D&O Liability Policies: A Potential Asset for Troubled Companies

The Insured v. Insured Exclusion

The insured v. insured exclusion is a claimant exclusion. Although the typical language of the exclusion has evolved over the years, the exclusion is designed to eliminate coverage for claims against insured directors and officers which are brought by an insured person or organization, such as current or former officers and directors, or the insured entity itself. The insured v. insured exclusion is designed to prevent coverage for friendly or collusive lawsuits. See Alstrin v. St. Paul Mercury Ins. Co., 179 F. Supp. 2d 376 (D. Del. 2002); see also In re County Seat Stores, Inc., 280 B.R. 319 (Bankr. S.D.N.Y. 2002); see also In re Molten Metal Technology, Inc., 271 B.R. 711 (Bankr. D. Mass. 2002); see also In re Buckeye Countrymark, Inc., 251 B.R. 835 (Bankr. S.D. Ohio 2000).

As is the situation with all policy provisions and exclusions, the applicability of the insured v. insured exclusion in a particular situation is governed by the specific language in the policy. Relevant rules of contract construction are, therefore, critical to an analysis of whether or not the exclusion precludes coverage.

Since the insured v. insured exclusion was introduced, its applicability to various types of claims has been the subject of many court decisions. In the context of bankruptcies, the overwhelming majority, and better-reasoned, view is that, in most circumstances, the insured v. insured exclusion is not applicable to preclude coverage for claims asserted against the debtor's current or former officers or directors. This article surveys a number of cases where the insured v. insured exclusion was determined to be inapplicable to claims in a bankruptcy context. Accordingly, directors' and officers' liability coverage should be considered a potential asset of a bankruptcy estate and, where there is such coverage, potential claims against officers and directors of the bankrupt company should be scrutinized and pursued.

Trustees in Bankruptcy

In In re Buckeye Countrymark, Inc., 251 B.R. 835 (Bankr. S.D. Ohio 2000) (applying Ohio law), the court concluded that an insured v. insured exclusion did not preclude directors' and officers' liability coverage for breach of fiduciary duty claims brought by a Chapter 7 bankruptcy trustee against former officers and directors of the debtor. The exclusion in the relevant policies provided that the insurers were not liable for loss resulting from directors', officers', or managers' acts where the claims were “brought by or on behalf of the Insured.” Id. at 838. The debtor was named as the Insured. In construing the applicability of the insured v. insured exclusion, the court, in part, applied the rules of construction that ambiguous language in an insurance policy is construed in the manner most favorable to the insured and, with respect to exclusionary provisions, in the manner which preserves coverage for the insured. Id. at 839-40.

The insurers in Buckeye Countrymark maintained that the exclusion applied because the trustee's claims were “only extensions” of claims which could have been by or on behalf of the Insured, but for the bankruptcy. They first argued that the language of the exclusion precluding claims brought “by” the Insured barred coverage because the trustee “stands in the shoes” of the debtor. The court rejected that contention, noting that real differences exist between a bankruptcy trustee and the debtor. A trustee in bankruptcy is a separate legal entity than the debtor. The trustee does not owe fiduciary duties to the debtor, nor does it represent the debtor. Rather, the trustee's duties and responsibilities are to the bankruptcy estate. Indeed, frequently, the trustee and debtor are at odds and often take adversarial positions. Thus, they are not the same entity or alter egos of each other.

Buckeye Contrymark similarly rejected the insurers' argument that the claims brought by the trustee were brought “on behalf of” the debtor, and therefore barred by the exclusion. Because the trustee is a representative of the bankruptcy estate, a trustee brings claims on behalf of the creditors, not on behalf of the debtor. In further support of its conclusion, the court noted that the purpose behind the insured v. insured exclusion, to prevent collusive claims and lawsuits, was completely inapplicable in this situation where the bankruptcy trustee's claims are genuinely and truly adverse to the officers and directors.

Both principles of contract construction as well as an analysis of the rights and powers of a trustee in bankruptcy supported the conclusion that the insured v. insured exclusion was inapplicable in In re Molten Metal Technology, Inc., 271 B.R. 711 (Bankr. D. Mass. 2002) (applying Massachusetts law). The policy exclusion in that case extended to losses for claims against an insured “brought by an Insured or by the company.” “Insured” was defined to include “past, present or future ' directors or officers of the company.” “Company” was defined as Molten Metal Technology, Inc. and its subsidiaries.

Molten Metal filed a Chapter 11 bankruptcy and managed the company as a debtor-in-possession for approximately nine months, at which time its lender moved for the appointment of a Chapter 11 trustee. The appointed trustee filed an action against former officers and directors for breach of fiduciary duty, corporate waste, breach of the duty of loyalty, gross negligence, and insider trading. Subsequently, the trustee filed an action against several insurers who had issued directors' and officers' liability policies to Molten Metal pre-petition seeking a declaration “that the insurers may not decline to provide coverage on the basis of the insured-versus-insured exclusion.” Id. at 716. The court agreed that the insurers could not decline coverage on the basis of that exclusion.

