The availability of a debtor’s insurance policy can have a significant impact on its chapter 11 case. Indeed, in certain chapter 11 cases insurance proceeds may be a creditor’s only opportunity to potentially receive a recovery on meritorious claims. Relying on insurance proceeds, however, is not infallible. An insurance policy may, for example, contain a coverage exclusion that would preclude a claim. For instance, nearly all directors’ and officers’ liability insurance policies traditionally include an insured v. insured exception that is designed to generally exclude from coverage any claim made against an insured that is brought by another insured, the company or any of the company’s security holders. Depending on the facts at hand, including the identity of the party asserting the claims against the insured directors and officers, and the court adjudicating the matter, an insured v. insured exception may preclude coverage. Courts across the country have rendered different decisions on whether an insured v. insured exception is triggered if a debtor-in-possession, creditors’ committee, trustee or liquidation trustee assert claims belonging to a company. And many times companies forced to file a chapter 11 petition do not pay close attention to the potential effect of this exclusion and the scope of any potential “carve-out” from the exclusion.

As insurance carriers and directors and officers that are defendants in lawsuits continue to press through murky judicial waters to receive definitive guidance on the treatment of insured v. insured exception provisions, the recent decision in Indian Harbor Ins. v. Clifford Zucker contributes to the fray.

Background

On August 9, 2012, Capital Bancorp Ltd. and its subsidiary Financial Commerce Corporation filed voluntary petitions for relief under chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the Eastern District of Michigan. The case is captioned In re Capital Bancorp Ltd. Pursuant to a joint chapter 11 liquidating plan, the debtors agreed to transfer all causes of actions belonging to them, including, inter alia, claims against their directors and officers, into a liquidating trust. The plan also provided that the recovery on such claims would be limited to any amounts that may be actually recovered from applicable insurance policies. The debtors’ directors’ and officers’ liability insurance policies and the proceeds therefrom were expressly listed as potential sources of creditor recovery.

Indian Harbor Insurance issued a primary directors’ and officers’ liability insurance policy to the debtors for a coverage period of September 9, 2010 through September 9, 2011 (the “2010 Policy”). Indian Harbor renewed the 2010 policy to cover the period of September 9, 2011 through September 9, 2012 (the “2011 Policy”). The 2011 policy was amended in September 2012 to add six additional endorsements and extend the policy period for another year, through September 9, 2013. Additional endorsements were added in September 2013 and the policy further extended for another year to September 9, 2014. Both the 2010 Policy and the 2011 Policy included an endorsement providing for an “Insured v. Insured Exclusion” that, in pertinent part, precludes coverage for claims brought by, on behalf of, or in the name or right of, the Company (defined to include debtor Capital Bancorp, its subsidiaries and 216 affiliated entities) or any Insured Person (as defined in the applicable policy), except in three circumstances. Specifically, the exclusion will not apply if a claim is (1) brought derivatively by a security holder who is acting independently of an Insured Person or the Company, (2) is in the form of a crossclaim, third party claim or other claim for contribution or indemnity by an Insured Person that is part of or results directly from a claim that is not otherwise excluded by the terms of the policy, or (3) an employment practices claim.

On August 8, 2014, the trustee of the liquidation trust filed a complaint against three of the debtors’ former directors for breach of fiduciary duties in the lawsuit captioned Zucker v. Reid et al. (the “Liquidation Trust Action”).

Indian Harbor subsequently commenced an action seeking a declaratory judgment that (1) the 2010 Policy and the 2011 Policy do not provide coverage for any loss, including defense expenses in connection with the Liquidation Trust Action because the policies’ Insured v. Insured Exclusion bars coverage, (2) that the 2010 Policy does not provide coverage for the Liquidation Trust Action because the claims were “first made” after the expiration of the applicable policy period, and (3) that other policy provisions contained in the 2010 Policy and/or the 2011 Policy may limit Indian Harbor’s contractual obligations and/or exclude coverage in connection with the Liquidation Action.

Analysis

The District Court first addressed whether the Insured v. Insured Exclusion bars coverage for the Liquidation Trust Action. The court reviewed the split in authority among federal courts as to whether a lawsuit against a corporation’s former directors and officers brought by a debtor in possession, trustee, creditors’ committee, or post-confirmation liquidating trustee, triggers the insured v. insured exclusion in a directors’ and officers’ liability insurance policy. One school of thought is that the claims of a company to which a debtor in possession or trustee had succeeded, fall squarely within the insured v. insured exclusion because such parties have all the rights of, and are subject to the same defenses as, the insured, had it brought the suit before it commenced its bankruptcy case. Other courts have taken the opposite view and held that the insured v. insured exclusion does not bar coverage for lawsuits commenced by a plan committee or trustee because such parties are separate legal entities far enough removed from the insured/debtor, the parties may take adversarial positions, and the potential for collusive suits between insureds to collect on the policy’s proceeds, which the exclusion is intended to prevent, is not present. It is evident from the split in authority that a determination as to whether the insured v. insured exclusion applies requires a fact specific analysis.

In the Indian Harbor case, based on the express language of the 2010 Policy and the 2011 Policy and the undisputed facts before the court, the District Court concluded that there was a direct connection between the debtors/insured and the liquidation trust. Accordingly, the District Court determined that the Insured v. Insured Exclusion contained in both the 2010 Policy and the 2011 Policy would be triggered. In particular, the court considered that Cristin Reid, a former officer of the debtors, was a defendant in the Litigation Trust Action and one of the three members serving as a litigation trust oversight committee. Ms. Reid, as Capitol Bancorp’s President, signed the settlement agreement with the creditors’ committee providing for the creation of the liquidation trust, signed the liquidation plan, and signed the liquidation trust agreement that caused the lawsuit naming her and two others as defendants. Additionally, the insured (debtor Capital Bancorp.) transferred and conveyed all of its claims and causes of action to the litigation trust, thus permitting the trust to “step into its shoes” and hold the right to assert its claims and causes of action. Under these facts and circumstances, the court held that the Litigation Trust Action squarely falls within the Insured v. Insured Exclusion in the policy, as an action by, on behalf of, or in the name or right of, the Company or any Insured Person.

In regards to the remaining two causes of action asserted by Indian Harbor, the defendants conceded that the 2010 Policy did not cover the Liquidation Trust Action, thus resulting in Indian Harbor prevailing on the merits that the exclusion applied. The District Court ultimately held that, given its grant of summary judgment to Indian Harbor on the first two counts, there was no need for further consideration with respect to any other exclusions under the applicable policies.

Conclusion

Undoubtedly, directors’ and officers’ liability insurance coverage is further complicated when a company files for chapter 11 due to the various factors percolating at a given time during a chapter 11 case that could trigger the insured v. insured exclusion. In the wake of conflicting decisions by various courts, Indian Harbor provides some clarity on evaluating the applicability of the oft used insured v. insured exclusion. Such clarity, even if limited in scope, is particularly important in the bankruptcy context where claims are traded, assigned and otherwise conveyed to various parties, certain key constituents have the ability to step into a debtor’s shoes to assert claims, and insurance policies are utilized as a means of creditor recovery. As individuals at the helm of troubled companies approach a bankruptcy filing, they should be cognizant of the varying interpretations of insured v. insured exceptions and they should also take heed of the considerations noted in the Bankruptcy Blog’s prior posts discussing the insured v. insured exclusion and its carve backs and providing an extensive guide to evaluating and purchasing directors’ and officers’ liability insurance.