d&o fiduciaryy duties when a company faces...

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D&O Fiduciary Duties yWhen a Company Faces InsolvencyStrategies for Avoiding and Defending Direct and Derivative Lawsuits

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

WEDNESDAY, JANUARY 19, 2011

Today’s faculty features:

Tony M. Davis, Partner, Baker Botts, Houston

Thomas C. Wolford, Partner, Neal Gerber Eisenberg, Chicago

Anthony P. Tatum, Partner, King & Spalding, Atlanta

Mark M. Maloney, Partner, King & Spalding, Atlanta

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Director and Officer Duties from "Facing Bankruptcy" to "Filing Bankruptcy"Bankruptcy" to "Filing Bankruptcy"

Tony M. DavisMatthew D. McCoyBaker Botts L.L.P.

(713) [email protected]

© 2010

[email protected]

Fiduciary Duties in General

Directors Owe Fiduciary Duties in Different Contexts

The Solvent Company

The Insolvent Company The Insolvent Company

The Insolvent Company in Bankruptcy

The Solvent Company in Bankruptcy

5

The Solvent Company

General Rules

Governed by state law Governed by state law Some states allow certain duties to be limited in chartering documents

See Del. Code Ann. tit 6, § 18-1101(c) (limited liability companies)

Directors of a solvent company owe fiduciary duties exclusively for the benefit f ' id l i k b h h ldof company's residual risk bearers -- shareholders Therefore, actions taken by directors are expected to benefit shareholders

See Prod. Res. Group, LLC v. NCT Group, Inc., 863 A.2d 772, 787 (Del. Ch. 2004)

Typically no duties owed to creditors other than those granted in agreementsyp y g g Courts believe creditors are capable of protecting themselves and are further

protected by fraudulent conveyance law and bankruptcy law Prod. Res. Group, LLC v. NCT Group, Inc., 863 A.2d 772, 787 (Del. Ch. 2004)

6

The Solvent Company (cont'd)

Business Judgment Rule Courts will not second guess a business judgment so long as a minimum g j g g

level of care was exercised Directors are presumed to have acted on an informed, independent, good faith

basis and with the honest belief that the action was in the best interest of company See, e.g., Solomon v. Armstrong, 747 A.2d 1098, 1111 (Del. Ch. 1999)

However, this presumption can be rebutted See, e.g., Angelo, Gordon & Co., L.P. v. Allied Riser Commc'n Corp., 805 A.2d 221, 229 (Del. Ch. 2002)

Policy underpinnings -- courts should not second guess a rational business decision, even if decision proves to be unwise in hindsight

Duty of Loyalty Directors must hold the best interest of corporation above any personal

interests

Directors must not self-deal, must not usurp corporate opportunities, must avoid conflicts of interest, and at times must disclose

7

The Solvent Company (cont'd)

Duty of Care Two components:

1. directors must act on an informed basis after due consideration; and

2. directors must act with due care in the discharge of their dutiesSee Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 367 (Del. 1993)

Stated differently, a director must exercise informed business judgment with due care d i d f ithand in good faith

Directors can rely on corporate records as well as information, statements, and opinions of officers, employees, and third-party professionalsSee Del. Code Ann. tit. 8, § 141(e)

General points of guidance: p g Avoid haste Prepare thoroughly Engage competent advisors Seek and assess relevant information from managementSee a d assess e e a o a o o a age e Beware of potential biases Ask questions and remain actively involved Keep a thorough written record Understand the alternatives

8

The Insolvent Company

The Insolvency Threshold Under Delaware law, insolvency occurs where:

1. liabilities exceed assets (i.e., balance sheet insolvency) or

2. there is an inability to pay debts as they mature in the ordinary courseSee, e.g., Prod. Res. Group, LLC v. NCT Group, Inc., 863 A.2d 772, 782 (Del. Ch. 2004)

Fid i D ti U I l Fiduciary Duties Upon Insolvency Upon insolvency, directors owe fiduciary duties for the benefit of shareholders

and creditors Creditors in effect become the senior residual risk bearersCreditors in effect become the senior residual risk bearers

Fiduciary duties are owed foremost to the entity itself, whether solvent or insolvent Insolvency makes creditors the principal constituency that may be injured by fiduciary breaches

that diminish the value of the enterprise

"The transformation of a creditor into a residual owner does not change the nature of the harm in a typical claim for breach of fiduciary duty by corporate directors”In re Adelphia Comm’ns Corp., 323 B.R. 345, 386 n.140 (Bankr. S.D.N.Y. 2005)

"duty to" vs. "duty for the benefit of" -- there is no shift

9

The Insolvent Company (cont'd)

Scope of Duties Owed

The fundamentals still apply directors must exercise informed business The fundamentals still apply -- directors must exercise informed business judgment in good faith in the best interest of enterprise

During insolvency the exercise of that judgment must include a consideration of the interest of creditors How does a particular course of action distribute risk and reward between

creditors and equity?

As the corporation's continued existence appears unlikely, acting in the best interest of corporation may require a course of action that benefits creditors more than equity However, just because a course of action benefits one constituency more than

another does not mean it is violative of a fiduciary dutyy y

10

The Insolvent Company (cont'd)

Example: Sale vs. Stay in Business

If company stays in business and is successful, creditors are paid in full and equity investors receive a 200% return on investment.

Insolvent CompanyIf company stays in business and is unsuccessful, creditors are paid fifty cents on the dollar and p y p yequity investors are wiped out.

If company does not stay in business and assets are sold, creditors are paid in full and equity investors are wiped out.

11

The Zone of Insolvency

"Zone of Insolvency"

U t i t t h th dit h h d i ht b f Uncertainty as to whether creditors have enhanced rights before the point of insolvency

Credit Lyonnais suggested that the expansion of duties to creditors can occur in the "vicinity of insolvency " which was unsettling and controversialoccur in the vicinity of insolvency, which was unsettling and controversial Credit Lyonnais Bank Nederland, N.V. v. Pathe Commc'ns Corp., 1991 WL 277613, *34 (Del. Ch. Dec. 30, 1991)

Vicinity standard is inherently vague

12

The Zone of Insolvency (cont'd)

Doubts About the "Zone"

D l S C t d i i i Gh ll t th t th t Delaware Supreme Court decision in Gheewalla suggests that the court may ultimately establish a bright line (e.g., insolvency)N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92 (Del. Ch. 2006)

However, commentators and courts have disagreed over whether duties expand for the benefit of creditors prior to insolvency

A recent Fifth Circuit decision, which applied Delaware law, may suggest that the "zone" remains a viable theoryTorch Liquidating Trust v Stockstill 561 F 3d 377 385-86 (5th Cir 2009)Torch Liquidating Trust v. Stockstill, 561 F.3d 377, 385-86 (5th Cir. 2009)

Southern District of New York has rejected “zone of insolvency” theory under NY Law: “creating a pre-insolvency duty of care to creditors would distort—and potentially g p y y p y

conflict with—the incentive structure for corporate managers that the law of fiduciary duties has been erected to create”RSL Comm’ns PLC v. Bildrici, 649 F.Supp.2d 184, 206 (S.D.N.Y. 2009)

