Beyond Chapter 11: Entity Coverage for Directors and Officers

More than 90% of public companies purchase “entity coverage” as part of their directors' and officers' (D&O) insurance policies. Entity coverage protects the company itself ' as opposed to its directors and officers ' against securities claims. During the last 2 years, however, it would have been difficult for the director of any public company to avoid hearing that entity coverage creates an undue risk of depriving the director of D&O coverage if the company for which he or she serves files for bankruptcy. One major D&O insurer distributed a paper containing this gratuitous advice to the directors of every public company in the country. Many legal seminars and D&O coverage proposals prepared by brokers also warn of this danger. Not surprisingly, CEOs and general counsel often are questioned by their boards about D&O coverage in the event of bankruptcy.

The dire warnings find little support in bankruptcy case law. In a number of recent major bankruptcies, including Enron, courts have allowed directors and officers access to the proceeds of their D&O policies despite the presence of entity coverage. The Southern District of New York's decision in In re Adelphia Communications Corp., 298 B.R. 49 (S.D.N.Y. 2003), follows this trend. Adelphia's directors and officers were charged with fraud in numerous civil and criminal proceedings. The directors and officers sought relief from the automatic stay to access the proceeds of their D&O policies to pay for their defense of these fraud cases. Although Adelphia's D&O policies contained entity coverage for Adelphia itself, the securities actions had been stayed as to Adelphia, and thus Adelphia had not sought reimbursement of any defense costs relating to those actions.

The bankruptcy court allowed Adelphia's directors and officers limited access to the D&O policy proceeds, but held that those proceeds were assets of Adelphia's bankruptcy estate because of the presence of entity coverage in Adelphia's D&O policies. In reversing the bankruptcy court, the district court offered even more protection to directors and officers seeking coverage under D&O policies. The district court held that the proceeds of the D&O policies were not even property of the estate. According to the district court, because Adelphia had not yet made any payment that would entitle it to entity coverage “[c]laiming [Adelphia] now [has] a property interest in those proceeds makes no sense at this juncture.”

The Adelphia decision assists in dispelling the unwarranted fear that the presence of entity coverage will deprive directors and officers of their D&O insurance protection if their company files for bankruptcy.

More than 90% of public companies purchase “entity coverage” as part of their directors' and officers' (D&O) insurance policies. Entity coverage protects the company itself ' as opposed to its directors and officers ' against securities claims. During the last 2 years, however, it would have been difficult for the director of any public company to avoid hearing that entity coverage creates an undue risk of depriving the director of D&O coverage if the company for which he or she serves files for bankruptcy. One major D&O insurer distributed a paper containing this gratuitous advice to the directors of every public company in the country. Many legal seminars and D&O coverage proposals prepared by brokers also warn of this danger. Not surprisingly, CEOs and general counsel often are questioned by their boards about D&O coverage in the event of bankruptcy.

The dire warnings find little support in bankruptcy case law. In a number of recent major bankruptcies, including Enron, courts have allowed directors and officers access to the proceeds of their D&O policies despite the presence of entity coverage. The Southern District of New York's decision in In re Adelphia Communications Corp., 298 B.R. 49 (S.D.N.Y. 2003), follows this trend. Adelphia's directors and officers were charged with fraud in numerous civil and criminal proceedings. The directors and officers sought relief from the automatic stay to access the proceeds of their D&O policies to pay for their defense of these fraud cases. Although Adelphia's D&O policies contained entity coverage for Adelphia itself, the securities actions had been stayed as to Adelphia, and thus Adelphia had not sought reimbursement of any defense costs relating to those actions.

The bankruptcy court allowed Adelphia's directors and officers limited access to the D&O policy proceeds, but held that those proceeds were assets of Adelphia's bankruptcy estate because of the presence of entity coverage in Adelphia's D&O policies. In reversing the bankruptcy court, the district court offered even more protection to directors and officers seeking coverage under D&O policies. The district court held that the proceeds of the D&O policies were not even property of the estate. According to the district court, because Adelphia had not yet made any payment that would entitle it to entity coverage “[c]laiming [Adelphia] now [has] a property interest in those proceeds makes no sense at this juncture.”

The Adelphia decision assists in dispelling the unwarranted fear that the presence of entity coverage will deprive directors and officers of their D&O insurance protection if their company files for bankruptcy.