Collecting D&O Insurance Proceeds

Much to the chagrin of the Competing Parties and their counsel, debtors have successfully employed three different strategies to block or delay competing claims to D&O Proceeds: 1) seeking a stay under 11 U.S.C. ' 362(a)(3) on the ground that the D&O Proceeds constitute property of the estate; 2) seeking an injunction under 11 U.S.C. ' 105(a) on the ground that recovering the D&O Proceeds is essential to a successful reorganization; and 3) seeking a stay under 11 U.S.C. ' 362(a)(1) on the ground that there is a sufficient identity of interest between the debtor and the director and officer defendants such that the debtor can be said to be the real defendant-in-interest in the lawsuit.

The success of these strategies depends on the jurisdiction and the structure of the insurance policy at issue. D&O Policies generally fall into three different categories: 1) policies that solely provide coverage for director and officer liability (Director Coverage); 2) policies that also cover the debtor's obligation to indemnify the directors and officers against judgments obtained against them by third parties (“Indemnity Coverage”); and 3) policies that also provide coverage for the liability of the debtor (“Entity Coverage”). This article addresses the likelihood of success of these strategies in the various jurisdictions with respect to each type of coverage.

Stay Pursuant to 11 U.S.C. ' 62(A)(3)

Under 11 U.S.C. ' 362(a)(3) of the Bankruptcy Code, an automatic stay is imposed as of the petition date and stays “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.”

The majority view is that insurance policies are property of the bankruptcy estate. See, eg, MacArthur Co. v. Johns-Manville Corp. (In re Johns-Manville Corp.), 837 F.2d 89, 92 (2d Cir. 1988); A.H. Robins Co., Inc. v. Piccinin (In re A.H. Robins Co., Inc.), 788 F.2d 994, 1001 (4th Cir. 1986); In re Minoco Group of Cos., Ltd., 799 F.2d 517, 519 (9th Cir. 1986).

The more fundamental issue, however, is whether the proceeds of such policies constitute property of the estate. Courts are in wide disagreement as to that issue. The determination as to whether D&O Proceeds constitute property of the estate depends primarily upon whether the D&O Policy includes Entity Coverage and/or Indemnity Coverage.

Where a D&O Policy provides Entity Coverage under a joint policy limit and the aggregate claims exceed such joint limit, courts have generally found that the policy proceeds constitute property of the estate. See Tringali v. Hathaway Machinery Co., 796 F.2d 553, 560 (1st Cir. 1986) (holding that the proceeds of an Entity Coverage policy are always property of the bankruptcy estate because the goal is to prevent claimants from “rac[ing] to the courthouse” to collect from the debtor in situations where claims may exceed policy limits); MacArthur Co. v. Johns-Manville Corp. (In re Johns-Manville Corp.), 837 F.2d 89, 92 (2d Cir. 1988); A.H. Robins Co. v. Piccinin, 788 F.2d 994, 1001 (4th Cir. 1986); Homsy v. Floyd (In re Vitek), 51 F.3d 530, 535 (5th Cir. 1995); In re Allied Digital Techs. Corp., 306 B.R. 505, 512 (Bankr. D. Del. 2004); In re Sacred Heart Hospital of Norristown, 182 B.R. 413, 419-420 (E.D. Pa. 1995). See also In re Adelphia Communs. Corp., 298 B.R. 49, 53-54 (S.D. N.Y. 2003) (holding that, although policy included Entity Coverage and Indemnity Coverage, debtor nevertheless lacked property interest in policy proceeds because debtor failed to make an indemnification or entity claim; court implied, however, that if debtor had made such claims, proceeds would be property of the estate).

