Monday, May 7, 2012

A Director's Worst Nightmare


If you serve as an officer or director you probably assume that if things go badly you will be protected by directors and officers insurance.  But if things go very badly and bankruptcy ensues, you may not have the protection you thought you had.

On April 10, 2012, Bankruptcy Judge Martin Glenn in MF Global Holdings Ltd., No. 11-15059, 2012 WL 1191892 (Bankr. S.D.N.Y., April 10, 2012) ruled against a commodity customer’s attempt to prevent the MF Global officers and directors from accessing the insurance to pay for their defense costs in various shareholder derivative suits.  On April 30, 2012, the court also denied the customer’s request for a stay pending appeal.

D&O insurance presents unique issues in bankruptcy.  The policy is usually owned by the company, meaning that it is property of the estate.  However, just because the policy is property of the estate does not mean the indemnity proceeds of the policy are property of the estate.  For example, the proceeds of a liability policy payable to a third party tort plaintiff are not usually property of the debtor tortfeasor’s bankruptcy estate.

But D&O is different and courts are split.  The typical policy has three separate coverages: Side A, which covers the directors and officers; Side B, which reimburses the company for any indemnity it provided to the officers and directors: and, possibly, Side C, which could cover, for example, the company’s own securities law liabilities.  The existence of Side B and C coverage means that the company might have an interest in proceeds and sets up a conflict between the officers and directors, on one hand, and the company and its creditors, on the other hand.

In MF Global, the company maintained $220 million in D&O insurance and also $150 million in errors and omissions insurance.  The directors sought relief, by stipulation, and the insurance company sought permission, by motion, to pay defense costs.  In D&O, the policy does not provide a defense, but the costs are part of the calculation of a loss, which means that payment of these costs reduces funds available for payment of claims, i.e., they are wasting policies.

The court’s opinion is a very good roadmap to the difficult issues presented by D&O insurance issues in bankruptcy.  The court noted as important the “Priority of Payments” provision in the policy, providing that Side A claims have priority in payment over other claims.  The court further noted that the directors and officers had contractual rights to payment that could not be excised by the objectors and also that pursuant to the McCarren-Ferguson Act, 15 U.S.C. §§ 1011-1015, New York Insurance Law § 3420(a)(1) gave the directors and officers statutory rights which would trump the Bankruptcy Code, even if the court found that the proceeds were property of the estate.  Finally the court held that since the commodity customers had not reduced their claims to judgment they had no vested rights in the policy proceeds.

MF Global is yet another case that emphasizes that directors and officers need to pay attention to their insurance coverage, and it also highlights that they should consider a different type of insurance known as a Side A Difference in Conditions coverage.  That type of policy provides no coverage whatsoever to the company and, while written as an excess policy, can drop down and cover the directors and officers if they can’t access the traditional first layer D&O policy.

Eckert Seamans Cherin & Mellott, LLC

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