In Bankruptcy, Are D&O Policy Proceeds Considered Estate Property?

October 2004

Heightened by the Enron and WorldCom bankruptcies, there has been increasing interest in the corporate boardroom in whether D&O policy proceeds are assets of a corporate debtor's bankruptcy estate and, if so, whether the directors and officers nevertheless can obtain relief from the automatic stay to access those proceeds. Insurers' marketing materials now abound with suggestions that D&O policies should be remade to exclude coverage for securities claims against the corporation itself (entity coverage) because the presence of that coverage may tip the scale in favor of a court holding the D&O policies' proceeds are bankruptcy estate assets. Entity coverage, the argument goes, unlike coverage to the directors and officers, provides a direct benefit to the bankrupt corporation and, thus, proceeds of a D&O policy providing entity coverage should be considered a bankruptcy estate asset.

The case law is mixed on this issue. See John H. Mathias, Jr., and Timothy W. Burns, “In Bankruptcy, How Accessible to Directors and Officers Are Their Insurance Policy Proceeds,” Insurance Coverage Law Bulletin No. 8 (September 2002). Recently, the Enron bankruptcy court addressed this issue. Although Enron's D&O policies provided entity coverage to the corporation as well as direct coverage to its directors and officers, the Enron court allowed former directors and officers access to D&O policy proceeds. Enron's policies contained an “order of payments” provision, which granted the directors and officers priority to the proceeds over the corporation and, thus, presented the bankruptcy court with an easy case.

In In re Adelphia Communications Corp., Case No. 02-41729 (REG) (Bankr. S.D.N.Y. Nov. 15, 2002), the bankruptcy court was presented with a much more difficult case. There, the D&O policies provided entity coverage to the corporation and direct coverage to the directors and officers, but contained no “order of payments” provision. Faced with motions by directors and officers to lift the bankruptcy stay to allow them access to the proceeds, the bankruptcy court candidly admitted that the case presented a peculiar set of circumstances. According to the court, one of the cocorporate debtors (1) stood a very real chance of paying all creditor claims in full and thus eventually could be in a position to pay securities claims covered under its entity coverage and (2) had made a showing that it would be difficult to retain directors and officers if the D&O policies' proceeds were depleted. Based on these circumstances, the court held (1) that the D&O policies' proceeds were estate assets and (2) the court nevertheless would lift the stay to allow the directors and officers some access to the proceeds. Notably, the court also held that the peculiar circumstances of that case required it to maintain strict control over the disbursement of the proceeds.

The Adelphia decision is uncommon in its rigorous analysis of the myriad issues involved in its holding. Dissecting those issues, the court made a number of statements that may prove useful to directors and officers in other cases in which they seek to obtain D&O policy proceeds. Most significantly, the court noted that it was the rare case in which entity coverage would require a bankruptcy court to hold D&O policy proceeds to be an asset of the estate. According to the court, “[t]hat coverage is rarely meaningful in bankruptcy cases (even in Chapter 11 cases), because under section 510(b) of the [Bankruptcy] Code, claims for securities fraud claims 'arising from rescission of a purchase or sale' of a security or for damages arising from such are subordinated to claims that are senior or equal in priority, and since there are rarely enough assets to pay all creditors in full, debtors rarely are in a position (and do not have a need) to make distributions on more junior claims.”

This article is reprinted with permission from the September edition of Insurance Coverage Law Bulletin, Copyright 2002 NLP IP Company. All rights reserved. Further duplication without permission is prohibited.