Where a D&O Policy does not include Entity Coverage, courts are in wide disagreement over whether to classify the policy proceeds as property of the estate. Some courts have found that Indemnity Coverage alone is sufficient to render the proceeds property of the estate. See In re Leslie Fay Cos., Inc., 207 B.R. 764, 785 (Bankr. S.D. N.Y. 1997) (holding that D&O Policy with Indemnity, but not Entity, Coverage is property of the bankruptcy estate because debtor has property interest in preventing the depletion of policy limits, which would prevent the estate from being reimbursed for indemnifying the directors and officers); Circle K. Corp. v. Marks (In re Circle K. Corp.) 121 B.R. 257, 258-59 (Bankr. D. Ariz. 1990).

Other courts have held that the proceeds of a policy providing only Indemnity Coverage are property of the estate only if an indemnification claim has already been brought against the estate. See In re Allied Digital Techs. Corp., 306 B.R. 505, 512 (Bankr. D. Del. 2004) (when there is indemnification coverage, but indemnification “has not occurred, is hypothetical, or speculative,” then proceeds are not property); In Re Medex Reg'l. Lab, 314 B.R. 716 (Bankr. E.D. Tenn. 2004) (same).

Finally, some courts have concluded that Indemnity Coverage alone is insufficient to render the proceeds property of the estate. La. World Exposition, Inc. v. Federal Ins. Co. (In re La. World Exposition, Inc.) 832 F.2d 1391, 1400 (5th Cir. 1987) (proceeds of D&O Policy with Indemnity Coverage are not property of the estate because debtor is not the direct beneficiary and “any payment under the liability coverage reduces the amount of the potential indemnification claim to the same extent that policy amounts available for indemnification are thus reduced”); Youngstown Osteopathic Hosp. Ass'n v. Ventresco (In re Youngstown Osteopathic Hosp. Ass'n), 271 B.R. 544, 550 (Bankr. N.D. Ohio 2002); In re Daisy Sys. Sec. Litig., 132 B.R. 752, 755 (N.D. Cal. 1991).

Injunction Pursuant to 11 U.S.C. ' 105(A)

Section 105 of the Bankruptcy Code provides that a bankruptcy court “may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.” Courts generally apply a two-part test when determining whether to issue a ' 105 injunction enjoining a competing claim to D&O Proceeds. The court must first determine whether the D&O Proceeds fall within its “related to” jurisdiction. If the court determines that the D&O Proceeds are within its “related to” jurisdiction, then the court must decide whether the issuance of a ' 105 injunction is appropriate.

Under the first component of the test, the majority of courts have determined that jurisdiction existed by applying the liberal standard delineated in Pacor, Inc. v. Higgins, 743 F.2d 984, 994 (3rd Cir. 1984). In Pacor, the Third Circuit held that a bankruptcy court has jurisdiction to enjoin a lawsuit against a non-debtor pursuant to ' 105 if the “proceeding could conceivably have any effect on the estate being administered.” Id. Nevertheless, in Feld v. Zale Corp., 62 F.3d 746, 756 (5th Cir. 1995), despite applying the Pacor standard, the Fifth Circuit concluded that certain third-party tort claims could have no effect on the bankruptcy case and, accordingly, found that it lacked jurisdiction thereover.

Under the second component of the test, courts generally consider the following four factors when deciding whether the issuance of a ' 105 injunction is appropriate: “1) substantial likelihood that the movant will eventually prevail on the merits; 2) a showing that the movant will suffer irreparable injury unless the injunction issues; 3) proof that the threatened injury to the movant outweighs whatever damage the proposed injunction may cause the opposing party; and 4) a showing that the injunction, if issued, would not be adverse to the public interest.” See, eg, In re Arrow Huss, Inc., 51 B.R. 853, 858 (Bankr. D. Utah 1985). Of these four factors, courts have focused primarily on whether the denial of the injunction will cause irreparable harm to the movant. Id. at 859; see also In re Boston Reg'l Med. Ctr., Inc., 285 B.R. 87, 96-98 (Bankr. D. Mass. 2002); In re Johns-Manville Corp., 33 B.R. 254, 270 (Bankr. S.D. N.Y. 1983); Sudbury, Inc. v. Escott, 140 B.R. 461, 465 (Bankr. N.D. Ohio 1992).

