• The “Insured v. Insured” Exclusion as Applied in Bankruptcy
  • August 11, 2017 | Author: Kurt M. Zitzer
  • Law Firm: Meagher & Geer, P.L.L.P. - Scottsdale Office
  • In the context of errors and omissions coverage related to Director and Officer Policies (D&O) or Banking Extended Professional Liability Policies (EPL), the reasonable expectation of the carrier and insured is that insurance is intended to protect directors and officers against claims made by outsiders, not intracompany claims. However, when the corporate entity sues its directors and officers (or other “Insured Persons” in the EPL context - such as advisory committee members, managers or employees) for malfeasance or wrongdoing, often times those insureds will turn to their D & O or EPL insurance coverage for defense and indemnity. Claims made by the corporate entity against individual Insured Persons are viewed as “friendly” lawsuits. The concern over these “friendly” lawsuits is that insurance will be utilized to subsidize poor business management, allowing the entity to recover losses through a suit against those who operated the entity; something the policy of insurance was never intended to cover.

    It is in this context, and in particular where this scenario plays out through a bankruptcy proceeding, that carriers will often site to the “insured v. insured” exclusion as a potential bar to coverage. The application of the insured v. insured exclusion in the bankruptcy context has historically led to inconsistent results based upon how various jurisdictions have interpreted the exclusion. As a case decided under Michigan law recently held, in the context of bankruptcy, intracompany claims should be excluded by reason of the insured v. insured exclusion. The rationale of this court was particularly helpful in understanding the interplay between the exclusion and intracompany claims against Insured Persons.

    The insured v. insured exclusion was developed by the insurance industry in response to large losses arising out of bank failures in the 1980’s. The Bank of America v. Powers, No. C 536-776 (Cal. Super Ct., filed March 1, 1985) and National Union Fire Ins. Co. v. Seafirst Corp., 1986 U.S. Dist. Ct. LEXIS 28065 (W.D. Wash. Dec. 19, 1986) cases resulted in D & O coverage for large loss claims asserted by the corporate entity against its own directors and officers for claims arising out of wrongful acts committed, including claims of negligence and breaches of fiduciary duties. The carriers had argued that the policy “was not intended to and does not cover claims brought by [the corporate entity] itself against former officers and directors….” Seafirst, LEXIS 28065 at *4. That argument was rejected because the courts had broadly interpreted the phases “any claim or claims” to include direct claims made by the corporate entity against its directors and officers. Id. at *15.

    As a result of being ordered to cover intracompany losses, the insurance industry responded by crafting the insured v. insured exclusion. The exclusion has taken various forms as it has developed over the years, but in essence, the exclusion is intended to preclude coverage for claims made by one insured under the policy, against another Insured Person under the policy. In Indian Harbor Ins. v. Zucker, 553 B.R. 633, 638 (W.D. Mich. 2016), the insured v. insured exclusion read as follows:

    “The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against an Insured Person...

    (G) by, on behalf of, or in the name or right of, the Company or any Insured Person, except and to the extent such Claim:

    (1) is brought derivatively by a security holder of the Company, who, when such Claim is made and maintained is acting independently of, and without the active solicitation, assistance, participation or intervention 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 which is part of or results directly from a Claim which is not otherwise excluded by the terms of the Policy;

    (3) is an Employment Practices Claim.”


    In the unique setting of bankruptcy, courts have struggled to apply the exclusion when the party asserting the claim post-petition may (or may not) fall outside the context of a party seeking to enforce rights originally held by the entity (an “Insured Person”) against a director or officer (also an “Insured Person”). In certain settings, it is difficult for the courts to determine whether the claim is being asserted for or on behalf of the Debtor, rather than a claim being pursued for the benefit of creditors. It is this factual fulcrum upon which the question turns of whether the insured v. insured exclusion applies. And, it is not always an easy issue to resolve.

    In Biltmore Assocs., LLC. v. Twin city Fire Ins. Co., 572 P.3d 663, 670-71, n. 15-17 (9th Cir. 2009, the court noted several decisions where bankruptcy courts around the country have disagreed on the treatment of a post-bankruptcy entity, with some treating the Debtor as different from the original entity before it entered chapter 11, while others treating the Debtor the same as the original entity for purposes of whether the claim is asserted by an “Insured Person”. See, Unified W. Grocers, Inc. v. Twin City Fire Ins. Co., 457 F.3d 1106 (9th Cir. 2006); Alstrin v. St. Paul Mercury Ins. Co., 179 F. Supp. 2d 376 (D.Del. 2002); Cohen v. Nat’l Union Fire Ins. Co. of Pittsburgh, 280 B.R. 319 (S.D.N.Y 2002)( partial list of courts treating the bankruptcy trustee and/or a creditor’s committee as a distinct entity separate from the debtor); and compare with, Nat’l Union Fire v. Olympia Holding, 148 F.3d 1070 (11th Cir. 1998); Reliance Ins. Co. v. Weis, 148 B.R. 575 (E.D. Mo. 1992); Stratton v. Nat’l Union Fire Ins. Co. of Pittsburg, 2004 WL 1950337 (D. Mass Sept. 3, 2004) (partial list of courts treating trustee and/or reorganized company successor entity the same as pre-bankruptcy debtor). Accordingly, in the bankruptcy context it can be particularly confusing to identify whose rights are being asserted against a director or officer because the analysis must begin with whether the claim is being made for the benefit of an “Insured Person” as opposed to someone standing outside the entity. In short, the question of whether a bankruptcy claim constitutes an intracompany claim can be difficult to analyze, and the analysis is not always resolved by simply looking at in whose “name” the claim is being asserted, but rather whether the claim is intended to benefit the company or a third party.

