A federal judge has ruled that directors and officers of a company in bankruptcy proceedings may continue to access an eroding liability policy to cover their defense costs. The court based its decision on a close examination of the policy language, and alternatively held that the individual directors and officers had shown they were entitled to relief from the automatic stay. In re: Downey Financial Corp., No. 08-bk-13041 (CSS) (Bankr.D.Del. May 7, 2010).
The debtor’s D&O policy provided up to $10 million in coverage, after a $1 million retention. The policy stated that it would pay first on behalf of individual insureds, and then on behalf of the organizational insured. It also stated that the carrier’s obligations would not be affected by any bankruptcy filing the organization might make.
Prior to its bankruptcy filing, the debtor had been involved in a number of lawsuits. In May and June 2008, two separate shareholder classes sued the debtor and some of its officers in federal court in California, alleging violations of federal securities laws. The debtor, some of its officers, and all of its directors were later sued in two separate shareholder derivative actions, filed in California’s state courts. The debtor paid all of the directors’ and officers’ defense costs, which amounted to $588,000 by November 2008.
That November, the Office of Thrift Supervision seized the debtor’s principal subsidiary, a savings and loan association located in California. The debtor filed its Chapter 7 petition on November 25, 2008. After the debtor filed its petition, the United States Trustee took the position that the debtor’s D&O policy was property of the estate and, therefore, could no longer pay the directors’ and officers’ defense costs. The directors and officers sought relief from the bankruptcy court.
After carefully reviewing the policy’s terms and relevant caselaw, the bankruptcy court disagreed with the Trustee. Because the policy gave first priority in the policy’s proceeds to the individual officers and directors, the court held that they had claims superior to those of the debtor. And, because the debtor was now insolvent, the court held, the policy’s terms required the D&O carrier to pay out the proceeds for the insureds’ defense costs, notwithstanding the fact that the entire retention amount had not first been paid. In other words, the court said that the policy’s proceeds belonged not to the bankrupt estate, but to the individual insureds.
In the alternative, the court held that the insureds were entitled to relief from the automatic stay, for purposes of receiving defense costs from the D&O carrier.