In so concluding, the court determined that the policy language was unambiguous and that the term “Company” was explicitly defined to include only Molten Metal and its subsidiaries. The definition did not include a bankruptcy trustee or other successor or assign. The insured v. insured provision in the policy expressly provided that the exclusion was intended to encompass shareholder derivative claims. It would have been unnecessary to include this specification if “Company” was intended to extend to third-party entities derivatively enforcing claims that originally belonged to Molten Metal.

Further, the insurer's argument that the term “brought by” was meant to exclude claims brought by a trustee on behalf of or as a successor-in-interest to the debtor was also rejected. While the underlying claims originally belonged to Molten Metal before it filed bankruptcy, upon its filing the petition, the claims became the property of the bankruptcy estate, a new entity. The trustee, therefore, brought the claims not on behalf of Molten Metal, but, rather, on behalf of the bankruptcy estate. In reaching this conclusion, the court observed that “[b]y its plain and unambiguous meaning, the focus of the phrase is who is bringing the claim, not who it originally belonged to.” Id. at 726.

The insurers' argument that a bankruptcy trustee is the legal equivalent of and essentially becomes the Company for purposes of the insured v. insured exclusion was similarly rejected. A bankruptcy trustee and the debtor are distinct and separate entities which co-exist, with different rights and powers. A trustee is not the alter ego or legal equivalent of the debtor. Rather, the trustee's responsibility is to the estate, and the trustee prosecutes claims, not on behalf of the debtor, but on behalf and for the benefit of the bankruptcy estate and those with valid claims against the estate.

Alstrin v. St. Paul Mercury Ins. Co., 179 F. Supp. 2d 376 (D. Del. 2002) (applying Delaware and Illinois law) reached a similar conclusion. The issue in Alstrin was whether the insured v. insured exclusion in directors' and officers' liability policies, with language identical to that in Molten Metal, excluded coverage for fraudulent transfer claims, fiduciary duty, and other common law claims against former officers and directors of the debtor, Reliance Acceptance Group, Inc. Although originally filed as a Chapter 11 bankruptcy, an estate representative (trustee) was subsequently appointed. The estate representative filed the adversary proceedings against the former officers and directors.

The court rejected the insurer's argument that the estate representative shared identity with the debtor such that the insured v. insured exclusion precluded coverage. The exclusion does not apply to claims brought by the estate representative because the representative and the debtor are separate legal entities. Claims brought by the estate representative are brought on behalf of the creditors of the bankruptcy estate, not the debtor. The estate representative's claims against the former directors and officers are “genuinely adverse.” The estate representative's claims are not the same as claims brought “by” the debtor under the exclusionary provision. Id. at 404. Thus, it did not operate to exclude coverage under the policies.

In re County Seat Stores, Inc., 280 B.R. 319 (Bankr. S.D.N.Y. 2002) (applying New York law) is in accord. A Chapter 11 trustee was appointed for County Seat who filed claims for corporate waste, mismanagement, breach of fiduciary duty, and fraudulent transfer against the debtor's officers and directors. As in many of the cases referenced above, the insured v. insured exclusion in the relevant directors' and officers' liability policy excluded claims against an insured “brought by an insured, or the company.” The “Company” was defined as County Seat, Inc.

The “brought by” language of the exclusion unambiguously focuses on the identity of the entity pursuing the claim. The trustee is neither the company nor an insured. Thus, the exclusion does not apply.

The court further found the insurers' argument that the trustee “stands in the shoes” of the debtor and should therefore be excluded unpersuasive for reasons similar to those articulated and in other cases. The trustee and the debtor are
distinct legal entities. The former's duties flow to the estate. Any claims belonging to the debtor before bankruptcy become the property of the estate once the petition is filed. Only the trustee can assert claims on behalf of the estate.

The court also analogized the claim to shareholder derivative actions, which were specifically excepted by the exclusion. Additionally, the trustee is a truly adverse party from the officers and directors. Thus, application of the exclusion would not further the purpose in preventing collusive lawsuits.

Rigby v. Underwriters at Lloyd's, London, 907 So. 2d 1187 (Fla. 3d Dist. Ct. App.), review granted, 917 So. 2d 192 (Fla. 2005), review dismissed as improvidently granted, 934 So. 2d 1183 (Fla. 2006) (applying Florida law) reached a similar result, with little discussion or analysis, relying strictly on the policy language and the capacity in which suit was filed. Atlas Environmental, Inc. filed a Chapter 11 bankruptcy, which was later converted to a Chapter 7. Kapila was appointed the Chapter 11 trustee.