Notwithstanding the foregoing, some courts have looked to a more limited set of factors when determining whether the issuance of an injunction is appropriate. For example, the bankruptcy court for the District of Massachusetts considered only three factors — namely, likelihood of success, irreparable harm to the movant's beneficiaries, and harm to the opposing party. In re Boston Reg'l Med. Ctr., Inc., 285 B.R. 87, 95-97 (Bankr. D. Mass. 2004). The bankruptcy court for the Southern District of New York considered solely irreparable harm and likelihood of success. In re Johns-Manville Corp., 33 B.R. 254, 262 (Bankr. S.D.N.Y. 1983). The Seventh Circuit has nearly done away with the test altogether, granting a stay where the court is satisfied that allowing the third party action to continue would “defeat or impair its jurisdiction over the case before it.” Fisher v. Apostolou, 155 F.3d 876, 882 (7th Cir. 1998). Indeed, the court went so far as to state that one “does not need to demonstrate an inadequate remedy at law or irreparable harm.” Id. at 882.

At the other end of the spectrum, other courts have considered additional factors beyond the four traditional factors discussed above, such as: “1) Whether continuation of the litigation against the nondebtor would frustrate the ability of the debtor to develop and go forward with its plan of reorganization; 2) Whether the debtor is close to having a confirmable plan that will fully satisfy the affected creditor's claims; and 3) Whether the nondebtors' continuing efforts on behalf of the debtor are essential to prepare and carry out the provisions of the plan.” In re Arrow Huss, Inc., 51 B.R. at 859; see also In re Johns-Manville Corp., 33 B.R. 254, 262-263 (Bankr. S.D. N.Y. 1983).

Applying these standards, the Second and Fourth Circuits have found the issuance of a ' 105 injunction to be appropriate where payment of proceeds to directors and officers would deplete the debtor's Indemnity Coverage. See In re Lomas Fin. Corp., 932 F.2d 147, 149 (2nd Cir. 1991) (affirming the bankruptcy court's order to enjoin third-party suit because debtor's indemnification obligation would impact bankrupt estate); A.H. Robins Co., Inc. v. Piccinin, 788 F.2d 994, 1001-1002 & 1008 (4th Cir. 1986) (affirming stay and injunction of third-party suits because payment of proceeds to directors and officers would deplete debtor's Indemnity Coverage).

The Seventh Circuit found an injunction to be appropriate where the third party and the debtor's estate hold competing claims for settlement from the same limited pool of insurance proceeds. See Fisher v. Apostolou, 155 F.3d 876, 883 (7th Cir. 1998) (granting injunction of third-party suit because bankrupt estate has priority when litigating suits with competing claims for settlement from limited pool of assets).

By contrast, despite exercising jurisdiction over the request for an injunction, courts in the First, Third, and Ninth Circuits have declined to enjoin a third party action seeking to recover D&O Proceeds. In re Pintlar Corp., 124 F.3d 1310, 1313-1314 (9th Cir. 1997) (injunction denied because payment of proceeds to directors and officers did not affect debtor's indemnification coverage); In re Cybermedica, Inc., 280 B.R. 12, 18 (Bankr. D. Mass. 2002) (declining to enjoin and lifting stay because payment of proceeds satisfies a claim the bankrupt estate would have to pay later); In re Reliance Acceptance Group, Inc., 235 B.R. 548, 561-562 (D. Del. 1999) (injunction overturned because estate may not take precedence over shareholders although both are seeking redress from same D&O Proceeds).

