• Comfortable with Your Directors and Officers Liability Policy? Take a Look Again
  • May 20, 2003 | Author: J. Bradford McIlvain
  • Law Firm: Dilworth Paxson LLP - Philadelphia Office
  • The effects of the scandals surrounding the bankruptcies of Enron, WorldCom, Tyco, and Adelphia are far ranging, and extend beyond compliance with new laws and requirements governing actions of officers and directors. These matters have also raised issues that require a fresh and thorough look at directors and officers insurance policies.

    Advantages and Disadvantages of Entity Coverage
    For example, suppose you are an officer or director in a troubled, publicly traded company. The company installs new management, who determine that the company must file for bankruptcy protection. The new management claims you did things wrong. As a result, you get sued by shareholders claiming that the problems were improperly disclosed to shareholders. Not to worry, though, the company had purchased D&O policy and you are obviously an insured under the policy. Imagine your shock when the bankruptcy court says you can only ask the D&O carriers to cover your defense costs and ultimate liability, but you cannot litigate that issue if the D&O carrier refuses coverage.

    To determine if this result is in the cards for you, you must determine if your D&O policy has entity coverage. So-called entity coverage in D&O policies generally was considered advantageous. Such coverage provides coverage to the company for all, or certain claims, under the policy. The existence of such coverage obviously was beneficial to the company because it provides coverage for certain claims. It also allows the company to recover the full amount of covered defense costs and claims when the company is defending claims brought against the officers and directors as well as the company.

    Entity coverage may not, however, be beneficial to the individual officers and directors, particularly in the event the company files for bankruptcy protection. The automatic stay stays all claims against property of the bankrupt company's estate. The question then is whether the D&O policy is property of the estate subject to the automatic stay when a company files bankruptcy. It is generally accepted that the policy is not an asset of the estate and not subject to the automatic stay when there is no entity coverage.

    Things become less clear when there is entity coverage. In that case, the bankrupt company is an insured under the policy. Obviously, the directors and officers are also insureds under the policy. The initial question is whether the interests of the officers and directors in the policy is an asset of the estate and subject to the automatic stay. The automatic stay prohibits efforts to recover against the property of a bankrupt entity. If they are subject to the automatic stay, then relief from automatic stay would be necessary to allow the officers and directors to recover under the policy. The courts have divided on the issue of whether the interests of the officers and directors in the policy are assets of the estate. As a practical matter, this uncertainty means that officers and directors cannot recover under the policy until the bankruptcy court rules on the issue in the particular matter. At the very least, this uncertainty will cause a delay in obtaining coverage from the insurance company.

    In those courts that have held that the interests of the officers and directors are property of the estate, the courts generally granted relief from the automatic stay. These cases recognized that the interests of the company and its officers and directors may conflict. The United States Supreme Court has instructed that bankruptcy does not create in the bankrupt entity more rights than the entity would have outside bankruptcy. Mindful of this rule, the courts that have found that the officers and directors' interest is property of the estate have generally granted relief from stay because they recognized that bankruptcy could not deprive the officers and directors of their interest in the policy. Even in the Enron bankruptcy, the court granted relief from the automatic stay to allow the officer and directors to recover from the policy.

    The Adelphia Precedent
    This general rule, however, changed in the Adelphia bankruptcy (the bankruptcy proceedings for Adelphia Communications Corp. and Adelphia Business Solutions). In that case, four Rigas family members, who were insureds under the D&O policy, moved for relief from the automatic stay so they could at least recover the costs to defend the more than forty civil suits filed against them all over the country. The insurance companies did not oppose the request, but the Adelphia entities did. They argued that the policy provided coverage for securities claims against the Adelphia entities, and therefore the policy proceeds, including the interest of the Rigases in the policy were property of the estate, subject to the automatic stay. Adelphia Communications Corp. also argued that if the Rigases were allowed to pursue their rights under the policy, that litigation could negatively impact Adelphia, particularly certain claims that Adelphia had asserted against the Rigases.

    The Bankruptcy Court issued a lengthy opinion finding that the Rigases' interest in the D&O Policy was an asset of the Adelphia entities bankruptcy estate. In balancing the harms to the all parties, the Bankruptcy Court concluded that the Rigases could ask the D&O carriers to pay defense costs up to a specified limit, but they could not pursue their request in court if the D&O carriers said no until after the conclusion of the criminal trial against some - but not all - of the Rigases, now scheduled for January 2004. In practical effect, the Court denied the Rigases the ability to pursue their rights in the D&O Policy because they have been alleged to have engaged in misdeeds, but has precluded them from pursing their claims against the D&O carriers and attempting to prove they did not engage in misdeeds.

    Recent cases demonstrate that the insurance landscape has changed. Entity coverage may be good for the company, but it can be bad for the individual officers and directors. Thus, it is time for officers and directors to take a fresh look at their D&O policies to determine if they really provide protection when things go wrong.