13

Case Law Update (cont'd)

In re Bridgeport Holdings, Inc. In sale context, board's failure to obtain valuation of assets and adequately market

those assets can constitute a breach of duty of care

Board abdicated responsibility to restructuring personnel and acquiesced to their decision to sell

Ruled on in context of motion of dismiss In re Bridgeport Holdings, Inc., 388 B.R. 548 (Bankr. D. Del. 2008)

In re TOUSA, Inc. Reaffirmed that subsidiary directors owe duties to insolvent subsidiary's creditorsReaffirmed that subsidiary directors owe duties to insolvent subsidiary s creditors

Court found that parent company's directors could be liable for aiding and abetting breaches of fiduciary duties by subsidiary directors

Court found that parent company's directors could be liable for directing insolvent subsidiaries to use their assets for sole benefit of parent companysubsidiaries to use their assets for sole benefit of parent company

Ruled on in context of motion to dismiss Official Comm. of Unsecured Creditors v. Technical Olympic (In re TOUSA, Inc.), 437 B.R. 447 (Bankr. S.D. Fla. 2010)

14

Case Law Update (cont'd)

CML V LLC v. Bax Delaware Court of Chancery recently and unexpectedly held that the Delaware LLC Act

denies derivative standing to creditors of an insolvent limited liability company CML V LLC v. Bax, 6 A.3d 238 (Del. Ch. 2010)

Sanford v. Waugh & Co., Inc.g , Individual creditors of insolvent corporation have no right to assert direct claims for

breach of fiduciary duty against corporation's officers and directors

Individual creditors of insolvent corporation can initiate a derivative claim on behalf of all creditors for breach of fiduciary dutiescreditors for breach of fiduciary duties Sanford v. Waugh & Co., Inc., 2010 WL 5139496, *4-8 (Tenn. Dec. 17, 2010)

15

The Insolvent Company in Bankruptcy

Duties Owed to Estate Directors of a chapter 11 debtor owe fiduciary obligations to bankruptcy estate for benefit

of all constituencies as their interests may appear from time to timeof all constituencies, as their interests may appear from time to timeSee Commodity Futures Trading Comm'n v. Weintraub, 471 U.S. 343, 355 (1985)

Balancing duties Interests of estate's constituencies are often conflicting and adversarial

A debtor simply cannot serve all interests all of the timeA debtor simply cannot serve all interests all of the time

Satisfying Duties Preserve and maximize value of debtor's assets

Exercise due care in making business decisions

When conflicts arise, negotiate honestly and in good faith in support of position determined to be in estate's best interest

Inherent conflict among constituencies can exist because of judicial supervision and the g j prights of parties in interest in the bankruptcy process

16

The Insolvent Company in Bankruptcy (cont'd)

Interaction Between State-law and Bankruptcy-based Duties Although state law fiduciary duties continue to apply in bankruptcy, the Bankruptcy g y pp y p y p y

Code preempts and supplements them to some extent

Section 541 impacts who has standing to assert claims for breach

Transactions outside ordinary course are governed by section 363

Incurring debt is governed by section 364

Creditor and equity committee structure under sections 1102 and 1103

Creditors and equity given right to vote on reorganization plans under sections 1124 and 1126

Trustee or examiner can be appointed under section 1104Trustee or examiner can be appointed under section 1104See Nat'l Convenience Stores Inc. v. Shields (In re Schepps Food Stores, Inc.), 160 B.R. 792 (Bankr. S.D. Tex. 1993)

Preemption especially applicable where state law actions or claims would delay or frustrate reorganization policy of Bankruptcy Code However, fiduciary duty action that does not impede bankruptcy proceedings may be allowed y y p p y p g y

(i.e., action seeking to compel annual meeting for election of directors)See Lionel Corp. v. Comm. of Equity Security Holders (In re Lionel Corp.), 30 B.R. 327 (Bankr. S.D.N.Y. 1983)

17


Example: The Conflicted Director What if a director owns substantial equity in debtor and board is faced with restructuring

transaction that pits interests of equity against interests of estate as a whole?

Duty of loyalty is implicated -- director should abstain and allow decision to be deliberated upon and made by independent directors

As plan proponent, debtor may elevate its interests above those of a particular constituency Example: cram down

So long as debtor and its management avoid self-dealing and seek to act in estate's best interest, they may pursue a course of action that disfavors a particular constituency

Fiduciary duties of a chapter 11 debtor may arise in connection with the exercise of business judgment in a transaction outside ordinary coursebusiness judgment in a transaction outside ordinary course See, e.g., In re Chrysler LLC, 405 B.R. 84, 105 (Bankr. S.D.N.Y. 2009)

18


Types of Suits Under state law and depending on the alleged wrong and relief at stake, a breach of

fiduciary duty may give rise to either:fiduciary duty may give rise to either:1. a direct (or "individual") cause of action or

2. a derivative action

Standing to Pursue SuitStanding to Pursue Suit In bankruptcy, an estate is created that includes all legal or equitable interests of the

debtor in property as of the commencement of the case, including all causes of action See 11 U.S.C. § 541; In re Educators Group Health Trust, 25 F.3d 1281, 1283 (5th Cir. 1984)

If a claim is derivative under state law, it becomes estate property and only the debtor in possession may exercise control over such asset Including claims based on post-petition conduct

Any direct cause of action is not property of the estate Any party in interest may seek the appointment of a trustee or examiner

11 U.S.C. § 1104

In some circumstances, a bankruptcy court may grant creditors standing to pursue a cause of action on behalf of the estateSee e.g., In La. World Exposition v. Fed. Ins. Co., 858 F.2d 233, 247 (5th Cir. 1988)

19

The Solvent Company in Bankruptcy

Can a chapter 11 debtor be solvent? Debtor may be balance sheet solvent, which would implicate interests of equity

Impact of Solvency Directors' duties continue to be amorphous Whereas outside of bankruptcy duties benefit only shareholders, in bankruptcy duties are

owed to estate as a whole Each constituency has standing to weigh in and protect its interest

Exclusivity and Plan Proposal Debtor's exclusive period to file a plan

11 U.S.C. § 1121(b)

Debtor's ability to cram down is inconsistent with the duty of loyalty to dissenting class, but consistent with its duties to the estate11 U.S.C. § 1129(b)

Bankruptcy Code does not distinguish debtors on the basis of solvency for purposes of plan proposal and confirmation, as it does in other contexts

Exclusivity is balanced with protections for creditors and equity, such as the right to vote and the requirements of cram down

20

D&O Fiduciary Duties When a Company Faces Insolvency:p y y

Strategies to Avoid and DefendBreach of Fiduciary Duty Lawsuits

Thomas C. WolfordPartnerNeal, Gerber & Eisenberg LLP(312) 269‐8000

The contents of these slides should not be construed as legal advice or a legal opinion on any specific fact or circumstance. The slides are intended for general purposes only, and you are urged to consult a lawyer concerning your own situation and any specific legal questions you may have. © Neal, Gerber & Eisenberg LLP 2011

(312) 269 8000www.ngelaw.com

When Can Directors and Officers be sued? By Whom?y

Which Claims? Breach of Fiduciary Duty which injures corporation

Prior to “Actual” Insolvency: The So‐Called “Zone” or “Vicinity” of InsolvencyVicinity of Insolvency

– Shareholders may bring derivative claims; Creditors have no standing (Gheewalla, 930 A.2d 92 (Del. 2007))

l l Upon Actual Insolvency– Creditors “take the place” of shareholders as the residual

beneficiaries of any increase in value, and may bring derivative claims (Gheewalla, at 930 A.2d at 101‐102); Sanford v. Waugh & Co., Inc., 2010 WL 5139496 (Tenn. 12‐17‐10)

22

When can Directors and Officers be sued? By Whom? –cont.

