that the debtor company’s D&O policy is part of the debtor’s estate and therefore its proceeds should not be disbursed for the defense of individual directors and officers against other claims given that it would “deplete” the estate. Many courts have found ways to allow directors to access the proceeds of a company’s D&O policy for their defense, either through lifting the automatic stay to allow access to the proceeds or a finding that the proceeds are not a part of the debtor’s estate. However, these “victories” have oft proven pyrrhic in nature as courts have imposed “soft caps” and other measures to monitor, or outright reduce the amount of D&O policy proceeds available to individual insured directors.
In order for directors to maximize their use of the D&O policy proceeds for their individual defense, they should review their D&O policies with a particularly critical eye towards overall coverage, the “priority of payments” provision (which directs the payout of proceeds) and the language used to define “defense cost” and other similar terms. Contractual language that prevents any other entity from collecting proceeds from a D&O policy until all claims against the individual insured directors and officers have been resolved can provide clear guidance to the bankruptcy court that the directors and officers have the best claim to the proceeds (it also makes clear the division of the proceeds between the individual Side A coverage for directors and officers versus the entity coverage under Side B coverage). The less explicit the “priority of payments” provision, the more wiggle room an attacking party has to argue that all of the proceeds of the D&O policy are for the entity and, thus, are a part of the debtor’s estate. Similarly, another key provision to review is the definition for “defense costs” and similar terms as these definitions may provide avenues for the insurance company to deny paying proceeds during bankruptcy. Additionally, to lessen the odds of coming up short in a potentially messy situation, directors may want to consider obtaining excess Side A coverage to provide for increased limits, greater assurance of coverage in bankruptcy situations and a source of insurance with potentially fewer exclusions than the primary policy.
Given that many of the D&O policies at issue were written during boom times, when bankruptcy was the last thing on anyone’s mind and policies were often very lightly scrutinized, it is very possible that key provisions are not written in the director’s best interest. Given the importance of these issues, a director needs to review policies early, well in advance of any potential restructuring, in order to maximize the benefit of these policies and to minimize unnecessary headaches.