Insured vs. Insured exclusions in post-insolvency claims
Published 25 May 2016
A common query with D&O insurance coverage is whether post-insolvency claims against the insolvent company’s directors and officers trigger the Insured vs. Insured exclusion found in most D&O policies. This issue arises when claims are brought on behalf of the insolvent company against directors in an attempt to recover money for creditors.
The US Court has recently considered the application of the exclusion in a claim involving Capitol Bancorp Limited, a bank holding company ("CBL"), which had filed a Chapter 11 bankruptcy petition in August 2012. Negotiations resulted in CBL agreeing to the creation of a Liquidation Trust, to which it would transfer all of its causes of action. Recoveries from such claims would be limited to insurance proceeds only. CBL's CEO signed the Liquidation Trust Agreement in her dual capacities as CEO of CBL and as a member of the Liquidating Trust Oversight Committee.
Two years later the Liquidation Trust issued a claim against three former directors and officers including the former CEO. The individuals sought cover for the claim under their D&O policy but cover was denied on the basis of the Insured vs. Insured exclusion, which provided that insurers would not be liable to pay losses connected to any claim made against an insured “by, on behalf of, or in the name or right of, the Company or any Insured Person". Insurers sought a judicial declaration to that effect.
The judge granted the declaration finding that there was "a direct connection between the debtor/company/insureds and the Liquidation Trust, which was created by agreement of the Debtors and the Creditors’ Committee”. She considered the claim to be “in effect an intracompany claim” – precisely the type for which the Insured vs. Insured exclusion precludes coverage and noted that in her view the Liquidation Trust could not be seen as a "genuinely adverse party".
The prospect of a claim against directors and officers goes up exponentially when a company not only encounters financial problems, but is wound up, with the old board replaced by a new board with limited interest in protecting the reputations of those they have replaced, or by a liquidator/receiver who is only interested in his duty of bringing in the assets.
The logic of the Insured vs. Insured exclusion is that cover should not be given in situations where the decision to bring a claim or not is within the control of an insured. The relationship between the parties and whether the claim is genuinely adversarial will be examined in this context.
The application of the decision will be determined by the scope of the Insured vs. Insured exclusion in any given wording, which has been significantly restricted in the relentlessly soft market. Some policies may include a carve back (so that the exclusion does not apply to insolvency proceedings and to claims brought by trustees, liquidators and the creditors committee), but this wording is not standard in all policies. Given the importance of the clause to the cover available, directors and officers should take time to consider the scope of cover provided by their D&O policy in light of the Insured vs. Insured exclusion.