Prior to filing for bankruptcy, Atlas obtained directors' and officers' liability policies from Lloyd's, which issued policy renewals during the bankruptcy. Once appointed trustee, Kapila requested that he be listed personally as an insured under the directors' and officers' liability policy.

Kapila, as trustee, sued a former director and officer of Atlas for breach of fiduciary duty and negligence on behalf of the estate's creditors. Lloyd's relied upon the insured v. insured exclusion to deny coverage. The exclusion provided that Lloyd's was not liable for claims brought “by, on behalf of, or at the direction of any of the Assureds.” The latter was defined to mean “the Company and the Directors and Officers.”

The court rejected Lloyd's position that the exclusion barred coverage. In so doing, the court noted that Kapila's endorsement as an insured under the policy did not change or alter his position of trustee. Kapila did not bring the underlying action as a director or officer, but, rather, as trustee of the estate, on behalf of the debtor's creditors pursuant to his statutory duties and authority. Accordingly, the insured v. insured exclusion did not apply.

In re Laminate Kingdom, LLC D/B/A Floors Today, Bankr. No. 07-10279-BKC-AJC, 2008 WL 704396 (Bankr. S.D. Fla. Mar. 13, 2008) (applying Florida law) likewise relied upon an analysis of the rights and responsibilities of a trustee in bankruptcy as well as principles of contract construction in concluding that an insured v. insured exclusion was inapplicable and did not preclude coverage.

Laminate Kingdom was the Insured Entity under a Management Liability Insurance Policy. Laminate Kingdom filed bankruptcy, and the Chapter 7 Trustee filed suit against a former member of the debtor's Board of Managers for constructive fraud, breach of fiduciary duty, and aiding and abetting such breaches. The insurer sought to deny coverage based upon the insured v. insured exclusion.

The relevant exclusion provided the insurer would not be liable for claims “by, on behalf of, or in the right of the Insured Entity.” The “Insured Entity” was defined as Laminate Kingdom and any subsidiaries. The insurer advanced the position that when a bankruptcy trustee asserts claims that accrued and belonged to the debtor pre-petition, the bankruptcy trustee is essentially the same entity as the debtor, thereby implicating the exclusion.

Analyzing the status and identity of the trustee versus the debtor, the court noted that claims belonging to the corporate entity pre-petition become the property of the estate by operation of law upon the filing of the bankruptcy. A bankruptcy trustee is conceptually separate from the debtor for purposes of bankruptcy law, and it is the Chapter 7 trustee who can assert claims on behalf of the bankruptcy estate. An action filed by a trustee is brought on behalf of the estate and its creditors. As a consequence, “the debtor does not own the claims and cannot bring this action. Rather, the bankruptcy trustee is prosecuting the claims on behalf of the estate and for the benefit of creditors having valid claims against it, and he is not prosecuting these claims 'by, on behalf of, in right of the Insured Entity (sic).'” Id. at *4. The trustee and the debtor are distinct and separate legal entities, and the insured v. insured exclusion in the policy did not apply.

Moreover, rules of construction require that exclusions in insurance contracts be strictly construed against the insurer and in such a manner as to favor coverage for the policyholder. The court observed that the insured v. insured exclusion in some directors' and officers' liability policies specifically excludes coverage for claims brought by debtors-in-possession or bankruptcy trustees. Id. at *5. The policy issued to Laminate Kingdom did not contain that specific exclusion. That omission indicated the exclusion did not apply to actions brought by bankruptcy trustees.

Creditors' Committees

In Cirka v. National Union, No. Civ. A. 20250-NC, 2004 WL 1813283 (Del. Ch. Aug. 6, 2004), the court concluded that an insured v. insured provision in a directors' and officers' liability policy did not operate to exclude from coverage claims brought by a creditors' committee for alleged breaches of fiduciary duty by current and former officers and directors of a Chapter 11 debtor.

The directors' and officers' liability policies considered in Cirka excluded coverage for losses in connection with claims made against an Insured “brought by or on behalf of any Insured of the Company.” The policies defined “Insured” to include a debtor-in-possession in a bankruptcy proceeding. There was, however, an exception in the bankruptcy context for examiners or trustees.

After entering bankruptcy, the insured company continued to manage its affairs as a debtor-in-possession. No trustee or examiner was appointed, but a creditors' committee was formed. The bankruptcy court granted the creditors' committee's motion to pursue claims for breaches of corporate officers' and directors' fiduciary duties of loyalty and due care and waste of corporate assets. In granting the motion, the bankruptcy court noted that the committee was the proper party to assert the claims on behalf of the estate, not the debtor, and that any recoveries were to be held for and distributed to creditors.

The issue analyzed by the court, therefore, was whether (where there is no examiner or trustee) a creditors' committee which has been authorized by a bankruptcy court to pursue an action that could have been maintained by the debtor-in-possession, brings that action “on behalf of” the debtor-in-possession so as to be excluded from coverage under the insured v. insured exclusion. The court concluded that it does not, because the creditors' committee's claims were derivative in nature, were brought on behalf of the estate, and, therefore, the
exclusion did not operate to bar coverage.

