Previously, I wrote about the alternatives that directors and officers can explore outside of bankruptcy if a corporation is facing financial problems. However, sometimes bankruptcy is the only choice.
While a corporation will find relief from litigation when it enters bankruptcy, its directors and officers may remain on edge because they can be sued individually or collectively – and the company is no longer able to indemnify them. Thus, when a company goes into bankruptcy, its Ds and Os are in an especially vulnerable position. Enter the D&O insurance policy.
A well-brokered D&O policy that has the right terms and was placed with a good insurance carrier is designed to protect directors and officers in exactly this situation.
Let’s take a closer look at four critical issues to consider if you want a D&O policy that will protect Ds and Os in bankruptcy.
1. A Specialized Broker and Policy Negotiator
Unlike some other lines of insurance, D&O insurance requires a specialist. Ideally, you will work with a broker that has helped many companies before yours though bankruptcies. This is an area where experience matters.
Consider the vital timing and technical issues surrounding policies. An experienced broker can walk you through the issues. Remember too that insurers are more willing to embrace broad bankruptcy terms the further away from bankruptcy your company is.
An experienced broker knows this too, and makes a point of negotiating broad bankruptcy policy coverage well before anyone else might think this sort of negotiation is important.
2. A Financially Solid, Dependable Insurance Carrier
It may be tempting to select your insurance coverage based on price, but there are other things to consider when evaluating a carrier. A critical issue for the Ds and Os of a company facing bankruptcy is the financial health of the insurance carrier. Another important consideration is the carrier’s track record of paying claims.
Insurance carriers that are unable or unwilling to pay legal bills timely are carriers that are leaving Ds and Os in a lurch.
As a general rule, Ds and Os being sued by a creditor or a bankruptcy trustee will want highly credentialed lawyers to defend them. This is expensive, and in the best case your insurance program will be with a carrier that is used to paying the fees of major law firms.
3. The “Side A” Insuring Agreement
“Side A” is the common term for the insuring agreement in a D&O policy that responds when a D or O is sued and the corporation is unable to respond, including due to bankruptcy. This insuring agreement should require no payment of a self-insured retention (like a deductible) before the policy will begin to respond.
Most public companies and many private companies purchase Side A as part of a broader insurance policy, and also purchase Side A insurance on a standalone basis. When the Side A policy is part of a broader policy that also includes coverage for the corporate entity, the policy is often referred to as an “ABC policy.”
This evolution of the D&O insurance program structure—companies’ purchasing Side A both within an ABC policy and also on a standalone basis—happened due to a concern about bankruptcy.
The worry is that, in bankruptcy, a trustee may attempt to assert that the ABC policy is an asset of the corporation since it includes corporate entity balance protection. If the trustee is successful in seizing the ABC policy and there were no separate standalone Side A policy, Ds and Os will be left with no coverage.
For more on the ABCs of D&O insurance, I recommend a previous post I wrote here.
Side note on additional coverage: Directors and officers might consider a separate wealth security policy, which is an extra safeguard of personal wealth. This is a backup plan for when a company’s D&O insurance falls short or becomes unavailable. Remember that your normal personal insurance policies (such as your personal umbrella policy) almost always exclude coverage for service on a for-profit company board.
4. Custom Contractual Terms
Terms specific to bankruptcy should be carefully crafted in the D&O policy. You’ll want to consider the following:
- Zero self-insured retentions. As mentioned previously, the policy should not require any payments by a corporation or its Ds and Os before the Side A insuring agreement responds to a claim.
- Specific triggers. Triggers can vary for Side A coverage, but at a minimum, filing for bankruptcy or the designation of a trustee should be triggers.
- Drop-down coverage. If, for some reason, your primary insurer can’t yet respond, a standalone Side A policy with drop-down coverage may be very helpful. In some cases it’s possible to purchase a more lenient standalone Side A as a back-up plan to step in for things like insolvency, a situation in which some companies will not honor their indemnification obligations to their Ds and Os notwithstanding the fact that they are not yet in bankruptcy.
- Waiver of the “automatic stay.” When a company files for bankruptcy, the bankruptcy court imposes an “automatic stay,” which halts creditors from collecting debt as well as litigation.You want your policy to specify that all parties to the D&O policy have agreed to waive the automatic stay imposed by bankruptcy. This provision is designed to persuade the bankruptcy court not to hold up payments by the D&O policy.
- Insured versus insured. Make sure there is carve-back to the insured vs. insured exclusion. In its classic form, this exclusion states insured parties under the same policy aren’t covered when one sues the other. The specific carve-back you are looking for from this exclusion (or a similarly worded one known as the entity vs. insured exclusion) provides for coverage even if a bankruptcy trustee standing in the shoes of the company attempts to sue directors and officers.
- Debtor in Possession as an Insured. If your company is looking at a Chapter 11 reorganization, it may well be the case that the current management team will remain in place during the bankruptcy. In such cases, the company becomes the “debtor in possession.” This is most likely to be the case if a company that has the resources to reorganize emerges out of bankruptcy as an operating company. Consistent with this outcome, you want the debtor in possession to be covered by the terms of the D&O policy.
- Order of payment. This language specifies who should be paid first under the policy—the Ds and Os or the corporation. Directors and officers will want to ensure the former.
- Run-off. Most policies will not respond to claims that arise out of activities that took place after a change of control. Instead, the policy is said to go into “run-off.” You’ll want language in your policy clarifying that your carrier does not view bankruptcy as a trigger for your policy to go into run-off policy. Instead, you want the policy to remain in place (and responsive to the evolving situation to support Ds and Os who are staying on to help right the ship).
- Non-cancellation. Confirm with the carrier that the policy cannot be cancelled for any reason except non-payment of premium—even if it’s the insured who is trying to cancel the policy. This helps to guard against a bankruptcy trustee who might attempt to cancel the policy in order to recover the policy premium for the benefit of the bankruptcy estate.
- Tail coverage. Purchasing a tail policy will allow the coverage to continue after the policy has expired for a specified period of time (usually up to six years). For more on tail coverage, see a post I wrote here.
A properly brokered D&O insurance policy is a director or officer’s best line of protection during a bankruptcy situation.
One hopes that the policy will never need to respond. However, it’s prudent to ensure well before the threat of a possible bankruptcy that the D&O policy could respond on behalf of Ds and Os if needed.
The views expressed in this blog are solely those of the author. This blog should not be taken as insurance or legal advice for your particular situation. Questions? Comments? Concerns? Email: firstname.lastname@example.org.