Stay Pursuant To 11 U.S.C. ' 362(A)(1)

Even if a court concludes that the D&O Proceeds are not property of the estate and declines to issue a Section 105 injunction, in some circuits, a stay may still issue under 11 U.S.C. ' 362(a)(1) if “unusual circumstances” exist such that an action against a third-party effectively constitutes an action against the debtor itself. Several courts have concluded that where there is a complete identity of interest between the debtor and the directors and officers, there are “unusual circumstances” warranting the issuance of a stay because a judgment against the third party will, in effect, be a judgment or finding against the debtor itself. See, eg, A.H. Robins Co. v. Piccinin, 788 F.2d 994, 1001-02, 1008 (4th Cir. 1986) (affirming stay and injunction of Dalkon Shield product liability actions against the debtor and debtor's insurer, officers, and employees where a number of the non-debtor defendants were also named under the debtor's product liability insurance policy and continued litigation would not only “reduce and diminish” the insurance proceeds available to the debtor, but also distract debtor's executives and officers from the reorganization effort).

Courts have found a sufficient identity of interest between a debtor and a non-debtor defendant to warrant extending the automatic stay to claims against non-debtors under two circumstances. First, the court has applied the stay in situations where the third-party has brought “suit against a [non-debtor] party who is entitled to absolute indemnity by the debtor on account of any judgment that might result against them in the case.” Id. at 999; In re Ionosphere Clubs, Inc., 111 B.R. 423, 434 (S.D. N.Y. 1990); In re Family Health Serv., Inc., 105 B.R. 937, 942-43 (Bankr. C.D. Cal. 1989). Second, courts have extended the stay to halt proceedings against non-debtor defendants whose debts are guaranteed by the debtor. Trimec, Inc. v. Zale Corporation, 150 B.R. 685, 687 (N.D. Ill. 1993); McCartney v. Integra Nat'l Bank North, 106 F.3d 506, 510-11 (3rd Cir. 1997).

Conversely, courts have declined to apply the automatic stay to actions brought against the debtor's guarantors or mere co-defendants. In such cases, judgment against the non-debtor party would have no effect on the debtor or bankruptcy estate because the non-debtor's liability is completely independent of the debtor. Veeco Inv. Co., L.P. v. Mercantile Nat'l Bank, N.A., 157 B.R. 452, 454 (Bankr. E.D. Mo. 1993); In re Veliotis, 79 B.R. 846 (Bankr. E.D. Mo. 1987); Lukas, Nace, Gutierrez & Sachs, Chartered, v. Havens, 245 B.R. 180, 183 (D. D.C. 2000).

Conclusion

Although debtors consider a variety of issues when selecting the venue in which to file a Chapter 11 bankruptcy case, they often fail to consider the impact of venue selection upon their ability to recover D&O Proceeds. As shown above, the choice of venue can be critical to obtaining a stay or injunction against the prosecution of suits brought against non-debtors aimed at recovering D&O Proceeds.

In an age of increasing scrutiny of the performance of officers and directors, the race to recover D&O Proceeds may become one of the principal battles in the context of a bankruptcy case. As in any war, knowledge of the battlefield and thoughtful tactics are likely to be the difference between victory and defeat.

Todd L. Padnos is a partner in the Los Angeles and San Francisco offices of LeBoeuf, Lamb, Greene & MacRae LLP. He concentrates his practice in the areas of bankruptcy, business reorganizations, workouts, and commercial litigation. He may be reached at 415-951-1140 or [email protected]. Paul S. Jasper is bankruptcy associate in the firm's San Francisco office.

In the race between a debtor and a third party to recover the proceeds of a directors' and officers' insurance policy (a “D&O Policy”), it is critical that the debtor employ the correct strategy for the applicable jurisdiction in order to enjoin its competitor from reaching the proceeds first. Choosing the wrong strategy could mean the difference between collecting tens of millions of dollars and obtaining a judgment not worth the paper upon which it is written. Indeed, the proceeds of the D&O Policy (“D&O Proceeds”) may be the largest asset of the estate. As a result, a successful reorganization could depend upon filing in the right jurisdiction and implementing the correct litigation strategy.

