By Charles Dale and Nathan Lander (Proskauer Rose LLP)
A recent Texas bankruptcy court decision In re Walker County Hospital Corporation highlights the importance of broadly drafted bankruptcy exceptions in “Insured versus Insured” (IvI) exclusions in directors and officers (D&O) insurance policies. IvI exclusions are standard in D&O policies, barring insurance coverage for claims asserted by one insured party against another insured party. Without specific policy language, current and former directors and officers may be exposed to personal liability under IvI exclusions.
After Walker County Hospital (the Hospital) filed for bankruptcy, the Hospital sued its former CEO for breach of fiduciary claims. The CEO tendered the claims to the Hospital’s D&O insurer and demanded a defense against the claims, but the insurer denied coverage on the basis of the IvI exclusion. Because the hospital and the former CEO were both “insureds” under the D&O policy, the IvI exclusion would typically bar coverage unless an applicable exception applied.
The court eventually ruled in the CEO’s favor after noting an exception in the policy for claims related to bankruptcy. The policy stated that “any Claim brought or maintained by or on behalf of a bankruptcy or insolvency trustee, examiner, receiver or similar official for the Company.” Because the Hospital filed suit in its capacity as a debtor-in-possession, the bankruptcy clause in the IvI exclusion was triggered. The court ruled that a “debtor-in-possession” qualified as a “similar official” to a bankruptcy trustee, as outlined in the policy. The court decided that the former CEO was entitled to coverage for the costs of defending the claims asserted against him by the Hospital.
While the case was eventually decided favorably for the former CEO, it highlights the material risk for directors and officers when their company’s D&O policies fail to provide proper coverage after a bankruptcy filing. When a company files for bankruptcy, the directors and officers can no longer rely on the company’s indemnification for claims that arose before the bankruptcy case and must rely on available insurance protection.
Ensuring that the IvI exclusion in a D&O policy has a broadly drafted “bankruptcy exception” is imperative, as the market exceptions can vay considerably. For example, in Walker County Hospital, the court noted there was some ambiguity as to whether a debtor-in-possession fell within the policy’s exception to the IvI exclusion, as it was not specifically named. Another way that directors and officers can help ensure that they have adequate protection for suits in a bankruptcy context is to insist that their company purchase “Side A” policies, which provide coverage to individuals for non-indemnified loss. These policies typically do not contain any IvI exclusion and are very limited in other exclusions.
D&O insurance exists to protect directors and officers, and bankruptcy is a setting where the need for protection is highest. Walker County Hospital is a reminder of the importance of ensuring that coverage doesn’t fail when it is needed the most.
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