Who can be sued? Both directors and officers

Gantler v. Stephens, 965 A.2d 695 (Del. 2009) (“In the past, we have implied that officers of Delaware corporations, like directors owe fiduciary duties of care and loyalty and thatdirectors, owe fiduciary duties of care and loyalty, and that the fiduciary duties of officers are the same as those of directors. We now explicitly so hold”)

23

Most Important Defense: Business Judgment Ruleg

Business Judgment Rule – Judicially created presumption that directors and officers have exercised

due care if they: • consider all material information that is reasonably available, prior to making business decision (Aronson v. Lewis, 473 A. 2d 805, 812 (Del. 1984))

• act in good faith and are disinterested in transaction (Aronson)

• have an honest belief their acts are in the company’s best interests

– Under such circumstances, court will refrain from substituting its business judgment for that of the directors. Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985))

– To rebut, a plaintiff must show that the directors or officers breached the duty of care or loyalty or acted in bad faith

2424

Most Important Defense: BusinessJudgment Rule – cont.Judgment Rule cont.

When Business Judgment Rule Unavailable: Entire or “Intrinsic” Fairness Test– Failure to qualify for the business judgment presumption will expose

management to a much less attractive standard, the "intrinsic fairness" or "entire fairness" standard

– Using this standard, the interested director must prove the "entire fairness" of the transaction. Orman v. Cullman, 794 A.2d 5, 23‐24 (Del. Ch. 2002)

– Fairness has two components: fair dealing and fair price, each of which will be subject to substantial debate in any given situation. Boyer v. Wilmington Materials, Inc., 754 A.2d 881, 898‐99 (Del. Ch. 1999)

25

Most Important Defense: Business Judgment Rule – cont.

– Fair dealing implicates the timing, initiation, structure, negotiation, di l d l f th t ti S B 754 A 2d t

g

disclosure and approval of the transaction. See Boyer, 754 A.2d at 898.

– Fair price relates to economic and financial considerations of d t tiproposed transaction

– Relevant factors include assets involved, market value, earnings, future prospects and other elements that affect intrinsic or inherent l f ' t kvalue of company's stock

– Subjective good faith will not protect director who engaged in self‐dealing or usurpation of corporate opportunity

– A transaction must be objectively fair to satisfy duty of loyalty. See, e.g., Mills Acquisition Co. v. MacMillan, Inc., 559 A.2d 1261, 1280 (Del. 1989)

26

Strategies to Avoid and Defend

Board should be vigilant to detect signals of financial distress,

g

so that directors and officers may take appropriate action as soon as possible– Recurring Losses– Industry Downturn– Significant competitor actions– Technological advances affecting the corporation’s business model or

b l f tobsolescence of assets– Strategies that may result in financial distress, such as emphasis on cash

flow to exclusion of profits (or vice versa)– Required amendment of credit termsRequired amendment of credit terms – Irregular accounting techniques– Covenant Defaults– Insufficient Availability Under Current Revolving Credit Facilities

2727

Strategies to Avoid and Defend – cont.

To the extent possible, preserve presumption of the business j d t l

g

judgment rule– Avoid transactions involving self‐interest– Assess available alternatives; gather available information and educate

lfyourself; – Fully participate and avoid rash decisions; devote reasonable time to

process– Utilize outside, disinterested professionalsUtilize outside, disinterested professionals– But do Not abdicate decision‐making authority to advisors; continue to

supervise them (See Bridgeport Holdings)– Disclose conflicts and recuse yourself (or resign), if necessary– Explore other potential risks

Assume all actions will be analyzed with benefit of hindsight after projected success did not occur

2828


Document Your Efforts

g

– Observe corporate formalities

– Address significant matters at a meeting rather than by written consent

– Document board and committee actions in appropriately detailed pp p yminutes, which acknowledge the duties during financial distress

– Record a summary of data sought and received

– Record alternatives considered; thoroughly discuss major decisionsRecord alternatives considered; thoroughly discuss major decisions

– Pursue multiple offers in connection with potential transactions and document efforts

Exercise diligence follow up in writing until satisfactory answers are– Exercise diligence – follow up in writing – until satisfactory answers are provided

2929


Document Your Efforts – cont.

g

– Obtain independent professional and expert advice prior to making decisions

• retain advisors have both skills and knowledge necessary to complete fassignment successfully

• where appropriate, obtain fairness opinions and/or solvency opinions

3030


Consider Interests of All Constituents – Shareholders,

g

Creditors and Value of Enterprise– Assume that company is insolvent

– Listen to the concerns of creditors if insolvency likelyListen to the concerns of creditors if insolvency likely

– Treat like creditors alike whenever possible, and do not prefer insiders

31


Typical Scrutinized Transactions

g

yp– Approving any new business plan

– Refusing to reduce overhead expenses in anticipation of receiving a new round of investment that may or may not materializenew round of investment that may or may not materialize

– Approving any sale of a major asset

– Taking on additional debt to finance an acquisition or to otherwise expand operationsexpand operations

– Approving any spin‐off

– Collateralizing previously unencumbered assets, especially in an effort i h i l d i h f f lto raise cash to meet operational needs in the face of losses

– Approving compensation package for senior executives, including severance payments and other benefits

32


Typical Scrutinized Transactions ‐ cont.

g

Typical Scrutinized Transactions cont.– Approving any dividend

– Untimely acquisition of D&O insurance policies

M th t di ti t l th t b fit t– Merger that disproportionately that benefits management

– Failing to consider strategic alternatives for the company or failing to conduct an adequate sale process

– Any transaction with an insider

– Approving a bankruptcy filing

33


Pay particularly close attention to transactions with

g

y p ymanagement and other insiders (and avoid if possible)– Obtain approval by independent directors

Obtain advice from independent advisors– Obtain advice from independent advisors

– See that any such transaction is fair to the company

Obtain Indemnification and Exculpation

34

Exculpation

Elimination or Limitation of Liability

p

– Delaware GCL §102(b)(7) – Certificate of Incorporation may contain a provision limiting or

eliminating personal liability of corporate directors for monetarydamages for breach of fiduciary duty, but:

• Not for breach of the duty of loyalty ((b)(7)(i))

• Not for acts or omissions not in good faith, involving intentional misconduct, or a knowing violation of law ((b)(7)(ii)) (includes fraud‐Zirn v. VLI Corp., 621 A.2d 773 (Del.1993)

• Not for willful or negligent conduct in paying dividends or repurchasing stock ((b)(7)(iii))repurchasing stock ((b)(7)(iii))

• Not for any transaction from which director derived improper personal benefit ((b)(7)(iv))

35

Exculpation

Elimination or Limitation of Liability – cont.

p

– Section 102(b)(7) does not eliminate duty of care, because injunctive relief still available (Walt Disney Co. Derivative Litigation, 2005 Del. Ch. LEXIS 113)

– Applies only to directors, not officers (McPadden v. Sihu, 2008 Del. Ch. LEXIS 123)

– no retroactive insulation from liability

– Affirmative defense –See Ad Hoc Comm. v. Wolford, 554 F. Supp.2d 538 (D. Del. 2008) (probably will not result in dismissal)

36

Indemnification

Indemnification and advancement of expenses– Delaware GCL §145

• Mandatory indemnification if director or officer is successful (including partial) (§145(c))

• Third party suits permitted indemnification if:• Third party suits ‐ permitted indemnification if:– acted in good faith; – reasonably believed to be in best interests of the corporation; and– no reasonable cause to believe conduct unlawful. (145(a))

• Suits by corporation and derivative suits – indemnification permitted for expenses if director or officer met above standards of conduct; butno indemnification for judgments or settlements or expenses if found liable to the corporation, unless court determines otherwise (§145(b))p , (§ ( ))

• Permitted to advance expenses to current director or officer who provides undertaking to repay if necessary

37

Indemnification – cont.

Right to indemnification can not be retroactively eliminated or impaired, unless the relevant indemnification provision provided for it at time of alleged act or omission

Some advantages to contractual indemnity (instead of inSome advantages to contractual indemnity (instead of in certificate of incorporation), but also vulnerable to rejection in bankruptcy

38

Indemnification – cont.

Cautionary Note: Dischargeability of Debt– In some states, violation of duty of loyalty in transactions involving

director may rise to level of “defalcation while acting in a fiduciary capacity” and create a non‐dischargeable debt in the director’s personal bankruptcy case. 11 U.S.C. § 523(a)(4); see, e.g., In re Kallmeyer, 242 B.R. 492 (9th Cir. BAP 1999); but see In re McKnew, 270 B.R. 593, 624‐630 (Bankr. E.D. Va. 2001)(gathering similar cases and concluding that “fiduciary capacity” in section 523(a)(4)and concluding that “fiduciary capacity” in section 523(a)(4) requires pre‐existing express trust).

39

Related Strategy to Avoid D&O Litigation: Become a Delaware LLC

Insulation from Exposure to Both LLC Members and Creditors– Members: 6 Del. C. §18‐1101(c) permits LLC agreement to restrict or

eliminate any duty (including fiduciary duties) to the LLC or its members or managers, other than implied contractual covenant of good faith and fair dealingdealing.

– Related Westpac LLC et al. v. JER Snowmass LLC et al., Del. Ch. 7/23/10) Defendant member negotiated for consent right with respect to major decisions which it could withhold to protect its own commercial interestsdecisions, which it could withhold to protect its own commercial interests. Held: When a “fiduciary duty’s claim is plainly inconsistent with the contractual bargain struck by the parties to an LLC or alternative entity agreement, the fiduciary duty claim must fall.”

– CML V, LLC v. Bax, et al. (Del. Ch. 11/3/10) Section 18‐1002 of Delaware LLC Act governs standing for derivative actions, and does not grant it to creditors.

40

Insurance

Obtain Appropriate D&O Insurance

41

Impact of Bankruptcy on D&O p p yInsurance Coverage

SPEAKERS:

Mark MaloneyMark MaloneyMark MaloneyMark MaloneyTony TatumTony Tatum

King & Spalding, AtlantaKing & Spalding, Atlantag & Spa d g, t a tag & Spa d g, t a ta

Speaker BiographySpeaker BiographyT T t i t i Ki & S ldi ' Atl t ffi d b f th fi ’ B iTony Tatum is a partner in King & Spalding's Atlanta office and a member of the firm’s BusinessLitigation Practice. Mr. Tatum’s practice focuses on complex commercial litigation, with an emphasis ininsurance coverage and recovery litigation, arbitration, and consultation, as well as securities andshareholder litigation.

Mr Tatum represents leading companies such as AFC Enterprises Inc Central Georgia Health

Tony Tatum

Mr. Tatum represents leading companies such as AFC Enterprises, Inc, Central Georgia HealthSystems, Inc., Harbert Management Corporation, Kelly Services, Inc., Kimberly-Clark Corporation, andThe Coca-Cola Company, and has litigation experience in state and federal courts at both the trial andappellate levels.

In his insurance coverage practice, Mr. Tatum regularly represents policyholders in all aspects ofy

[email protected]

404-572-3519

g g y yinsurance coverage disputes, including complex litigation and arbitration relating to property damage,business interruption, directors and officers liability (D&O), environmental and pollution, employmentpractices liability, fiduciary liability, errors and omissions, fidelity and crime coverage, and othermanuscripted lines of coverage. Mr. Tatum regularly advises clients and their directors and officersregarding D&O indemnification and insurance issues related to these matters, and in negotiating best inl t d diti f li t ith U S d i t ti l i f D&O d th liclass terms and conditions for clients with U.S. and international insurers for D&O and many other lines

of insurance coverage.

Mr. Tatum obtained his undergraduate degree in Risk Management and Insurance from The Universityof Georgia. Subsequently, Mr. Tatum worked as a senior analyst with two leading financial servicescompanies in the areas of regulatory insurance compliance Mr Tatum graduated cum laude fromcompanies in the areas of regulatory insurance compliance. Mr. Tatum graduated, cum laude, fromGeorgia State University College of Law. He was a law clerk for the U.S. Attorneys Office, Departmentof Justice and an extern for former Georgia Congressman Ed Jenkins. In both 2006 and 2007, and2009, Mr. Tatum was named a "Georgia Rising Star" by Atlanta Magazine. Mr. Tatum was also nameda “Future Litigation Star” in Georgia by Benchmark Litigation in both 2009 and 2010.