Introduction

Faced with the prospect of receiving less than a 100% distribution on account of its allowed claim or interest, a creditor or shareholder (often as a class representative) may attempt to circumvent the priority scheme of the Bankruptcy Code by filing suit against the debtor's officers or directors for the purpose of reaching the D&O Proceeds. Because the policy will invariably have a coverage limit insufficient to satisfy the competing claims of both the competing shareholder/creditor (the “Competing Party”) and the debtor, it is essential that the debtor reach the proceeds first. If the debtor fails to anticipate the Competing Party's tactics, and files in a jurisdiction unwilling to enjoin the competing lawsuit, the debtor may lose its opportunity to recover upon the policy, thereby squandering a valuable asset.

Much to the chagrin of the Competing Parties and their counsel, debtors have successfully employed three different strategies to block or delay competing claims to D&O Proceeds: 1) seeking a stay under 11 U.S.C. ' 362(a)(3) on the ground that the D&O Proceeds constitute property of the estate; 2) seeking an injunction under 11 U.S.C. ' 105(a) on the ground that recovering the D&O Proceeds is essential to a successful reorganization; and 3) seeking a stay under 11 U.S.C. ' 362(a)(1) on the ground that there is a sufficient identity of interest between the debtor and the director and officer defendants such that the debtor can be said to be the real defendant-in-interest in the lawsuit.

The success of these strategies depends on the jurisdiction and the structure of the insurance policy at issue. D&O Policies generally fall into three different categories: 1) policies that solely provide coverage for director and officer liability (Director Coverage); 2) policies that also cover the debtor's obligation to indemnify the directors and officers against judgments obtained against them by third parties (“Indemnity Coverage”); and 3) policies that also provide coverage for the liability of the debtor (“Entity Coverage”). This article addresses the likelihood of success of these strategies in the various jurisdictions with respect to each type of coverage.

Stay Pursuant to 11 U.S.C. ' 62(A)(3)

Under 11 U.S.C. ' 362(a)(3) of the Bankruptcy Code, an automatic stay is imposed as of the petition date and stays “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.”

The majority view is that insurance policies are property of the bankruptcy estate. See, eg, MacArthur Co. v. Johns-Manville Corp. (In re Johns-Manville Corp.), 837 F.2d 89, 92 (2d Cir. 1988); A.H. Robins Co., Inc. v. Piccinin (In re A.H. Robins Co., Inc.), 788 F.2d 994, 1001 (4th Cir. 1986); In re Minoco Group of Cos., Ltd., 799 F.2d 517, 519 (9th Cir. 1986).

The more fundamental issue, however, is whether the proceeds of such policies constitute property of the estate. Courts are in wide disagreement as to that issue. The determination as to whether D&O Proceeds constitute property of the estate depends primarily upon whether the D&O Policy includes Entity Coverage and/or Indemnity Coverage.

Where a D&O Policy provides Entity Coverage under a joint policy limit and the aggregate claims exceed such joint limit, courts have generally found that the policy proceeds constitute property of the estate. See Tringali v. Hathaway Machinery Co. , 796 F.2d 553, 560 (1st Cir. 1986) (holding that the proceeds of an Entity Coverage policy are always property of the bankruptcy estate because the goal is to prevent claimants from “rac[ing] to the courthouse” to collect from the debtor in situations where claims may exceed policy limits); MacArthur Co. v. Johns-Manville Corp. (In re Johns-Manville Corp.), 837 F.2d 89, 92 (2d Cir. 1988); A .H. Robins Co. v. Piccinin , 788 F.2d 994, 1001 (4th Cir. 1986); Homsy v. Floyd (In re Vitek), 51 F.3d 530, 535 (5th Cir. 1995); In re Allied Digital Techs. Corp., 306 B.R. 505, 512 (Bankr. D. Del. 2004); In re Sacred Heart Hospital of Norristown, 182 B.R. 413, 419-420 (E.D. Pa. 1995). See also In re Adelphia Communs. Corp., 298 B.R. 49, 53-54 (S.D. N.Y. 2003) (holding that, although policy included Entity Coverage and Indemnity Coverage, debtor nevertheless lacked property interest in policy proceeds because debtor failed to make an indemnification or entity claim; court implied, however, that if debtor had made such claims, proceeds would be property of the estate).

