New York Appellate Court Holds Bankruptcy Exception to Insured vs. Insured Exclusion Restores Directors and Officers Insurance Coverage

Directors and Officers (“D&O”) liability policies, like many other liability policies, often have an exclusion that precludes coverage when one insured sues another insured.  Coverage, however, can be restored under certain exceptions.  One of those exceptions is the bankruptcy exception, which allows a bankruptcy trustee or comparable authority to sue on behalf of the estate against another insured like a director or officer.  How that exception works when there is a creditor’s trust formed to pursue legal actions on behalf of unsecured creditors was the subject of a recent decision by a New York appellate court.

In Westchester Fire Insurance Co. v. Schorsch, No. 651026/18 (N.Y. App. Div. 1st Dep’t May 14, 2020), a company filed for bankruptcy.  As part of its reorganization plan, a Creditor’s Trust was created to pursue legal claims of the estate on behalf of the unsecured creditors.  Once the plan was confirmed, the Trust sued the directors and officers of the company for wrongful acts.

The directors and officers sought coverage from the company’s D&O insurers. The excess insurer next in line to pay defense expenses disclaimed coverage based on the insured vs. insured exclusion in the D&O policy.  The excess insurer then commenced an action seeking a declaration that it had no coverage obligations.  On cross-motions for partial summary judgment, the motion court granted the directors and officers motion on its counterclaim for breach of contract for coverage and denied the excess insurer’s motion to dismiss the counterclaim.

The D&O policy had an insured vs. insured exclusion eliminating coverage for any claim made against an insured person by the company or another insured person.  The exclusion, however, had a bankruptcy exception, which restored coverage excluded under the insured vs. insured exclusion for claims brought by a bankruptcy trustee, examiner, assignee of the trustee or examiner, any receiver, conservator, rehabilitator or liquidator “or comparable authority of the Company.”

The appellate court noted at the outset that this appeal raised an issue of apparent first impression: whether the bankruptcy exception in a D&O policy, which allows claims asserted by a bankruptcy trustee or “comparable authority,” applies to claims by a Creditor’s Trust, post-confirmation, to restore D&O coverage removed by the insured vs. insured exclusion. The court held that it does, finding that a post-confirmation litigation trust has comparable authority to a bankruptcy trustee listed in the bankruptcy exception.

The court held that the insured vs. insured exclusion and the bankruptcy exception were unambiguous.  The plain language, stated the court, indicated no intent to bar coverage for D&O claims brought by a Creditor’s Trust as a post-confirmation litigation trust. As the court found,

In other words, because the D&O policy covers the debtor in the insured vs. insured exclusion even in the event of bankruptcy, the D&O policy allows the company when transformed into a DIP or debtor corporation upon the filing of a petition to retain its factual identity as far as the insured vs. insured exclusion is concerned.

The court viewed the Creditor’s Trust’s identity as a separate entity from the debtor as support of its standing to pursue post-confirmation litigation under the Bankruptcy Code, making it a comparable authority.  The court also found no valid rationale for excluding D&O claims when brought by a Creditor’s Trust, where coverage would otherwise exist if the same claims were brought by a chapter 11 trustee.

Notably, while agreeing with the motion court on the bankruptcy exception issue, the court modified the order on the grant of summary judgment finding that there were factual issues that precluded summary judgment for the directors and officers on the issues of breach of contract and coverage.

Leave a Reply

Your email address will not be published. Required fields are marked *