43

Speaker BiographySpeaker BiographyMark Maloney is a partner in the Atlanta office of King & Spalding and a member of the FinancialRestructuring Practice Group. Mr. Maloney’s practice includes representation of a broad range ofclients in litigation matters involving creditors’ rights, bankruptcy, lender liability and other financialand commercial disputes. He has represented debtors, official committees, secured and unsecuredcreditors, and other parties in interest in major Chapter 11 bankruptcy cases and other insolvency

di i 20 t t d th Di t i t f C l bi F 2003 th h 2010 h h b

Mark M. Maloney

proceedings in over 20 states and the District of Columbia. From 2003 through 2010 he has beenlisted as one of the top bankruptcy attorneys in the country by The Deal Magazine. In addition, Mr.Maloney has been selected by his peers as a Georgia Super Lawyer, as published in AtlantaMagazine, and as a member of the Georgia Legal Elite, as published in GeorgiaTrend magazine.Mr. Maloney also has served as Chairman of the American Bankruptcy Institute’s LitigationCommittee and is a Board Member of both the Southeastern Bankruptcy Law Institute and they

[email protected]

404-572-4857

Committee and is a Board Member of both the Southeastern Bankruptcy Law Institute and theBankruptcy Section of the State Bar of Georgia.

Mr. Maloney is a frequent lecturer on bankruptcy topics and serves as Co-Chairman and facultymember for the Litigation Skills Symposium sponsored by the American Bankruptcy Institute. Hispublications include "Orix Credit Alliance, Inc. v. Delta Resources, Inc.- Poor Losers," in the AnnualSurvey of Bankruptcy Law, "At Your Service: Deciphering the Amendments to the Service Rules," inBankruptcy Litigation, "Specific Personal Jurisdiction and the 'Arise From or Related To'Requirement…What Does It Mean?" in the Washington & Lee Law Review. Mr. Maloney is also aco-author of the Aspatore Books publication Inside the Minds: The Roles and Motivations of KeyPlayers in Bankruptcy Cases, and co-author of the West Group treatise Successful PartneringBet een Inside and O tside Co nsel He has ser ed pre io sl as co editor of Bankr ptcBetween Inside and Outside Counsel. He has served previously as co-editor of BankruptcyLitigation and as a member of the Advisory Board for the Annual Survey of Bankruptcy Law.

44

Key Coverage Issues to AddressKey Coverage Issues to Address

D&O i d h ?• D&O insurance proceeds – who owns?

• Effect of automatic stay on insurer’s ability to advance defense costsadvance defense costs

• Policy provisions that provide maximum protection to directors and officers (Including “I v I” exclusion)to directors and officers (Including I v. I exclusion)

• D&O coverage for companies emerging from bankruptcyp y

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D&O Insurance Proceeds D&O Insurance Proceeds --Who Owns?Who Owns?Who Owns? Who Owns?

M k M lM k M lMark MaloneyMark Maloney

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D&O Insurance Proceeds D&O Insurance Proceeds -- Who Owns?Who Owns?

Traditional D&O Coverage

Traditionally directors’ and officers’ liability policies provided twoTraditionally, directors and officers liability policies provided twotypes of coverage:

• Insuring Agreement A (or “Side A Coverage”): Liability coveragebl di tl t th D &O f l i f f l t hpayable directly to the Ds&Os for claims for wrongful acts when

indemnification is not permitted or not available due to insolvency; and

• Insuring Agreement B (or “Side B Coverage”): Coverage payable tothe corporation/insured entity to reimburse it for indemnificationthe corporation/insured entity to reimburse it for indemnificationprovided to their Ds&Os and officers for claims for wrongful actsagainst them.

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D&O Insurance Proceeds D&O Insurance Proceeds -- Who Owns? Who Owns?

Entity Coverage Entity Coverage

• Insuring Agreement C (or “Entity Coverage”): liability coveragepayable directly to an insured entity for its wrongful acts.

• This type of coverage is typically limited to securities claims inpolicies issued to publicly-traded companies, but it may be broaderin other types of private company policies.

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D&O Insurance Proceeds D&O Insurance Proceeds -- Who Owns? Who Owns?

Aggregate Limit of Liability

Claims Against Directors & Officers Claims AgainstCorporate Entity

Indemnification?

Direct payment of Reimbursement of

Reimbursement of paidloss to corporate entity

Applicable self insured

NO YES

Indemnification?

Direct payment ofloss by insurer

No self-insured retention

Personal asset

Reimbursement ofindemnified loss

Applicable self insured retention

Balance sheet

Applicable self insured retention

Balance sheetprotection

Personal asset protection

Balance sheetprotection

Non-Indemnifiable“Side A” D&O coverage

Corporate Reimbursement“Side B” D&O Coverage

Entity Liability“Side C” D&O Coverage

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D&O Insurance Proceeds D&O Insurance Proceeds -- Who Owns?Who Owns?

If a Company becomes subject to a bankruptcy proceeding, theCompany will likely be unable to fund its D&O indemnificationobligation.

Will the filing of bankruptcy convert the underlying Side B claim to a• Will the filing of bankruptcy convert the underlying Side B claim to a“non-indemnifiable” Side A claim under the policy?

If the D&O policy also provides entity coverage (Side C), it may beconsidered by the courts as an asset of the bankruptcy estate.

• If the policy is an asset of the bankruptcy estate, are the “proceeds”frozen so that the insurer cannot pay Side A claims to the Ds&Os?p y

• What provisions can be included in a D&O policy to help ensure thatDs&Os are indemnified under the policy if the Company is inbankruptcy?

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Effect of “Automatic Stay” on Effect of “Automatic Stay” on Insurer’s Ability to AdvanceInsurer’s Ability to AdvanceInsurer s Ability to Advance Insurer s Ability to Advance

Defense CostsDefense Costs

Mark MaloneyMark Maloney

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Effect of “Automatic Stay” on Insurer’s Ability to Advance Effect of “Automatic Stay” on Insurer’s Ability to Advance Defense CostsDefense Costs

Section 362(a) of the Bankruptcy Code

• The automatic stay under Section 362(a) of theThe automatic stay under Section 362(a) of theBankruptcy Code provides that the filing of a petition inbankruptcy automatically stays certain actions directedagainst the debtor’s property The automatic stayagainst the debtor s property. The automatic staygenerally does not extend to actions pending against thedebtor’s Ds&Os unless it amounts to an “act to obtainpossession of property of the estate” or “to exercisepossession of property of the estate or to exercisecontrol over property” of the estate.” See Steyr-Daimler-Puch of America Corp. v. Pappas, 852 F.2d 132 (4th Cir.1988) Accordingly in cases where the debtor and its1988). Accordingly, in cases where the debtor and itsDs&Os are defendants, the lawsuit will likely beautomatically stayed as to the debtor only.

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Extension of the Automatic Stay to Pending Litigation Against the Debtor’s Ds&Os

• Ds&Os often seek to enjoin litigation pending against themarguing that (1) an adverse judgment would increase thedebtor’s indemnification exposure if the debtor’s insurer refuseddebtor s indemnification exposure if the debtor s insurer refusedto advance defense costs or if the costs exceed policy limits; (2)the litigation would be disruptive to the management of thedebtor or interfere with the reorganization of the debtor; (3) thedebtor or interfere with the reorganization of the debtor; (3) thecontinued litigation is an attempt to circumvent the automaticstay; or (4) that a judgment against the non-debtor createscollateral estoppel issues for the debtor.pp

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Effect of “Automatic Stay” on Insurer’s Ability to Advance Effect of “Automatic Stay” on Insurer’s Ability to Advance Defense CostsDefense CostsDefense CostsDefense Costs

• Exception Applied - A few courts have accepted thesearguments although largely in the products liability arena whereg g g y p ythe argument of circumvention of the automatic stay is arguablystronger than in the securities fraud space. See, e.g., LomasFin. Corp. v. N. Trust Co. (In re Lomas Fin. Corp.), 117 B.R. 64,p ( p )68 (S.D.N.Y. 1990); A.H. Robins Co. v. Piccinin, 788 F.2d 994,1001 (4th Cir. 1986).

