A recent decision by the United States Bankruptcy Court for the Southern District of Texas in In re Walker County Hospital Corporation serves as an important reminder to customers purchasing or renewing directors and officers (“D&O”) insurance coverage that the “Insured vs. Insured” exclusion should contain the broadest possible exclusions for claims brought against directors and officers after a bankruptcy filing . Without the specific language of the policy, current and former directors and officers may be exposed to personal liability.
After Walker County Hospital (the “Hospital”) filed for bankruptcy, as a debtor in possession, the Hospital sued its former CEO (“CEO”) for breach of fiduciary duty claims. The CEO presented the claims to the hospital's D&O insurer and requested that the insurer provide defense against the claims. The insurer denied coverage in reliance on the Insured-versus-Insured Exclusion (“IvI Exclusion”)—a standard D&O coverage exclusion that, subject to certain specified exceptions, limits insurance coverage for claims brought by one insured party against another insured party.
The bankruptcy court began by noting that because both the Hospital (in its capacity as debtor-in-possession) and its former CEO were “Insured” under the policy, the IvI Exclusion would bar coverage unless applicable exception of the applied exception. Carefully reading the policy text, the court noted that the IvI exclusion contained an exception for “any action brought or maintained by or on behalf of a bankruptcy or insolvency practitioner, examiner, receiver or similar officer of the Company.” The court further explained that the relevant provisions of the Bankruptcy Code give a Chapter 11 debtor “all the powers, functions, and duties of a trustee” and reasoned that because a debtor-in-possession has essentially the same authority as a bankruptcy trustee, it qualifies as “a receiver-like official who triggers the exemption from exemption IvI. Thus, the court held that the IvI exclusion did not apply and the former CEO was entitled to coverage for the costs of defending the claims brought against him by the hospital (acting in its debtor-in-possession capacity).
Although the case was decided in favor of the former CEO, the dispute in Walker County Hospital highlights the material risk to directors and officers when their company's governance and management policies fail to provide adequate coverage following a bankruptcy filing. When a company files for bankruptcy, directors and officers can no longer rely on the company's indemnification for claims that arose before the bankruptcy case and must instead rely on available insurance protection. If a company's D&O policy excludes claims brought during the bankruptcy case—due to an overly broad IvI exclusion—current and former directors and officers may be exposed to personal liability.
Ensuring that the IvI exclusion in the D&O policy has a broadly worded 'bankruptcy exclusion' is extremely important as market exclusions can vary widely. For example, while the Court in Walker County Hospital noted that there is ambiguity as to whether claims brought by the hospital as a debtor in possession fall within the policy's exception to the IvI exclusion (and construes that ambiguity against the insurer), many other policies on the market do not have such ambiguity, because they either expressly state that claims brought by a debtor-in-possession fall within an exception to the exclusion (or, alternatively, that they do not). Specificity is critical.
Another way directors and officers can help ensure they have adequate protection for claims in an insolvency context is to insist that their company purchase 'Side A' policies, which provide cover to individuals for uninsured losses and usually do not contain the IvI Exclusion and very limited other exclusions. D&O insurance exists to protect directors and officers, and bankruptcy is an environment where the need for protection is highest. Walker County Hospital is an important reminder of the importance of ensuring coverage does not fail when it is most needed.