One of the finest sources of useful and practical information about D&O, E&O and professional liability policies – among other insurance and risk management topics – is the International Risk Management Institute (“IRMI”).* I particularly enjoy their D&O MAPS updates (paid subscription required) prepared periodically by Bob Bregman. A recent update on April 29 contained the “D&O Practice Tip” column entitled Improve Bankruptcy Carve-Back of the Insured versus Insured Exclusion.

It should be noted that what used to be a much broader insured versus insured exclusion has today evolved in most policy forms or by way of endorsement into an entity vs. insured exclusion, i.e. one which will preclude coverage for any claim brought by or on behalf of an entity insured under the policy against any other insured entity or an insured person. This has eliminated the need for many carve-backs, but a few key ones remain for the protection of the insureds such as for claims brought by any bankruptcy trustee, receiver, liquidator, conservator, rehabilitator or similar official or legal entity. While an argument can be made that any claim brought by a committee of secured or unsecured creditors is not within the scope of the exclusion, the column wisely suggests that it would not hurt to add these committees to the bankruptcy carve-back.

The column suggests that an ideal carve-back to the exclusion from the insureds’ perspective might read as follows:

            This exclusion does not apply to 

1. a Claim by the Examiner, Trustee, Receiver, Liquidator, or similar official appointed for the Insured Organization (or any assignee thereof),
2. a Claim by a Creditor Committee, Bondholder Committee, Equity Committee, Noteholder Committee, or similar committee established for the Insured Organization (or any assignee thereof), or
3. a Claim by the Insured Organization as Debtor-in-Possession (or any assignee thereof), provided that such Claim is made without the solicitation, assistance, or active participation of any Director and/or Officer.

Like any good lawyer, I can suggest alternative wording, but I have little conceptual quarrel with (1) and (2). It is (3), however, that troubles me from both an insured and insurer perspective, particularly when coupled with the column’s suggestion that the policy definition of insured organization should not include the company as a debtor-in-possession.**

When a company operates as a debtor-in-possession (“DIP”) under the Bankruptcy Code it continues to manage its own affairs without the supervision of any outsider such as a trustee. That is not to say, however, that it is not under considerable supervision from the bankruptcy court itself. For purposes of D&O insurance coverage by virtue of the Company definition, the DIP is the Company. Nonetheless, there is a wealth of bankruptcy jurisprudence as to whether the DIP is legally the same as the pre-petition entity.

Brokers typically insist on including it in the Insured Organization definition so that the DIP continues to enjoy any entity coverage that the policy may provide and that entering into DIP status does not trigger any “change in control” condition in the policy. On the other hand, precisely because the DIP is in a real sense the same as the company, insurers will not want to carve it back from the insured vs. insured exclusion lest they run the risk of de facto converting a liability policy to first party coverage or potentially exposing themselves to collusive claims. Indeed, the court decision that triggered the concerns expressed in the D&O MAPS column, Biltmore Assoc., LLC v. Twin City Fire Ins. Co., 572 F. 663 (9th Cir. 2009), recognized the legitimate interests of the insurer in avoiding these situations. Biltmore held that an assignee of the DIP stands in the shoes of the DIP, and its claims are thus barred by the I v I exclusion because the DIP is in turn the same entity as the original company that became a DIP. This was a well-reasoned decision of a respected federal appeals court and, with my admitted bias, I have no quarrel with it.

Thus, I would be reluctant to recommend to a client, whether insured or insurer, that they amend the definition and exclusion in the way that my friends at D&O MAPS suggest. Of course, insureds should welcome the carve-back in (3) above, so long as it is not coupled with a removal of the DIP from the definition of Insured Organization. Insurers, however, should strongly resist this for all of the reasons discussed above.

I welcome creative ideas and suggestions from the readership for a potential resolution.

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*I highly recommend that readers visit the IRMI website at www.irmi.com to learn more about the organization and what it offers.

**I suggest that the “provided that” clause at the end of (3) is not necessary if the exclusion itself is of the entity vs. insured variety and does not apply to claims brought by or on behalf of any insured person.