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• Exception Inapplicable - However, most courts have refused toextend the automatic stay to actions against a debtor’s Ds&Os,finding that the requisite “unusual circumstances” do not existbecause the underlying litigation typically does not interfere withthe debtor’s reorganization, the litigation is based oni d d t t t b h b th D &O d/ thindependent torts or breaches by the Ds&Os, and/or thedefendants’ indemnification claims, if any, are not absolute.See, e.g., Goldin Primavera Familienstiftung Tag Assocs. (In reGranite Partners L P ) 194 B R 318 337-38 (Bankr S D N YGranite Partners, L.P.), 194 B.R. 318, 337-38 (Bankr. S.D.N.Y.1996).

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If the automatic stay does not apply to pending litigation,y pp y p g g ,the Ds&Os will want the policy to fund defense coststhat otherwise would have been advanced by thedebtor.

D&O “Policies” vs. “Proceeds” D&O Policies vs. Proceeds

• Many courts consider the D&O policy and its proceedsseparately in determining whether they are the property ofp y g y p p ythe insured debtor’s bankruptcy estate.

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• D&O “Policies” - Most courts consider D&O policies property ofthe debtor’s estate See e g La World Exposition Inc v Fedthe debtor s estate. See, e.g., La. World Exposition, Inc. v. Fed.Ins. Co. (In re La. World Exposition, Inc.), 832 F.2d 1391, 1399(5th Cir. 1987) (“There are a great many bankruptcy casesholding that liability insurance policies that provide coverage forth b k t’ li bilit b l t th b k t’ t t ”)the bankrupt’s liability belong to the bankrupt’s estate.”);MacArthur Co. v. Johns-Manville Corp., 837 F.2d 89 (2d. Cir.1988)

Th iti l i i h th th D&O li d• The more critical issue is whether the D&O policy proceeds arethe property of the estate. This issue typically arises when aninsurer is asked to advance defense costs to Ds&Os or makeother payments under the policy when the company is inp y p y p ybankruptcy.

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D&O “Proceeds” - Case Authority Addressing “Proceeds”

If D bt H N Di t I t t i P li “P d ”• If Debtor Has No Direct Interest in Policy “Proceeds”» Many courts have held that where the debtor does not have a “direct

interest” in the proceeds of a D&O policy, the proceeds are notproperty of the bankruptcy estate. See, e.g., La. World Exposition, Inc.v. Fed. Ins. Co. (In re La. World Exposition, Inc.), 832 F.2d 1391 (5th

Cir. 1987); In re MCSi, Inc., Secs. Litig., No. C-3-015, 371 B.R. 270(S.D. Ohio Feb. 26, 2004).(S.D. Ohio Feb. 26, 2004).

» These courts reason that the D&O policy benefited only the Ds&Os byproviding either direct coverage for claims made against them orindirect coverage by reimbursing the corporation for its indemnificationindirect coverage by reimbursing the corporation for its indemnificationof the Ds&Os. See also Houston v. Edgeworth (In re Edgeworth), 993F.2d 51 (5th Cir. 1993).

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• If The Debtor Has Made Indemnification ClaimsOther co rts ha e held that here there are claims for» Other courts have held that where there are claims forindemnification coverage under Insuring Agreement B, the D&Opolicy proceeds may be property of the bankruptcy estate. See In reAllied Digital Techs. Corp., 306 B.R. 505 (Bankr. D. Del. 2004); In reg p ( )Tom’s Foods, Inc., 2006 Bankr. LEXIS 3319 (Bankr. M.D. Ga. Dec. 7,2006).

» These courts reason that payments to the Ds&Os for defense costswould deplete the policy limits, thereby increasing the debtor’sexposure to indemnification claims in other litigation. The debtor’sinterest in being reimbursed by the insurer for the amounts it mustindemnify its Ds&Os is sufficient to hold that the policy’s proceedsindemnify its Ds&Os is sufficient to hold that the policy s proceedsare an asset of the bankruptcy estate.

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• Where the D&O Policy Provides “Side C” Entity Coverage» Some courts have held that D&O policies that provide entity coverage are the

property of the bankruptcy estate. See Homsy v. Floyd (In re Vitek, Inc.), 51 F.3d530 (5th Cir. 1995); Metro Inv. Sec., Inc. v. Cavvel (In re Metro. Mortg.), 325 B.R.851 (Bankr E D Wash 2005)851 (Bankr. E.D. Wash. 2005).

» These courts reason that the existence of direct coverage for the entity makesthe policy a vehicle for both individual and corporate protection. Because theproceeds of the policy are “commingled,” the debtor’s interest in the policyp p y g p yproceeds is sufficient to bring the entirety of the policy proceeds into the estate.

» However, some courts have held that the proceeds of a D&O policy are not theproperty of the bankruptcy estate even though the policy included Side C entitycoverage See In re First Cent Fin Corp 238 B R 9 17 (Bankr E D N Y 1999)coverage. See In re First Cent. Fin. Corp., 238 B.R. 9, 17 (Bankr. E.D.N.Y 1999)(The “mere appendage of entity coverage [for securities claims] to [the] Policy byway of a rider . . . does not provide sufficient predicate, per se, to metamorphosethe proceeds into estate property.”)

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Effect of “Automatic Stay” on Insurer’s Ability to Advance Effect of “Automatic Stay” on Insurer’s Ability to Advance Defense CostsDefense CostsDefense CostsDefense Costs

General Principles Regarding Policy “Proceeds”

• Typically a bankruptcy court will treat “proceeds” as owned by the Ds&Os• Typically, a bankruptcy court will treat proceeds as owned by the Ds&Osif it is a Side A only policy. On the other end the spectrum is the policy withSide C entity coverage, there is greater likelihood of the proceeds beingtied up in the estate, although some courts have held even if the policycontains entity coverage, the policy proceeds are not part of the estatebecause the main purpose of the policy is to protect Ds&Os.

• The middle of the spectrum is the policy with both Side A and Side Bcoverage. Courts are split on whether the existence of Side B coveragecompels a conclusion that the proceeds belong to the estate.

• Thus, the “Sliding Scale” - A Policy with Side A only is the safest; A policywith Side A and Side B is riskier for the Ds and Os; and a policy thatincludes Side C presents the greatest risk to recovery by the Ds and Os.

