Negative quarterly GDP growth … inflation and recession concerns … the slowdown and ending of government assistance programs … all are factors that have led to predictions of increased Chapter 11 bankruptcy filings in 2022. How have the predictions borne out so far? The message appears to be mixed. For example, there were 447 commercial Chapter 11 filings in June 2022, a 29 percent increase over filings in June 2021. Likewise, Chapter 11 filings in May 2022 were 34 percent more than those in May 2021. Nevertheless, total year-to-date filings (January through June 2022) are actually down year-on-year: 1,765 Chapter 11 filings in the first six months of 2022 versus 2,155 during the same period in 2021, an 18 percent decrease.
With business slowdowns and concerns surrounding cash management, bankruptcy filings may be inescapable for many organizations. Retail companies are being hit particularly hard in the first half of the year. Moreover, with statutory asset freezes (Bankruptcy Code section 362’s “Automatic Stay” provision) accompanying bankruptcy filings, indemnification protections on which directors and officers rely may not be readily available. As a last line of defense, D&O coverage may be the only protection corporate leaders can turn to.
Coverage for foreseeable insolvency-related claims is generally contemplated within the D&O policy. Direct or derivative claims may be filed by creditors and/or bankruptcy trustees who may allege breaches of fiduciary duty, corporate waste and/or deepening the insolvency. In those cases, defense costs, compensatory damages, and settlements are generally subject to coverage; however, other policy provisions may be relevant, depending on the scope and nature of any given matter. Those provisions may include the following:
- Entity v. Insured/Insured vs. Insured exclusion: In the context of bankruptcy, claims may be asserted against directors and officers by trustees, receivers, the company itself as a debtor-in-possession, and other bankruptcy constituencies. To protect against application of the exclusion, companies should seek to exempt such claims from the exclusion. Additional exclusion carvebacks should be considered and sought.
- Side A: Coverage for non-indemnifiable D&O losses could be impacted to the extent bankruptcy law restrictions may impede the company’s ability to advance or indemnify losses. Side A is a D&O coverage tool that can yield different results depending on the breadth and levels of coverage, form choices, coverage enhancements, and program structure. To the extent companies maintain Side A only policies in their programs, it is less likely that bankruptcy courts would attempt to assert control over the policies.
- Bankruptcy waiver: A D&O policy’s bankruptcy clause may protect a director’s or officer’ personal assets by specifying that (1) a filing will not relieve the insurer of its coverage obligations, (2) the policy is intended to benefit individual insureds as a matter of priority, and (3) the parties will not oppose or object efforts to obtain relief from the Automatic Stay to pay claims.
- Order of payments: Related to the bankruptcy clause, a properly worded “order of payments,” or “priority of payments” provision should specify that the insurer is bound to prioritize claim payments under Side A before paying losses under Side B or C. In some cases, the clause may authorize the organization to advise the insurer to delay payments under Sides B and C in favor of future Side A payments.
- Fraud and deliberate conduct exclusion: Claims may be excluded where the alleged wrongdoing is proven in a final, non-appealable adjudication. Policy wording specialists are able to strengthen the exclusion’s conditions to ensure its limitations do not inadvertently and prematurely trigger.
- Definition of Loss: Coverage may be limited with respect to some forms of non-compensatory relief (such as disgorgement of ill-gotten gain), as well as certain civil fines, penalties, and taxes. Here, again, insurance broker support from distressed risk coverage specialists should be engaged to strengthen what items constitute “Loss” and to maximize efforts to remove or mitigate other limitations in the definition.
D&O liability insurance is, first and foremost, a policy designed to cover third party liability exposures. Nevertheless, the policy often includes first party coverages that could be beneficial to companies that are insolvent or in the zone of insolvency.
- Crisis management: first party coverage may be available in certain instances for crisis management expenses to the extent a company has experienced a “crisis,” as defined in the policy. Events that may trigger coverage include negative earnings announcements, key executive resignations, employee layoffs, product recalls, elimination or suspension of dividends, among others. The coverage is customarily subject to a sublimit of liability.
- Reputational risk: Similar to crisis management coverage, some policies may include first party coverage for a director’s or officer’s “reputation crisis.” Also traditionally sublimited, the coverage may be applicable to individuals to the extent their reputations are adversely impacted in crisis events. The triggers may be narrow and could require the act of an enforcement authority.
Conclusion
Understanding the D&O coverage implications of distressed risk and corporate insolvency will help risk professionals anticipate internal questions in a more focused manner. As annual program renewals approach, it is essential to address program structure (particularly with respect to Side A coverages), to model and scrutinize limits adequacy, and to enhance coverage breadth as much as possible with distressed risk exposures front of mind.
Disclaimer
Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).
