D&O Policy 'Bankruptcy Exclusion' Held To Be an Unenforceable 'Ipso Facto' Clause

As a predicate to such assumption, a debtor must either "cure" or provide "adequate assurance" that it will "promptly cure" any defaults in existence at the time that assumption is proposed. 11 U.S.C. §365(b)(1)(A). If a contract provides that simply being in bankruptcy is a default, although such cure would seem to be impossible to accomplish, the Bankruptcy Code solves for this problem by providing that the cure obligation "does not apply to a default that is a breach of a provision relating to (A) the insolvency or financial condition of the debtor … [or] (B) the commencement of a [bankruptcy] case …." 11 U.S.C. §365(b)(2). These disfavored provisions generally are referred to (although not in the statute) as "ipso facto clauses."

Recently, in the U.S. District Court for the Eastern District of Michigan, these principles were determined to prevent an insurance company from enforcing an insurance policy exclusion purporting to prevent coverage for claims asserted by a reorganization trust against a debtor's former officers and directors. In reaching this conclusion, the court made two significant and necessary findings: First, the court determined that the insurance policy was an executory contract susceptible to assumption during the bankruptcy case; second, the relevant exclusion was classified as an unenforceable "ispo facto clause."