Where a D&O Policy does not include Entity Coverage, courts are in wide disagreement over whether to classify the policy proceeds as property of the estate. Some courts have found that Indemnity Coverage alone is sufficient to render the proceeds property of the estate. See In re Leslie Fay Cos., Inc., 207 B.R. 764, 785 (Bankr. S.D. N.Y. 1997) (holding that D&O Policy with Indemnity, but not Entity, Coverage is property of the bankruptcy estate because debtor has property interest in preventing the depletion of policy limits, which would prevent the estate from being reimbursed for indemnifying the directors and officers); Circle K. Corp. v. Marks (In re Circle K. Corp.) 121 B.R. 257, 258-59 (Bankr. D. Ariz. 1990).

Other courts have held that the proceeds of a policy providing only Indemnity Coverage are property of the estate only if an indemnification claim has already been brought against the estate. See In re Allied Digital Techs. Corp., 306 B.R. 505, 512 (Bankr. D. Del. 2004) (when there is indemnification coverage, but indemnification “has not occurred, is hypothetical, or speculative,” then proceeds are not property); In Re Medex Reg'l. Lab, 314 B.R. 716 (Bankr. E.D. Tenn. 2004) (same).

Finally, some courts have concluded that Indemnity Coverage alone is insufficient to render the proceeds property of the estate. La. World Exposition, Inc. v. Federal Ins. Co. (In re La. World Exposition, Inc.) 832 F.2d 1391, 1400 (5th Cir. 1987) (proceeds of D&O Policy with Indemnity Coverage are not property of the estate because debtor is not the direct beneficiary and “any payment under the liability coverage reduces the amount of the potential indemnification claim to the same extent that policy amounts available for indemnification are thus reduced”); Youngstown Osteopathic Hosp. Ass'n v. Ventresco (In re Youngstown Osteopathic Hosp. Ass'n), 271 B.R. 544, 550 (Bankr. N.D. Ohio 2002); In re Daisy Sys. Sec. Litig., 132 B.R. 752, 755 (N.D. Cal. 1991).

Injunction Pursuant to 11 U.S.C. ' 105(A)

Section 105 of the Bankruptcy Code provides that a bankruptcy court “may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.” Courts generally apply a two-part test when determining whether to issue a ' 105 injunction enjoining a competing claim to D&O Proceeds. The court must first determine whether the D&O Proceeds fall within its “related to” jurisdiction. If the court determines that the D&O Proceeds are within its “related to” jurisdiction, then the court must decide whether the issuance of a ' 105 injunction is appropriate.

Under the first component of the test, the majority of courts have determined that jurisdiction existed by applying the liberal standard delineated in Pacor, Inc. v. Higgins , 743 F.2d 984, 994 (3rd Cir. 1984). In Pacor, the Third Circuit held that a bankruptcy court has jurisdiction to enjoin a lawsuit against a non-debtor pursuant to ' 105 if the “proceeding could conceivably have any effect on the estate being administered.” Id. Nevertheless, in Feld v. Zale Corp. , 62 F.3d 746, 756 (5th Cir. 1995), despite applying the Pacor standard, the Fifth Circuit concluded that certain third-party tort claims could have no effect on the bankruptcy case and, accordingly, found that it lacked jurisdiction thereover.

