An automatic stay in bankruptcy prevents anyone from accessing the property of the debtor estate, including the directors’ and officers’ liability (D&O) policies which insure individual directors and officers of the estate as well as the debtor.  That does not mean, however, that the policy limits can be treated as a slush fund to satisfy creditors’ claims against the estate.  The policy limits (or proceeds) remain available to settle covered liability claims against the covered individuals or, if they exist, covered liability claims against the company which survive the bankruptcy proceeding.

In deciding whether the D&O policy proceeds are subject to the stay, courts look to whether the policy only provides coverage to directors and officers (Side A coverage), or whether it also provides coverage to the debtor (Side B coverage or Side C coverage).  In the former case, the proceeds are not considered property of the estate.  However, if the individuals and the company both maintain legitimate claims for coverage under Side B or C of the policy, the result can turn on the specific facts unique to the case. Where the individuals and the estate have legitimate competing claims against the policy, “the bankruptcy court must balance the harm to the debtor if the stay is modified with the harm to the directors and officers if they are prevented from executing their rights to defense costs.”  Even in cases where the D&O policy proceeds are considered property of the estate, courts may nonetheless grant relief from the stay “to allow the insurer to advance defense costs payments when the harms weigh more heavily against the directors or officers than the debtor.”  Id. at 544.

The prevailing wisdom is that D&O policy proceeds should not be frozen in bankruptcy, but should be available to cover the individual directors’ and officers’ defense and indemnity obligations for covered claims.  However, an aggressive trustee or creditors’ committee may block, or at the very least delay, access to those proceeds.  They may be motivated by the desire to preserve policy proceeds for claims which would otherwise deplete the estate.  Or, more cynically, they may be motivated by the desire to force an individual to resolve a claim brought by the estate, because the insurance policy limits will not be available to fund a vigorous defense.  Whatever the reason, the individual insured may be forced to incur significant legal fees (which may not be covered under the D&O policy) to obtain relief from the bankruptcy stay.  Even in situations where relief from the stay is granted, courts may impose caps in the amount of the proceeds which can be used for defense costs by individual insureds.  Courts may also require counsel for the individuals to submit their bills to the court or the trustee to review for reasonableness – a requirement which could put privileged or strategic information to the wrong hands.

Features built into D&O policies may strengthen the argument that the policy proceeds should be made available to the directors and officers for defense of claims, even if the debtor corporation also has valid claims under the policy.  A well-drafted “Priority of Payments” provision in the policy will make clear that the individuals have first rights to coverage for any losses that are not indemnified by the debtor estate.  It should also confirm that the coverage available to the individuals survives bankruptcy, and that all parties (including the debtor estate) will cooperate to obtain relief from the stay to make the proceeds available for claims against the individuals.

Excess Side A coverage, which sits above the Side A layer of the A-B-C policy (and may contain broader “Difference In Conditions” coverage), provides coverage for non-indemnifiable loss incurred by directors and officers.  Another former of Side A coverage, Independent Directors’ Liability (“IDL”), is reserved only for outside, or independent, directors.  The Company is not insured under either of these policies, so the estate has no rights to the policies or their proceeds.  Adding these policies to a D&O program assures that some funds will be available to respond to claims regardless of any disputes regarding the propriety of lifting the automatic stay.

Attention to D&O policy provisions and the program structure well before bankruptcy is even contemplated will increase the likelihood that the policy will serve the purpose for which it originally was intended: protection of the directors and officers.