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D&O Policy Provisions that MayD&O Policy Provisions that MayD&O Policy Provisions that May D&O Policy Provisions that May Help Provide MaximumHelp Provide Maximum

Protection to Ds&OsProtection to Ds&OsProtection to Ds&OsProtection to Ds&Os

T T tT T tTony TatumTony Tatum

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D&O Policy Provisions that May Help Provide Maximum D&O Policy Provisions that May Help Provide Maximum Protection to Ds&OsProtection to Ds&Os

Key D&O Policy Provisions to Consider

• Change in Control Provision

• Definition of “Financial Insolvency” and “PresumptiveIndemnification”Indemnification

• “Insured v. Insured” Exclusion

• “Priority of Payments” Provisiony y

• “Waiver of Automatic Stay” Provision

• Advancement of Defense Costs

• Dedicated Side A Limits

• Excess Policy Considerations

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Change in Control Provisions

• Typical Provision:» If, during the Policy Period, there is a Change in Control, the coverage

provided under this Policy shall continue to apply but only with respect to aClaim against an Insured for a Wrongful Act committed or allegedlycommitted up to the time of the Change in Control; and

(a) coverage will cease with respect to any Claim for a Wrongful Actcommitted subsequent to the Change in Control; andcommitted subsequent to the Change in Control; and

(b) The entire premium for the Policy will be deemed to be fully earnedimmediately upon the consummation of a Change in Control.

» “Change in Control” means “the appointment of a Receiver» Change in Control means . . . the appointment of a Receiver,Conservator, Liquidator, Trustee, Rehabilitator, or any comparableauthority, with respect to the Parent Company.”

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• Implication for Insureds:P li i t ff f i d f li t» Policy goes into run-off for remainder of policy term

» No coverage for acts after effective date of transaction

» Premium is fully earnedy

• Options:» During policy renewal, request removal of bankruptcy event as

triggering the change in control provision

» If event occurs during the policy period with a bankruptcy trigger in theprovision, seek waiver of the change in control

» Otherwise, work with broker and counsel to secure new D&Ocoverage as necessary for post-filing “wrongful acts”

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• Definition of “Financial Insolvency” and “Presumptive Indemnification”Indemnification

» D&O policies usually contain two separate retention provisions for Side A coverage(direct coverage for non-indemnifiable loss) and Side B coverage (corporatereimbursement for indemnifiable loss). Typically, there is no retention for Side Aco erage In contrast the retention applicable to Side B or C co erage is m chcoverage. In contrast, the retention applicable to Side B or C coverage is muchlarger (e.g., up to or exceeding $1 million for large publicly traded corporations).

» D&O policies generally contain “presumptive indemnification” provisions that provideif the corporation is required or permitted to indemnify its Ds&Os, then the larger

t ti li bl t Sid B ill l Th i ti f h th thretention applicable to Side B coverage will apply. Thus, irrespective of whether thecompany actually indemnifies its Ds&Os, if indemnification is permissible, the largerSide B retention will apply.

» Presumptive indemnification provisions typically do not apply when the insuredf &O f “f ”entity is unable to indemnify its Ds&Os as a result of “financial insolvency” or

“financial impairment.”

» Some policies equate financial insolvency with the insured organization becoming adebtor-in-possession under the Bankruptcy Code, or with a receiver, liquidator,

66rehabilitator, etc. being appointed.

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» Other D&O policies define financial insolvency or impairment as the inabilityfinancially to advance defense costs under applicable law. In addition, somepolicies do not define the terms “financial insolvency” or “financial impairment ”policies do not define the terms financial insolvency or financial impairment.

• Implication:» Unless the policy defines “financial insolvency” to include a debtor-in-possession,p y y p

D&O insurer may argue that a debtor-in-possession is or could be required, orpermitted, by the Court to indemnify its Ds&Os. The insurer may withhold firstdollar coverage for defense costs leaving the Ds&Os to pay the Side B retentionwhich is often substantial.

• Options:» Request inclusion in the D&O policy of a specific definition of “financial

insolvency” that includes debtor in possession or other bankruptcy filing eventinsolvency that includes debtor-in-possession or other bankruptcy filing event.

» Dedicated Side A excess limits to “drop down” if the primary D&O insurer deniesadvancement of defense costs.

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“Insured v. Insured” (“I v. I”) Exclusion

Th t f th I I l i G ll th I I• The terms of the I v. I exclusion vary. Generally, the I v. Iexclusion bars coverage for claims “brought by” or claims“brought by or on behalf of” one insured against anotherinsured.

• The main issue in the bankruptcy context is whether abankruptcy trustee creditors committee or assignee of thebankruptcy trustee, creditors committee or assignee of thedebtors’ or creditor’ rights constitutes an “Insured” underthe policy such that claims brought by them against thedebtor’s Ds&Os trigger the I v I exclusiondebtor s Ds&Os trigger the I v. I exclusion.

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• Insurers argue that because a bankruptcy trustee standsin the debtor’s shoes for purposes of asserting claimsp p gagainst its Ds&Os, the I v. I exclusion bars coverage forthe trustee’s claims just as it would bar coverage forclaims brought in the name of or by the debtor itself.claims brought in the name of or by the debtor itself.

• Trustees and creditors committees (and Ds&Os) argue,however, that the debtor and the trustee are legallyseparate entities and that the purpose of the I v. Iexclusion is not implicated in the bankruptcy contextbecause the actions by trustees or creditors committeesare not collusive.

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• Options:» Most insurers will grant a carveback to the “I v. I”

exclusion for claims brought by the trustee:

» Exclusion applies unless the claim:

• is brought by the Bankruptcy Trustee or Examiner of theCompany or any assignee of such Trustee or Examiner;Company or any assignee of such Trustee or Examiner;or any Receiver, Conservator, Rehabilitator, Liquidator,Custodian, or comparable authority of the Company.

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• Priority of Payments Provision

» If there is a single limit of liability and claims are brought that triggercoverage provided to both the corporate entity (Side C) and to its Ds&Os(Side A), a bankruptcy trustee or creditor will argue that the policy and itsproceeds should be considered an asset of the bankruptcy estate and asa result the policy proceeds cannot be used to pay costs of Ds&Osa result the policy proceeds cannot be used to pay costs of Ds&Os.

• Options:» Include an order of payments provision that specifies that the Ds&Osp y p p

have first claim to the policy proceeds. This should provide a basis forthe bankruptcy court to allow the Ds&Os access to the proceeds of thepolicy to pay for defense expenses and potential liabilities.

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Sample Policy Language: “It is understood and agreed that ifLoss, including Defense Expenses, shall be payable under morethan one of the INSURING AGREEMENTS then the Insurer shallthan one of the INSURING AGREEMENTS, then the Insurer shall,to the maximum extent practicable pay such Loss as follows:

• first, the insurer shall pay that Loss, if any, which the Insurer maybe liable to pay on behalf of the Insured Persons under INSURINGAGREEMENT (A);

• second, the Insurer shall pay that Loss, if any, which the Insurer, p y , y,may be liable to pay on behalf of the Company under INSURINGAGREEMENT (B); and

• third, the Insurer shall make such other payments which the Insurerthird, the Insurer shall make such other payments which the Insurermay be liable to make under INSURING AGREEMENT (C) orotherwise.”