Under the second component of the test, courts generally consider the following four factors when deciding whether the issuance of a ' 105 injunction is appropriate: “1) substantial likelihood that the movant will eventually prevail on the merits; 2) a showing that the movant will suffer irreparable injury unless the injunction issues; 3) proof that the threatened injury to the movant outweighs whatever damage the proposed injunction may cause the opposing party; and 4) a showing that the injunction, if issued, would not be adverse to the public interest.” See, eg, In re Arrow Huss, Inc., 51 B.R. 853, 858 (Bankr. D. Utah 1985). Of these four factors, courts have focused primarily on whether the denial of the injunction will cause irreparable harm to the movant. Id. at 859; see also In re Boston Reg'l Med. Ctr., Inc., 285 B.R. 87, 96-98 (Bankr. D. Mass. 2002); In re Johns-Manville Corp., 33 B.R. 254, 270 (Bankr. S.D. N.Y. 1983); Sudbury, Inc. v. Escott , 140 B.R. 461, 465 (Bankr. N.D. Ohio 1992).

Notwithstanding the foregoing, some courts have looked to a more limited set of factors when determining whether the issuance of an injunction is appropriate. For example, the bankruptcy court for the District of Massachusetts considered only three factors — namely, likelihood of success, irreparable harm to the movant's beneficiaries, and harm to the opposing party. In re Boston Reg'l Med. Ctr., Inc., 285 B.R. 87, 95-97 (Bankr. D. Mass. 2004). The bankruptcy court for the Southern District of New York considered solely irreparable harm and likelihood of success. In re Johns-Manville Corp., 33 B.R. 254, 262 (Bankr. S.D.N.Y. 1983). The Seventh Circuit has nearly done away with the test altogether, granting a stay where the court is satisfied that allowing the third party action to continue would “defeat or impair its jurisdiction over the case before it.” Fisher v. Apostolou , 155 F.3d 876, 882 (7th Cir. 1998). Indeed, the court went so far as to state that one “does not need to demonstrate an inadequate remedy at law or irreparable harm.” Id. at 882.

At the other end of the spectrum, other courts have considered additional factors beyond the four traditional factors discussed above, such as: “1) Whether continuation of the litigation against the nondebtor would frustrate the ability of the debtor to develop and go forward with its plan of reorganization; 2) Whether the debtor is close to having a confirmable plan that will fully satisfy the affected creditor's claims; and 3) Whether the nondebtors' continuing efforts on behalf of the debtor are essential to prepare and carry out the provisions of the plan.” In re Arrow Huss, Inc., 51 B.R. at 859; see also In re Johns-Manville Corp., 33 B.R. 254, 262-263 (Bankr. S.D. N.Y. 1983).

Applying these standards, the Second and Fourth Circuits have found the issuance of a ' 105 injunction to be appropriate where payment of proceeds to directors and officers would deplete the debtor's Indemnity Coverage. See In re Lomas Fin. Corp., 932 F.2d 147, 149 (2nd Cir. 1991) (affirming the bankruptcy court's order to enjoin third-party suit because debtor's indemnification obligation would impact bankrupt estate); A.H. Robins Co., Inc. v. Piccinin , 788 F.2d 994, 1001-1002 & 1008 (4th Cir. 1986) (affirming stay and injunction of third-party suits because payment of proceeds to directors and officers would deplete debtor's Indemnity Coverage).

The Seventh Circuit found an injunction to be appropriate where the third party and the debtor's estate hold competing claims for settlement from the same limited pool of insurance proceeds. See Fisher v. Apostolou , 155 F.3d 876, 883 (7th Cir. 1998) (granting injunction of third-party suit because bankrupt estate has priority when litigating suits with competing claims for settlement from limited pool of assets).

By contrast, despite exercising jurisdiction over the request for an injunction, courts in the First, Third, and Ninth Circuits have declined to enjoin a third party action seeking to recover D&O Proceeds. In re Pintlar Corp., 124 F.3d 1310, 1313-1314 (9th Cir. 1997) (injunction denied because payment of proceeds to directors and officers did not affect debtor's indemnification coverage); In re Cybermedica, Inc., 280 B.R. 12, 18 (Bankr. D. Mass. 2002) (declining to enjoin and lifting stay because payment of proceeds satisfies a claim the bankrupt estate would have to pay later); In re Reliance Acceptance Group, Inc., 235 B.R. 548, 561-562 (D. Del. 1999) (injunction overturned because estate may not take precedence over shareholders although both are seeking redress from same D&O Proceeds).

