The U.S. Court of Appeals for the Ninth Circuit has held that a creditor trustee could not recover claims under a Director & Officer insurance policy because of the policy's "insured v. insured" exclusion. Biltmore Assocs., LLC v. Twin City Fire Ins. Co., Ad. No. 07-16036, 2009 US App. LEXIS 15322 (9th Cir. July 10, 2009).

The case is an important one because creditors of a bankrupt company often investigate the pre-petition actions of current and former officers and directors to determine whether their conduct may have caused or worsened the company's poor financial condition. Officers and directors, in turn, aware of this potential exposure and risk, customarily insist that the company employing them indemnify them from most claims, other than claims arising from intentional misdeeds or gross negligence. Hence, companies typically obtain Director and Officer (D&O) liability coverage to pay the costs associated with defending claims brought against their directors and officers, and any judgments awarded on account of such claims.

In Biltmore Associates, the Ninth Circuit dismissed a claim brought in the chapter 11 case of Visitalk, an Arizona corporation, against various insurance companies (the "Insurers") that provided different layers of D&O liability coverage to Visitalk and its former officers and directors.

The claims initially were brought by Visitalk, an insured under the D&O liability policies and then were assigned by Visitalk to a creditor trust, established for the benefit of Visitalk's creditors. The trustee of the creditor trust, Biltmore Associates ("Biltmore"), continued to prosecute the claims after the assignment.

Insured v. Insured Exclusion

The D&O policies at issued named Visitalk as well as the directors and officers as insured parties. The policies promised to pay covered claims brought by third parties, and specifically excluded claims brought "by or on behalf of" an insured party. This exclusion is known as the insured v. insured exclusion, and essentially bars one insured under a policy from recovering thereunder by bringing a claim arising from the wrongful actions of another insured. The D&O policies at issue contained some exceptions to the insured vs. insured exclusion, none of which the court found applicable to the facts of this case.

After the Insurers refused to cover claims initially brought against the former officers and directors by Visitalk, because of the D&O policies' insured v. insured exclusion, Visitalk assigned the claims to the creditor trust, and Biltmore, as trustee, stepped into Visitalk's shoes. The Insurers posited that the fact that the claims had been assigned to the creditor trust and then were being pursued by Biltmore had no bearing on the continuing effect of the insured v. insured exclusion.

The court agreed with the insurers, finding that the insured v. insured exclusion continued to bar the claims being pursued by the creditor trust because the underlying claim still was being "brought or maintained on behalf of an Insured in any capacity," and thus was excluded from coverage.

According to the Ninth Circuit, a cause of action for mismanagement of a company belongs to the corporation that was mismanaged. It can be pursued derivatively by shareholders and creditors, but it belongs to the corporation. Coverage for such claims, however, is excluded if the company sues the directors and officers as it did in this case. Changing plaintiffs does not serve to breathe new life into the plaintiff's right to recover under the policies.

Open Question

As the assignee of the company's claims, Biltmore can have no greater right than the party from whom the claim was assigned.

The court noted the anomaly that Biltmore had to step into Insured's shoes to have any basis for coverage under the policy, and then step out again to recover thereunder because of the insured v. insured exclusion. According to the court, this alone justified the dismissal of the claims. The court did not buy the argument made by Biltmore that the pre-petition debtor differed from the debtor-in-possession, and therefore it could be an insured under the policy but also a plaintiff when it became a debtor-in-possession.

The court did leave open the question of whether a chapter 11 or chapter 7 trustee would have been able to overcome the insured v. insured defense to coverage had it been the plaintiff in this case.