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Waiver of Automatic Stay Provision

• Typical language: If a liquidation or reorganization isd b th P t C d Titl ll f th U it dcommenced by the Parent Company under Title ll of the United

States Code, then with respect to a covered Claim, the insuredshereby:

( ) i d l t ti t i j ti t th t t» (a) waive and release any automatic stay or injunction to the extentit may apply in such proceeding to the proceeds of this Policy undersuch Bankruptcy Law; and

» (b) agree not to oppose or object to any efforts by the Insurer or» (b) agree not to oppose or object to any efforts by the Insurer orany Insured to obtain relief from any stay or Injunction applicable tothe proceeds of this Policy as a result of the commencement ofsuch liquidation or reorganization proceeding.

• Benefit: Insurer should be able to cover Ds&Os despite thebankruptcy of the company. Enforceability of provision has notbeen meaningfully tested yet in the courts.

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Advancement of Defense Costs

• The D&O policy should have a provision stating that the insurerwill pay covered Defense Costs on an as-incurred basis. If thewill pay covered Defense Costs on an as incurred basis. If theD&O policy does not specify that an insurer must pay defensecosts as they are incurred, then the Ds&Os may find themselvesin a situation where they are obligated to pay millions of dollarsof defense costs out of their own pockets until a claim is finallyof defense costs out of their own pockets until a claim is finallyresolved and the insurer is obligated to pay the covered defensecosts and the damages.

• A typical D&O policy that has an advancement of defense costs• A typical D&O policy that has an advancement of defense costsprovision will also provide that if it is finally determined that anydefense costs paid by the Insurer are not covered under thisPolicy, the Insureds agree to repay those non-covered Defensey g p yCosts to the Insurer. Many carriers will agree to delete this latterrequirement.

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Dedicated Side A Limits

• Typical Benefits:» No “presumptive indemnification;”

» Specifically non-rescindable;

» Full severability of the application and conduct exclusions;» Full severability of the application and conduct exclusions;

» Policy drops down as primary in the event of insolvency of theunderlying carrier;

» Less restrictive fraud exclusion;» Less restrictive fraud exclusion;

» Less restrictive I v. I exclusion;

» Covers Ds&Os where company refuses to indemnify; and

» Covers where primary policy has been deemed an asset of thedebtor’s estate in bankruptcy.

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Other Excess Policy Considerations

• Several recent decisions suggest an excess D&O insurer is notggobligated to pay covered claims or defense costs unless theunderlying D&O insurer itself has fully paid the limits of its policy.See Qualcomm, Inc. v. Certain Underwriters at Lloyd’s, London,

th161 Cal. App. 4th 184 (2008).

• If the D&O policy does not contain flexible exhaustion language thatreduces restrictions on payments of loss, there is a possibility thatp y , p ythe insurer will argue that the excess D&O policy's paymentobligations will never be triggered if the underlying D&O insurersettles with the policyholder for anything less than full policy limits.

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D&O Policy Provisions that May Help Provide Maximum D&O Policy Provisions that May Help Provide Maximum Protection to Ds&OsProtection to Ds&OsProtection to Ds&OsProtection to Ds&Os

Options:

• An excess D&O insurance policy should have a provision thatspecifically states that payment of the underlying policy limits forcovered claims, by either the insurer or the policyholder, or ay ycombination of both, is sufficient to exhaust the underlyingcoverage.

• All D&O excess coverage should also include clear “follow form”All D&O excess coverage should also include clear follow formprovisions that state precisely the underlying policies thatgovern the application of D&O coverage in the program. Apolicyholder purchases follow form excess D&O insurance inp y porder to obtain seamless coverage for the same set of potentiallosses.

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D&O Coverage for D&O Coverage for C i E iC i E iCompanies Emerging Companies Emerging

from Bankruptcyfrom Bankruptcyp yp y

Tony TatumTony TatumTony TatumTony Tatum

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D&O Coverage for Companies Emerging from BankruptcyD&O Coverage for Companies Emerging from Bankruptcy

Run-off Coverage Triggers:

C i t ti ll t i d b th ‘ h f t l’ i i i th li Coverage is automatically triggered by the ‘change of control’ provision in the policy:

Policy goes into run-off for remainder of policy term

• No coverage for acts after effective date of transaction• No coverage for acts after effective date of transaction

• The entire premium is fully earned

Primary D&O

(AIG example language)

Clause 12 Organizational Changes: If the Named Entity shall consolidate with, merge into, or sell all or substantially all of its assets to any other person or entity or group of person or entities acting in concert; or any person or entity or group of persons or entities acting in concert shall acquire management control of the namedor entities acting in concert shall acquire management control of the named entity…coverage converts to prior acts only. Clause 10 Discovery: The Insurer shall offer such discovery period pursuant to such terms, conditions, exclusions and additional premium as the Insurer may reasonably decide.

Excess D&O All Excess policies follow form of the primary policy

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Excess D&O All Excess policies follow form of the primary policy.

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RunRun--Off Option plus Ongoing CoverageOff Option plus Ongoing Coverage -- Stand alone pre-bankruptcy run-off program plus stand alone post-bankruptcy program.

Pre-Bankruptcy 6-Year Run-Off Program

Post Bankruptcy ProgramPost Bankruptcy Program

Features

Separate dedicated run-off limits for incumbent D&Os.

*Day Zero

Non-cancelable term assures run-off duration.

“Clean sheet” program with separate limits for post bankruptcy company.

*Day Zero is determined when the insured emerges from bankruptcy.80

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D&O Coverage for Companies Emerging from BankruptcyD&O Coverage for Companies Emerging from BankruptcySecuring Run-off Coverage:

Incumbent markets may have a competitive advantage in placing this coveragecoverage

• They know the existing board, management, operations and history of company – good or bad

• Depending on timing of the deal to the expiration date, there may be “ d” i t l“unearned” premium at play

If close to the renewal date, will seek to ensure that the existing policy provisions are competitive with what would have been received at renewal – enhancements for the run-off period can usually be negotiated.p y g

Outstanding claims – most run-offs are extensions of existing limit in place as opposed to a fresh aggregate. Outstanding claims can be an issue if the existing limits are being eroded.

An alternative would be to seek competitive quotes from non-incumbent markets.

Communication with underwriters is critical.

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Immediate Strategy Activities – Run-Off:

Confirm Timeline and Due Dates

Submission information needed

Confirm lines of coverage and limits desiredg

Request run-off quotes from existing carriers – Unearned premium to be applied to run-off premium

– Premiums to include commission

– Target range 1X - 1.5X rating

Request run-off quotes from non-incumbent carriers, if neededq q ,

Arrange for underwriting conference calls, if needed

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d&o fiduciaryy duties when a company faces...

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