It’s smart to prepare for risks such as bankruptcy in these uncertain economic times. But, how? Here we share D&O policy considerations ahead of a potential insolvency.
By Greg Boornazian, Christie Vu and Ben Young
The U.S. Federal Reserve’s current push to slow down the U.S. economy is threatening to send the country into a recession[1], putting privately held companies at greater risk for bankruptcy due to their inability to pay down debt and the rising costs of borrowing funds.
Small and medium-sized businesses may face even greater refinancing risk in the coming months due to the reduced availability of credit, interest rate increases and the tightening of lending guidelines.
In the first quarter of 2023 alone, overall commercial bankruptcies increased 19% compared to the first quarter of 2022.[2] With the expiration of most COVID relief programs, such as the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, and rate increases by the U.S. Federal Reserve, more bankruptcies may be on the horizon.[3]
To help protect against these potential risks, organizations can rely on their Directors and Officers (D&O) liability insurance to safeguard their teammates and their business.
D&O insurance helps protect a company’s bottom line and the personal assets of their corporate executives — past, present and future — against lawsuits brought by shareholders or other parties, including employees, regulators, creditors, vendors, customers and competitors, for their decisions and actions in managing a private company. Coverage is typically for:
- Defense costs
- Judgments
- Settlements
D&O Policy Coverage Considerations
Because of the state of the economy today, now is the time for you to evaluate your organization’s D&O policy coverage to ensure you are protected in the event of a bankruptcy or other financial insolvency by reviewing the terms, conditions and limits against your current expected operating environments and bankruptcy ruling trends with your broker.
Here are 10 coverage considerations to keep in mind:
1. Debtor-in-possession: In a bankruptcy, typically the company’s current management team stays in place to continue operating the company and is referred to as the “debtor-in-possession.”[4] Your D&O policy should include “debtor-in-possession” as part of its definition of an Insured so that coverage continues.
2. Insured vs. insured exclusion: This provision protects the insurer from providing coverage for collusion and internal disputes between insured parties by excluding coverage for any claim brought by or on behalf of an insured against another insured on the same policy. Ensure the exclusion in your policy includes a carve-back stating that the exclusion does not apply in the event a claim is brought in a bankruptcy proceeding — or some other similar wording — so that the policy provides coverage for any claims brought by a bankruptcy trustee.
3. Conduct exclusion: The actions of your D&Os will likely be scrutinized if a bankruptcy occurs and triggers your policy’s conduct exclusion. For example, a bankruptcy trustee may claim that its D&Os committed fraud, which led to the company’s bankruptcy. Since conduct exclusion language differs across insurers, make sure to:
- Carefully read the language in your policy to ensure it advances defense protection to the D&Os.
- Include a requirement that the exclusion applies only if a final, non-appealable judgment against the insured D&O happens.
- Review the final adjudication requirement in your policy to see if it’s based on “the” or “any” underlying proceeding, to determine how broad the exclusion applies.
4. Order of payment: Review your policy to determine how payments will be made if a bankruptcy occurs. This provision should indicate that payments first be made to the directors and officers to cover any costs not reimbursed by the company.
5. Side-A Coverage and Presumptive Indemnification: Once a bankruptcy proceeding is filed, the court suspends any litigation proceeding except for litigation against directors and officers.[5] As a result, your D&O’s Side-A policy could still be used by directors and officers since it protects them if the company can’t indemnify them.[6] Your D&O policy should include the following two provisions:
- Any bankruptcy or insolvency issue your company faces does not absolve the insurer of its obligations under the policy.
- The parties waive any automatic stay that may apply to any proceeds of the policy.
6. Side-B Coverage and Presumptive Indemnification: D&O policies typically include a presumptive indemnification provision stating that the insurer assumes that directors and officers are indemnified by the company to the fullest extent permitted by law.
Whereas Side-A coverage does not include a retention, Side-B coverage does, which is similar to a deductible. The difference: a retention requires the insured to pay for any costs up to the specified amount before the insurer begins to pay.