    Turning back to Zucker, the court does an excellent job of analyzing the agreement that formed the basis for the claim that was eventually asserted against the directors and officers. From there, the court provided a breakdown of the factors useful to decide whether the claim was made for the benefit of an Insured Person for purposes of also determining whether the insured v. insured exclusion applied. The case began as a declaratory judgment action asking the court to determine that the insured v. insured exclusion precluded coverage for two directors and officers of Capitol Bancorp, arising out of a claim filed by the Liquidation Trustee.

    In the bankruptcy proceeding, the Debtor settled with the Creditors Committee whereby a Liquidation Trust was created and a Liquidation Trustee was appointed in exchange for the approval of the Liquidating Plan. The Liquidation Trustee’s purpose was, in part, to “pursue Causes of Action … for the benefit of Beneficiaries….” Zucker, at 636. However, with respect to pre-petition conduct, the parties agreed to a Confirmation Order that stated the Debtor’s directors and officers were not released from any claims “but amounts they shall be required to pay on account of causes of action transferred by the Debtor to the Liquidating Trust shall be ‘strictly limited’ to amount actually recovered by insurance.” Id. at 637. The agreement further obligated the directors and officers to timely submit notices under the Debtor’s D & O insurance policy, take action to pursue such coverage or contest any denials, and not compromise a coverage claim without the express written consent of the Trustee. Id.

    After examining the claim as a whole, and even though the stated purpose of asserting causes of action was for the plan beneficiaries (non-Insured Persons), the court found that the claim amounted to an intracompany claim and precluded insurance coverage by reason of the insured v. insured exclusion. The court loosely followed a four factor test to identify whether the claim was an action “by, on behalf of, or in the name or right of, the Company or any Insured Person.” The factors by which the court was guided in its analysis of whether the exclusion should apply were: “1) whether ‘true adversity’ exists between the litigating parties; 2) the status of the plaintiff at the time the claim is made; 3) the identity of the beneficiaries of the claim, or stated differently, on whose behalf are the claims being pursued; and 4) the reasonable expectations of the parties” Id. at 642, citing, Michael D. Sousa, Making Sense of the Bramble-Filled Thicket: the “Insured v. Insured” Exclusion in the Bankruptcy Context, 23 Emory Bankr. Dev. J. 365, 371 (2007).

    As to whether “true adversity” existed, the court took note of the fact that the Debtor and the Creditor’s Committee settled claims to establish the Liquidation Trust, which included the preservation of D & O claims. As such, the claims being brought by the Trustee were not the product of true adversity existing without the settlement agreement. Id. Moreover, the Trustee obtained its right of action by transference or assignment of the Debtor; standing in the shoes of the Debtor. So, the status of the plaintiff at the time the claim was made was essentially that of the Debtor for purposes of deciding “on whose behalf” the claim could be made. Id. at 643. The court also cited to Biltmore, supra, for the proposition that a “cause of action for mismanagement belongs to the corporation….That the creditors rather than the shareholders will get whatever money the insurer pays does not avoid the exclusion. Id., citing Biltmore, 572 F.3d at 699. Accordingly, even though the stated purpose of the settlement agreement establishing the Liquidation Trustee was for recovery to the benefit of the plan Beneficiaries, the court found that by limiting recovery on the claims to only insurance proceeds, clearly the Insured Persons also benefited by the agreement. Id. at 642. Finally, the court noted that the reasonable expectations of the parties to this action was that insurance was to protect claims against outsiders, rather than claims being made for or on behalf of an Insured Person. Id. at 644. Consequentially, the court held that the insured v. insured exclusion precluded coverage for the Trustee’s claims against the former directors and officers.

    The Zucker court’s analysis is a helpful guide for conducting an insured v. insured analysis in the context of bankruptcy proceedings, were settlements, divergent interests, deals, amendments and plan confirmation can create a web of confusion over “on whose behalf” a claim is being asserted against a director, officer or other Insured Person. As Zucker soundly reasoned, the mere fact a claim is being pursued by a Trustee rather than the Debtor itself, and for the stated purpose of benefiting creditors, does not resolve the question of whether the claim is truly an intracompany claim. Carriers will need to closely examine the facts behind the claim to identify the true interests being prosecute so that they can properly asserted the insured v. insured exclusion.