Stay Pursuant To 11 U.S.C. ' 362(A)(1)

Even if a court concludes that the D&O Proceeds are not property of the estate and declines to issue a Section 105 injunction, in some circuits, a stay may still issue under 11 U.S.C. ' 362(a)(1) if “unusual circumstances” exist such that an action against a third-party effectively constitutes an action against the debtor itself. Several courts have concluded that where there is a complete identity of interest between the debtor and the directors and officers, there are “unusual circumstances” warranting the issuance of a stay because a judgment against the third party will, in effect, be a judgment or finding against the debtor itself. See, eg, A.H. Robins Co. v. Piccinin , 788 F.2d 994, 1001-02, 1008 (4th Cir. 1986) (affirming stay and injunction of Dalkon Shield product liability actions against the debtor and debtor's insurer, officers, and employees where a number of the non-debtor defendants were also named under the debtor's product liability insurance policy and continued litigation would not only “reduce and diminish” the insurance proceeds available to the debtor, but also distract debtor's executives and officers from the reorganization effort).

Courts have found a sufficient identity of interest between a debtor and a non-debtor defendant to warrant extending the automatic stay to claims against non-debtors under two circumstances. First, the court has applied the stay in situations where the third-party has brought “suit against a [non-debtor] party who is entitled to absolute indemnity by the debtor on account of any judgment that might result against them in the case.” Id. at 999; In re Ionosphere Clubs, Inc., 111 B.R. 423, 434 (S.D. N.Y. 1990); In re Family Health Serv., Inc., 105 B.R. 937, 942-43 (Bankr. C.D. Cal. 1989). Second, courts have extended the stay to halt proceedings against non-debtor defendants whose debts are guaranteed by the debtor. Trimec, Inc. v. Zale Corporation , 150 B.R. 685, 687 (N.D. Ill. 1993); McCartney v. Integra Nat'l Bank North , 106 F.3d 506, 510-11 (3rd Cir. 1997).

Conversely, courts have declined to apply the automatic stay to actions brought against the debtor's guarantors or mere co-defendants. In such cases, judgment against the non-debtor party would have no effect on the debtor or bankruptcy estate because the non-debtor's liability is completely independent of the debtor. Veeco Inv. Co., L.P. v. Mercantile Nat'l Bank, N.A. , 157 B.R. 452, 454 (Bankr. E.D. Mo. 1993); In re Veliotis, 79 B.R. 846 (Bankr. E.D. Mo. 1987); Lukas, Nace, Gutierrez & Sachs, Chartered, v. Havens , 245 B.R. 180, 183 (D. D.C. 2000).

Conclusion

Although debtors consider a variety of issues when selecting the venue in which to file a Chapter 11 bankruptcy case, they often fail to consider the impact of venue selection upon their ability to recover D&O Proceeds. As shown above, the choice of venue can be critical to obtaining a stay or injunction against the prosecution of suits brought against non-debtors aimed at recovering D&O Proceeds.

In an age of increasing scrutiny of the performance of officers and directors, the race to recover D&O Proceeds may become one of the principal battles in the context of a bankruptcy case. As in any war, knowledge of the battlefield and thoughtful tactics are likely to be the difference between victory and defeat.

Todd L. Padnos is a partner in the Los Angeles and San Francisco offices of LeBoeuf, Lamb, Greene & MacRae LLP. He concentrates his practice in the areas of bankruptcy, business reorganizations, workouts, and commercial litigation. He may be reached at 415-951-1140 or [email protected]. Paul S. Jasper is bankruptcy associate in the firm's San Francisco office.