The current financial crisis has led to a number of corporate bankruptcies.  Lehman’s filing in September 2008 – the largest bankruptcy case the


has ever seen – is one obvious example.  There are bound to be many more bankruptcies in 2009 as the financial crisis chew up more struggling businesses.  As the Lehman bankruptcy shows, corporate bankruptcies can give rise to numerous claims for mismanagement, waste and inaccurate financial disclosures.  Plaintiffs may assume that all, or nearly all, the money available to satisfy their claims has either evaporated or will be divided among thousands of creditors.  But, plaintiffs might be able to directly access the company’s D&O insurance to satisfy their claims.

The filing of a bankruptcy petition stays creditors from exercising control over assets of the bankruptcy estate.  Depending on the circumstances, this “automatic stay” may not apply to the proceeds of a D&O policy.  If the debtor does not have a direct interest in the policy proceeds, a bankruptcy court likely will not treat those proceeds as estate property.  This allows creditors to access those proceeds without having to obtain relief from the automatic stay.

The debtor does not have an interest in the proceeds of the policy if it covers only the company’s directors and officers, not the company itself.  The status of the policy proceeds is less clear if the policy provides coverage to both the company and its directors and officers.  The directors and officers might argue that the proceeds are not property of the estate, and therefore not subject to the automatic stay, if their own liabilities exceed the policy limits.  D&O policies typically require the insurer to fully satisfy all the directors and officers’ insurance claims before paying those of the company.  If the individuals’ covered liabilities exceed the policy limits, the company is not entitled to any of the policy proceeds.  They therefore might not be treated as estate assets.

By pursuing a bankrupt company’s directors and officers for losses suffered as a result of their mismanagement, plaintiffs will increase their chances of recovering their losses directly from the company’s D&O liability policies.  We discussed this and related coverage issues in a presentation to the Association of Corporate Counsel of America in December 2008 entitled Beyond Subprime: Insurance Issues in the New Wave of Financial Litigation (Download ACCA Powerpoint).