Last month’s Alert discussed a New York bankruptcy court ruling allowing insurers to reimburse and/or advance defense costs to debtors’ current and former officers, directors and employees named as defendants in pending class action lawsuits in connection with ongoing investigations. In re MF Global Holdings Ltd., 2012 WL 1191892 (Bankr. S.D.N.Y. Apr. 10, 2012). There, the court rejected the arguments made by one debtor’s commodity customers and another debtor’s security holders—plaintiffs in pending actions—that (1) the proceeds of the policies were property of the debtor’s estate; and (2) allowing insurers to pay the individual insureds’ defense costs would improperly diminish the amount of funds available to compensate victims. Faced with analogous circumstances, a Missouri district court reached the same conclusion in Sec. and Exch. Comm’n v. Burton Douglas Morriss, 2012 WL 1605225 (E.D. Mo. May 8, 2012).
In Burton Douglas Morriss, the SEC filed suit against several investment entities, alleging fraud and misappropriation of funds. The court appointed a receiver and froze the assets of the investment companies. One of the companies, Acartha, turned to Federal Insurance Company for defense of itself and two of its executives. Federal accepted tender and began advancing defense costs as required by the policy. Federal also advanced defense costs to Acartha and one of its executives in connection with a later-filed investor suit. The receiver objected to the advancement of defense costs, arguing that the insurance policy belonged to the receivership estate and that under principles of equity, it should be preserved for compensating defrauded investors.
As in In re MF Global Holdings, the Federal policy here provided coverage to both the company and the individual officers. Thus, the court held that the determination of whether policy proceeds belonged to the receiver or alternatively could be used to fund the individuals’ defense turned on the specific policy language. Here, several provisions in the Federal policy justified the advancement of defense costs: (1) a priority of payment provision requiring Federal to first pay claims against individuals before claims against the organization, and (2) an advancement of defense costs provision requiring Federal to pay defense costs without regard to other potential liability or future payment obligations. The court’s rational suggests that other courts may reach a different result in the absence of specific policy language dictating the priority afforded to the advancement of defense costs in similar factual settings.