Some courts have found that D&O policy proceeds are part of the bankruptcy estate since it is corporate reimbursement coverage, not individual protection coverage.7 This could leave D&Os exposed since an automatic stay does not suspend any lawsuits made against them.
TIP: Ensure your D&O policy includes carve-backs to the presumptive indemnification stating the insurer will pay any costs if the company refuses, is unable or fails to advance or indemnify its D&Os, without applying any retention, unless and until the company has agreed (voluntarily or by court order) to make these payments.
7. Run-Off Coverage. This covers directors and officers up to six years after a merger or acquisition occurs, and only covers actions that happened before the merger or acquisition. Ideally, the D&O policy should not include bankruptcy as a trigger for run-off coverage so the policy can support D&Os who have remained with the company to manage it through murky waters.
TIP: Discuss terms and pricing with your underwriter in advance, as the quote for this coverage typically is not offered at renewal or when negotiations begin.
8. Wind-Down Coverage. Discuss the need for inclusion of wind down coverage with your broker, concurrent with run-off terms. This helps cover directors and officers while wind-down activities take place after the run-off coverage begins. Endorsements may specify coverage for actual or alleged wrongful acts committed by an insured in connection with the winding down of the business and operations.
TIP: Ask your broker about what the excess layers of your D&O program are offering in terms of pricing and coverage in the event of a run-off, as this coverage can be expensive.
9. Policy Period Extension. In Chapter 11 bankruptcies, a company is usually allowed to continue its business operations while restructuring its debt and working with an assigned committee to develop a reorganization plan.[7] Since D&O policies typically run annually, an extension to the policy period will likely be needed through expected emergence.
TIP: Confirm if your insurer is willing to offer an extension. In addition, ask about restrictions on policy period lengths due to reinsurance requirements. Also ask your broker if incumbent markets are likely to offer go-forward coverage or will a complete remarketing effort be required.
10. Additional D&O Limits. D&O policy liability limits are shared across your organization’s Side-A, Side-B and Side-C coverage. This D&O policy liability limits are shared across your organization’s Side-A, Side-B and Side-C coverage. This can leave directors and officers exposed if the limits have been used on claims to indemnify the company or other employees. To safeguard directors and officers from personal liability, additional limits can be purchased solely for your directors and officers in case the company cannot indemnify them. Here’s a short list of additional D&O limits to consider:
- An additional limit for Side-A coverage that would apply once the D&O policy and any excess policy is exhausted.
- A difference-in-conditions policy. This standalone Side-A policy has few exclusions and may drop down in certain situations, including filling gaps when there are disputes between carriers and insureds.
- An independent director’s liability (“IDL”) policy may be considered for additional protection. IDL policies are purchased by the individual and may be tailored for those who sit on multiple boards. It’s useful for high-net-worth individuals who serve on boards of small, start-up or non-profit operations whose operating history or financial scope may be limited.
The above considerations highlight just a few of the ways a D&O policy can protect your directors and officers in the event of a bankruptcy. For more advice on how to build your D&O program and to learn more about executive liability, contact B&B Protector Plans.
For information on what underwriters are looking for in placing a D&O policy, read Part II of this article here.
This information is intended for informational purposes only. Protector Plans Executive Liability is not liable for any loss or damage arising out of or in connection with the use of this information.
[1] CNBC “No exit ramp for Fed’s Powell until he creates a recession, economist says,” March 8, 2023.
[2] Epiq “Bankruptcy Filings Increase All Chapters in March; Commercial Filings Up 79 Percent Year-Over-Year,” April 3, 2023.
[3] S&P Global Market Intelligence “US corporate bankruptcy filings hit 12-year high in first 2 months of 2023,” March 3, 2023.
[4] United States Courts “Chapter 11 – Bankruptcy Basics.”
[5] Rivkin Radler “The Reach of the Automatic Stay in Bankruptcy: Far, But Not That Far,” December 10, 2015.
[6] American Bar Association. “Whose Policy is It, Anyway? A Debtor’s Insurance Policies and Rights to Policy Proceeds,” December 14, 2014.
[7] Houston Chronicle “What is the Difference Between Liquidation and Emergency in Bankruptcy?”
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