The court reasoned as follows. A bankruptcy “estate is like the corpus of a trust” which includes all property interests belonging to the debtor at the time the bankruptcy is filed. The claims of the debtor pre-bankruptcy belong to the estate once the bankruptcy is filed. Typically, the trustee or debtor-in-possession pursues claims on behalf of the estate as the estate representative. In a Chapter 11 bankruptcy, it is unusual for a trustee to be appointed. However, under the Bankruptcy Code, with certain exceptions not relevant to the issue under consideration, the debtor-in-possession, as the representative of the estate, has all the rights and powers of an appointed trustee.

The Bankruptcy Code provides for creditors' committees to ensure that the trustee or debtor-in-possession maximizes the estate and does not act in a manner that prefers the interests of certain individuals or entities over others. Creditors' committees have the right to appear and be heard on any issue that affects the case. Thus, in the absence of an appointed trustee, the debtor-in-possession functions as the corporate management, while the creditors' committee functions in a manner as to provide “checks on managerial discretion.” Id. at *5.

A creditors' committee's standing to pursue claims on behalf of the estate is derivative of standing conferred on a trustee or debtor-in-possession to pursue claims belonging to the estate. Id. at *7; Official Comm. Of Unsecured Creditors of Cybergenics Corp. ex rel Cybergenics v. Chinery, 330 F.3d 548, 561-62 (3d Cir. 2003). Thus, a bankruptcy court may authorize a creditors' committee to bring suit derivatively. Cirka, 2004 WL 1813283, at *8.

The issue then, in determining whether the insured v. insured exclusion was applicable, was the nature of the derivative standing, i.e., “does one who is granted derivative standing necessarily bring suit 'on behalf of' the entity in which the right to bring suit rests?” Id. at *7. In concluding that it does not and that, therefore, the insured v. insured exclusion does not apply, the court found the creditors' committee's derivative standing analogous to derivative standing in the corporate context. In the latter, a shareholder brings a derivative action to enforce a corporate right. In this circumstance, the creditor's committee brings a derivative action to enforce a right belonging to the estate.

Though the case could have been brought by the debtor-in-possession, and thereby been excluded from coverage, it was not. The creditors' committee was not bringing the action “on behalf of” the debtor-in-possession, such as to be excluded from coverage. Rather, it was “simply enforcing a right belonging to the Estate.” Id.

State Court Liquidators

Similarly, the insured v. insured exclusion may not operate to bar directors' and officers' liability coverage in state court liquidation proceedings. QBE International Insurance v. Clark, No. 01C 0508, 2003 WL 22433117 (N.D. Ill. Oct. 24, 2003) (applying Illinois law) considered the issue of whether claims asserted by a liquidator of a workers' compensation trust against the trust's former trustees for negligence and breaches of fiduciary duties were covered by a directors' and officers' liability policy or precluded by the insured v. insured exclusion. In concluding that the exclusion did not bar coverage, that court analyzed the statutory powers and duties of the liquidator under Illinois law, as well as the language in the policies and principles of policy construction. Critical to that conclusion was the fact that other participants, such as the trust's creditors, had an interest in the claims asserted by the liquidator against the former trustees of the trust.

Conclusion

The specter of potential insolvency and bankruptcy raises myriad issues, which must be carefully studied and evaluated in formulating the appropriate vehicle and course of conduct to maximize the recovery of assets for the benefit of those with claims against the involved entity. Where the investigation reveals that corporate problems may have resulted from officers' or directors' negligence or mismanagement, the pursuit of claims against the former officers and directors should be closely examined. Part of that analysis involves evaluating the assets available to satisfy those liabilities if the claims are successful. One potential asset that should not be forgotten in the appropriate circumstances is directors' and officers' liability coverage.

Sallie Lux is a shareholder of Brouse McDowell, resident in its Akron, OH office. Since 2004, Lux has chaired the firm's Litigation Practice Group. She is also a member of the firm's Insurance Recovery Group.

One has only to open the newspaper, access the Internet, or turn on a television or radio to get a glimpse of the current turbulent economic climate. Businesses are cutting back or cutting jobs in an effort to survive, and the ongoing viability of many corporations and institutions appears to be in jeopardy. Historically, this type of economic climate is predictive of increased bankruptcy filings, liquidations, and other insolvencies. Under the appropriate circumstances, a company's directors' and officers' liability policies are potential corporate assets that should not be forgotten or ignored.

