A Maryland bankruptcy court has declared that Side A benefits under a D&O policy are not property of the bankrupt estate, with the result that two former executives who have been accused of making illegal payments and diverting funds from their former employer to start a new venture may be able to recoup certain defense costs. In re: TMST, Inc. f/k/a Thornburg Mortgage, Inc., et al., Docket No. 09-17787 (Bankr.D.Md. Aug. 17, 2010). A copy of the motion is available here, and a copy of the court’s decision is available here.

The debtor filed for a voluntary Chapter 11 petition on May 1, 2009. Shortly thereafter, a creditors’ committee launched an investigation into the activities of two former executives’ alleged use or appropriation of their company’s assets. Four different adversary proceedings were later commenced, each of which generally alleged turnover of corporate property and the former executives’ breach of the duties of loyalty and good faith, as well as corporate waste and civil consipracy. The directors tendered to their company’s D&O carrier, which agreed that two of the adversary proceedings were likely covered. It denied any obligation, however, for the remaining two suits and the committee’s investigation.

Declaring that the policy’s Side A coverages and benefits were not assets of the bankrupt estate, the court’s order permitted the defendant executives to apply to the carrier for the payment of their defense costs, subject to a 10-day objection period. The order also permitted the Trustee to challenge coverage for any Side A payment claims, on grounds that the Trustee’s interest in Side B benefits could be diminished as payments erode the remaining policy limits.