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Article by Brett M. Amron and Zakarij N. Laux published In Business Law Today – December 2017

Posted on December 22, 2017 in

Debtors, Fiduciaries, and Directors and Officers Beware: The Limits of D&O Liability Policy Coverage

By Brett Amron and Zakarij N. Laux

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  • Bankruptcy fiduciaries who are not court-appointed Chapter 7 or Chapter 11 trustees have been generally successful in pursuing claims against debtors’ D&O policies.
  • However, a recent Sixth Circuit decision may erode this success and have other far-reaching ramifications for fiduciaries who are not court-appointed.

Sometimes, uncontrollable financial circumstances precipitate a company’s decision to seek the protection of the Bankruptcy Code. Other times, a bankruptcy filing results, at least in part, from poor decisions made by the company’s management. A bankruptcy trustee is duty-bound to scrutinize the decisions of management and determine whether certain errors were made that caused harm to the debtor or its creditors and, if appropriate, commence litigation against the relevant decision makers for the benefit of the bankruptcy estate and its creditors. These suits often involve allegations that directors and officers have breached their fiduciary duties.

This type of litigation is all the more likely in cases where the debtor has or had a director and officer liability policy (D&O policy) in place to cover such claims, but most D&O policies contain an “insured vs. insured” exclusion, which excludes claims made by an insured against another insured under the policy.

Although not all courts have agreed, in a majority of jurisdictions, court-appointed trustees (Chapter 7 and Chapter 11) have circumvented insured vs. insured exclusions by arguing that there is no risk of collusion when the suit is brought by an independent, court-appointed fiduciary, and that the debtor company and the debtor’s estate—on whose behalf a trustee is bringing suit—are distinct legal entities.

But what about bankruptcy fiduciaries who are not court-appointed Chapter 7 or Chapter 11 trustees? A debtor-in-possession often will include in its Chapter 11 plan of reorganization the appointment of a litigation trustee, liquidating trustee, or other fiduciary to oversee litigation and make distributions for the benefit of creditors. Just like a court-appointed trustee, these fiduciaries will see a D&O policy as a source of potential recovery.

© 2017