Directors' and officers' liability policies provide protection to officers and directors for claims against corporate officers and directors arising out of “wrongful acts” taken in their official capacities. “Wrongful acts” are defined in the policy itself, but typically extend to both acts and omissions, subject to stated exclusions. A wrongful act is typically defined as “breach of duty, neglect, error, misstatement, misleading statement, omission, or their misconduct as a director or officer.” A wide variety of activities may be covered, such as negligent omissions in proxy materials, misrepresentations of financial conditions and operations, violations of state law, overstating the corporation's net worth and future prospects, breaches of fiduciary duty, certain claims of self-dealing, misrepresentation, and constructive fraud.

Directors' and officers' coverage began as a fairly straightforward and relatively inexpensive policy. An explosion of liability claims in the 1980s and the resultant insurance drain caused a dramatic change in directors' and officers' coverage. Premiums rose and coverage was reduced with the addition of numerous exclusions. As a general rule, there are typically a number of broad categories of exclusions in directors' and officers' liability policies, including conduct exclusions, other insurance exclusions, claimant exclusions, and laser exclusions.

The Insured v. Insured Exclusion

The insured v. insured exclusion is a claimant exclusion. Although the typical language of the exclusion has evolved over the years, the exclusion is designed to eliminate coverage for claims against insured directors and officers which are brought by an insured person or organization, such as current or former officers and directors, or the insured entity itself. The insured v. insured exclusion is designed to prevent coverage for friendly or collusive lawsuits. See Alstrin v. St. Paul Mercury Ins. Co. , 179 F. Supp. 2d 376 (D. Del. 2002); see also In re County Seat Stores, Inc. , 280 B.R. 319 (Bankr. S.D.N.Y. 2002); see also In re Molten Metal Technology, Inc., 271 B.R. 711 (Bankr. D. Mass. 2002); see also In re Buckeye Countrymark, Inc., 251 B.R. 835 (Bankr. S.D. Ohio 2000).

As is the situation with all policy provisions and exclusions, the applicability of the insured v. insured exclusion in a particular situation is governed by the specific language in the policy. Relevant rules of contract construction are, therefore, critical to an analysis of whether or not the exclusion precludes coverage.

Since the insured v. insured exclusion was introduced, its applicability to various types of claims has been the subject of many court decisions. In the context of bankruptcies, the overwhelming majority, and better-reasoned, view is that, in most circumstances, the insured v. insured exclusion is not applicable to preclude coverage for claims asserted against the debtor's current or former officers or directors. This article surveys a number of cases where the insured v. insured exclusion was determined to be inapplicable to claims in a bankruptcy context. Accordingly, directors' and officers' liability coverage should be considered a potential asset of a bankruptcy estate and, where there is such coverage, potential claims against officers and directors of the bankrupt company should be scrutinized and pursued.

Trustees in Bankruptcy

In In re Buckeye Countrymark, Inc., 251 B.R. 835 (Bankr. S.D. Ohio 2000) (applying Ohio law), the court concluded that an insured v. insured exclusion did not preclude directors' and officers' liability coverage for breach of fiduciary duty claims brought by a Chapter 7 bankruptcy trustee against former officers and directors of the debtor. The exclusion in the relevant policies provided that the insurers were not liable for loss resulting from directors', officers', or managers' acts where the claims were “brought by or on behalf of the Insured.” Id. at 838. The debtor was named as the Insured. In construing the applicability of the insured v. insured exclusion, the court, in part, applied the rules of construction that ambiguous language in an insurance policy is construed in the manner most favorable to the insured and, with respect to exclusionary provisions, in the manner which preserves coverage for the insured. Id. at 839-40.

The insurers in Buckeye Countrymark maintained that the exclusion applied because the trustee's claims were “only extensions” of claims which could have been by or on behalf of the Insured, but for the bankruptcy. They first argued that the language of the exclusion precluding claims brought “by” the Insured barred coverage because the trustee “stands in the shoes” of the debtor. The court rejected that contention, noting that real differences exist between a bankruptcy trustee and the debtor. A trustee in bankruptcy is a separate legal entity than the debtor. The trustee does not owe fiduciary duties to the debtor, nor does it represent the debtor. Rather, the trustee's duties and responsibilities are to the bankruptcy estate. Indeed, frequently, the trustee and debtor are at odds and often take adversarial positions. Thus, they are not the same entity or alter egos of each other.

Buckeye Contrymark similarly rejected the insurers' argument that the claims brought by the trustee were brought “on behalf of” the debtor, and therefore barred by the exclusion. Because the trustee is a representative of the bankruptcy estate, a trustee brings claims on behalf of the creditors, not on behalf of the debtor. In further support of its conclusion, the court noted that the purpose behind the insured v. insured exclusion, to prevent collusive claims and lawsuits, was completely inapplicable in this situation where the bankruptcy trustee's claims are genuinely and truly adverse to the officers and directors.

Both principles of contract construction as well as an analysis of the rights and powers of a trustee in bankruptcy supported the conclusion that the insured v. insured exclusion was inapplicable in In re Molten Metal Technology, Inc., 271 B.R. 711 (Bankr. D. Mass. 2002) (applying Massachusetts law). The policy exclusion in that case extended to losses for claims against an insured “brought by an Insured or by the company.” “Insured” was defined to include “past, present or future ' directors or officers of the company.” “Company” was defined as Molten Metal Technology, Inc. and its subsidiaries.

Molten Metal filed a Chapter 11 bankruptcy and managed the company as a debtor-in-possession for approximately nine months, at which time its lender moved for the appointment of a Chapter 11 trustee. The appointed trustee filed an action against former officers and directors for breach of fiduciary duty, corporate waste, breach of the duty of loyalty, gross negligence, and insider trading. Subsequently, the trustee filed an action against several insurers who had issued directors' and officers' liability policies to Molten Metal pre-petition seeking a declaration “that the insurers may not decline to provide coverage on the basis of the insured-versus-insured exclusion.” Id. at 716. The court agreed that the insurers could not decline coverage on the basis of that exclusion.

In so concluding, the court determined that the policy language was unambiguous and that the term “Company” was explicitly defined to include only Molten Metal and its subsidiaries. The definition did not include a bankruptcy trustee or other successor or assign. The insured v. insured provision in the policy expressly provided that the exclusion was intended to encompass shareholder derivative claims. It would have been unnecessary to include this specification if “Company” was intended to extend to third-party entities derivatively enforcing claims that originally belonged to Molten Metal.

Further, the insurer's argument that the term “brought by” was meant to exclude claims brought by a trustee on behalf of or as a successor-in-interest to the debtor was also rejected. While the underlying claims originally belonged to Molten Metal before it filed bankruptcy, upon its filing the petition, the claims became the property of the bankruptcy estate, a new entity. The trustee, therefore, brought the claims not on behalf of Molten Metal, but, rather, on behalf of the bankruptcy estate. In reaching this conclusion, the court observed that “[b]y its plain and unambiguous meaning, the focus of the phrase is who is bringing the claim, not who it originally belonged to.” Id. at 726.

The insurers' argument that a bankruptcy trustee is the legal equivalent of and essentially becomes the Company for purposes of the insured v. insured exclusion was similarly rejected. A bankruptcy trustee and the debtor are distinct and separate entities which co-exist, with different rights and powers. A trustee is not the alter ego or legal equivalent of the debtor. Rather, the trustee's responsibility is to the estate, and the trustee prosecutes claims, not on behalf of the debtor, but on behalf and for the benefit of the bankruptcy estate and those with valid claims against the estate.

Alstrin v. St. Paul Mercury Ins. Co. , 179 F. Supp. 2d 376 (D. Del. 2002) (applying Delaware and Illinois law) reached a similar conclusion. The issue in Alstrin was whether the insured v. insured exclusion in directors' and officers' liability policies, with language identical to that in Molten Metal, excluded coverage for fraudulent transfer claims, fiduciary duty, and other common law claims against former officers and directors of the debtor, Reliance Acceptance Group, Inc. Although originally filed as a Chapter 11 bankruptcy, an estate representative (trustee) was subsequently appointed. The estate representative filed the adversary proceedings against the former officers and directors.

The court rejected the insurer's argument that the estate representative shared identity with the debtor such that the insured v. insured exclusion precluded coverage. The exclusion does not apply to claims brought by the estate representative because the representative and the debtor are separate legal entities. Claims brought by the estate representative are brought on behalf of the creditors of the bankruptcy estate, not the debtor. The estate representative's claims against the former directors and officers are “genuinely adverse.” The estate representative's claims are not the same as claims brought “by” the debtor under the exclusionary provision. Id. at 404. Thus, it did not operate to exclude coverage under the policies.

In re County Seat Stores, Inc., 280 B.R. 319 (Bankr. S.D.N.Y. 2002) (applying New York law) is in accord. A Chapter 11 trustee was appointed for County Seat who filed claims for corporate waste, mismanagement, breach of fiduciary duty, and fraudulent transfer against the debtor's officers and directors. As in many of the cases referenced above, the insured v. insured exclusion in the relevant directors' and officers' liability policy excluded claims against an insured “brought by an insured, or the company.” The “Company” was defined as County Seat, Inc.

The “brought by” language of the exclusion unambiguously focuses on the identity of the entity pursuing the claim. The trustee is neither the company nor an insured. Thus, the exclusion does not apply.

The court further found the insurers' argument that the trustee “stands in the shoes” of the debtor and should therefore be excluded unpersuasive for reasons similar to those articulated and in other cases. The trustee and the debtor are
distinct legal entities. The former's duties flow to the estate. Any claims belonging to the debtor before bankruptcy become the property of the estate once the petition is filed. Only the trustee can assert claims on behalf of the estate.

The court also analogized the claim to shareholder derivative actions, which were specifically excepted by the exclusion. Additionally, the trustee is a truly adverse party from the officers and directors. Thus, application of the exclusion would not further the purpose in preventing collusive lawsuits.

Rigby v. Underwriters at Lloyd's, London , 907 So. 2d 1187 (Fla. 3d Dist. Ct. App.), review granted , 917 So. 2d 192 (Fla. 2005), review dismissed as improvidently granted , 934 So. 2d 1183 (Fla. 2006) (applying Florida law) reached a similar result, with little discussion or analysis, relying strictly on the policy language and the capacity in which suit was filed. Atlas Environmental, Inc. filed a Chapter 11 bankruptcy, which was later converted to a Chapter 7. Kapila was appointed the Chapter 11 trustee.

Prior to filing for bankruptcy, Atlas obtained directors' and officers' liability policies from Lloyd's, which issued policy renewals during the bankruptcy. Once appointed trustee, Kapila requested that he be listed personally as an insured under the directors' and officers' liability policy.

Kapila, as trustee, sued a former director and officer of Atlas for breach of fiduciary duty and negligence on behalf of the estate's creditors. Lloyd's relied upon the insured v. insured exclusion to deny coverage. The exclusion provided that Lloyd's was not liable for claims brought “by, on behalf of, or at the direction of any of the Assureds.” The latter was defined to mean “the Company and the Directors and Officers.”

The court rejected Lloyd's position that the exclusion barred coverage. In so doing, the court noted that Kapila's endorsement as an insured under the policy did not change or alter his position of trustee. Kapila did not bring the underlying action as a director or officer, but, rather, as trustee of the estate, on behalf of the debtor's creditors pursuant to his statutory duties and authority. Accordingly, the insured v. insured exclusion did not apply.

In re Laminate Kingdom, LLC D/B/A Floors Today, Bankr. No. 07-10279-BKC-AJC, 2008 WL 704396 (Bankr. S.D. Fla. Mar. 13, 2008) (applying Florida law) likewise relied upon an analysis of the rights and responsibilities of a trustee in bankruptcy as well as principles of contract construction in concluding that an insured v. insured exclusion was inapplicable and did not preclude coverage.

Laminate Kingdom was the Insured Entity under a Management Liability Insurance Policy. Laminate Kingdom filed bankruptcy, and the Chapter 7 Trustee filed suit against a former member of the debtor's Board of Managers for constructive fraud, breach of fiduciary duty, and aiding and abetting such breaches. The insurer sought to deny coverage based upon the insured v. insured exclusion.

The relevant exclusion provided the insurer would not be liable for claims “by, on behalf of, or in the right of the Insured Entity.” The “Insured Entity” was defined as Laminate Kingdom and any subsidiaries. The insurer advanced the position that when a bankruptcy trustee asserts claims that accrued and belonged to the debtor pre-petition, the bankruptcy trustee is essentially the same entity as the debtor, thereby implicating the exclusion.

Analyzing the status and identity of the trustee versus the debtor, the court noted that claims belonging to the corporate entity pre-petition become the property of the estate by operation of law upon the filing of the bankruptcy. A bankruptcy trustee is conceptually separate from the debtor for purposes of bankruptcy law, and it is the Chapter 7 trustee who can assert claims on behalf of the bankruptcy estate. An action filed by a trustee is brought on behalf of the estate and its creditors. As a consequence, “the debtor does not own the claims and cannot bring this action. Rather, the bankruptcy trustee is prosecuting the claims on behalf of the estate and for the benefit of creditors having valid claims against it, and he is not prosecuting these claims 'by, on behalf of, in right of the Insured Entity (sic).'” Id. at *4. The trustee and the debtor are distinct and separate legal entities, and the insured v. insured exclusion in the policy did not apply.

Moreover, rules of construction require that exclusions in insurance contracts be strictly construed against the insurer and in such a manner as to favor coverage for the policyholder. The court observed that the insured v. insured exclusion in some directors' and officers' liability policies specifically excludes coverage for claims brought by debtors-in-possession or bankruptcy trustees. Id. at *5. The policy issued to Laminate Kingdom did not contain that specific exclusion. That omission indicated the exclusion did not apply to actions brought by bankruptcy trustees.

Creditors' Committees

In Cirka v. National Union, No. Civ. A. 20250-NC, 2004 WL 1813283 (Del. Ch. Aug. 6, 2004), the court concluded that an insured v. insured provision in a directors' and officers' liability policy did not operate to exclude from coverage claims brought by a creditors' committee for alleged breaches of fiduciary duty by current and former officers and directors of a Chapter 11 debtor.

The directors' and officers' liability policies considered in Cirka excluded coverage for losses in connection with claims made against an Insured “brought by or on behalf of any Insured of the Company.” The policies defined “Insured” to include a debtor-in-possession in a bankruptcy proceeding. There was, however, an exception in the bankruptcy context for examiners or trustees.

After entering bankruptcy, the insured company continued to manage its affairs as a debtor-in-possession. No trustee or examiner was appointed, but a creditors' committee was formed. The bankruptcy court granted the creditors' committee's motion to pursue claims for breaches of corporate officers' and directors' fiduciary duties of loyalty and due care and waste of corporate assets. In granting the motion, the bankruptcy court noted that the committee was the proper party to assert the claims on behalf of the estate, not the debtor, and that any recoveries were to be held for and distributed to creditors.

The issue analyzed by the court, therefore, was whether (where there is no examiner or trustee) a creditors' committee which has been authorized by a bankruptcy court to pursue an action that could have been maintained by the debtor-in-possession, brings that action “on behalf of” the debtor-in-possession so as to be excluded from coverage under the insured v. insured exclusion. The court concluded that it does not, because the creditors' committee's claims were derivative in nature, were brought on behalf of the estate, and, therefore, the
exclusion did not operate to bar coverage.

The court reasoned as follows. A bankruptcy “estate is like the corpus of a trust” which includes all property interests belonging to the debtor at the time the bankruptcy is filed. The claims of the debtor pre-bankruptcy belong to the estate once the bankruptcy is filed. Typically, the trustee or debtor-in-possession pursues claims on behalf of the estate as the estate representative. In a Chapter 11 bankruptcy, it is unusual for a trustee to be appointed. However, under the Bankruptcy Code, with certain exceptions not relevant to the issue under consideration, the debtor-in-possession, as the representative of the estate, has all the rights and powers of an appointed trustee.

The Bankruptcy Code provides for creditors' committees to ensure that the trustee or debtor-in-possession maximizes the estate and does not act in a manner that prefers the interests of certain individuals or entities over others. Creditors' committees have the right to appear and be heard on any issue that affects the case. Thus, in the absence of an appointed trustee, the debtor-in-possession functions as the corporate management, while the creditors' committee functions in a manner as to provide “checks on managerial discretion.” Id. at *5.

A creditors' committee's standing to pursue claims on behalf of the estate is derivative of standing conferred on a trustee or debtor-in-possession to pursue claims belonging to the estate. Id. at *7; Official Comm. Of Unsecured Creditors of Cybergenics Corp. ex rel Cybergenics v. Chinery , 330 F.3d 548, 561-62 (3d Cir. 2003). Thus, a bankruptcy court may authorize a creditors' committee to bring suit derivatively. Cirka, 2004 WL 1813283, at *8.

The issue then, in determining whether the insured v. insured exclusion was applicable, was the nature of the derivative standing, i.e., “does one who is granted derivative standing necessarily bring suit 'on behalf of' the entity in which the right to bring suit rests?” Id. at *7. In concluding that it does not and that, therefore, the insured v. insured exclusion does not apply, the court found the creditors' committee's derivative standing analogous to derivative standing in the corporate context. In the latter, a shareholder brings a derivative action to enforce a corporate right. In this circumstance, the creditor's committee brings a derivative action to enforce a right belonging to the estate.

Though the case could have been brought by the debtor-in-possession, and thereby been excluded from coverage, it was not. The creditors' committee was not bringing the action “on behalf of” the debtor-in-possession, such as to be excluded from coverage. Rather, it was “simply enforcing a right belonging to the Estate.” Id.

State Court Liquidators

Similarly, the insured v. insured exclusion may not operate to bar directors' and officers' liability coverage in state court liquidation proceedings. QBE International Insurance v. Clark, No. 01C 0508, 2003 WL 22433117 (N.D. Ill. Oct. 24, 2003) (applying Illinois law) considered the issue of whether claims asserted by a liquidator of a workers' compensation trust against the trust's former trustees for negligence and breaches of fiduciary duties were covered by a directors' and officers' liability policy or precluded by the insured v. insured exclusion. In concluding that the exclusion did not bar coverage, that court analyzed the statutory powers and duties of the liquidator under Illinois law, as well as the language in the policies and principles of policy construction. Critical to that conclusion was the fact that other participants, such as the trust's creditors, had an interest in the claims asserted by the liquidator against the former trustees of the trust.

Conclusion

The specter of potential insolvency and bankruptcy raises myriad issues, which must be carefully studied and evaluated in formulating the appropriate vehicle and course of conduct to maximize the recovery of assets for the benefit of those with claims against the involved entity. Where the investigation reveals that corporate problems may have resulted from officers' or directors' negligence or mismanagement, the pursuit of claims against the former officers and directors should be closely examined. Part of that analysis involves evaluating the assets available to satisfy those liabilities if the claims are successful. One potential asset that should not be forgotten in the appropriate circumstances is directors' and officers' liability coverage.

Sallie Lux is a shareholder of Brouse McDowell, resident in its Akron, OH office. Since 2004, Lux has chaired the firm's Litigation Practice Group. She is also a member of the firm's Insurance Recovery Group.