A liquidating trust delegated to prosecute claims belonging to a chapter 11 debtor cannot recover from the insurance carrier in view of the so-called insured vs. insured exclusion, according to District Judge Janet T. Neff of Grand Rapids, Mich.
When a liquidating trust or creditors’ committee sues officers and directors, Judge Neff said there is “universal recognition that the courts are divided on this issue in the bankruptcy context.” She went on to say there are “inconsistent decisions across the country” where courts generally emphasize different factors “to support contradictory outcomes.”
The case involved a corporate debtor’s chapter 11 plan that created a liquidating trust. As part of a settlement approved by the bankruptcy court alongside confirmation, the company transferred breach of fiduciary duty claims against officers and directors to the trust. In return, the trust and creditors agreed to collect only from insurance proceeds.
The insurance company filed a motion to dismiss, contending that the claims were barred by the insured vs. insured exclusion, which provided that the insurer would not be liable on any claim “by ... or in the name or right of the company.”
In her March 31 decision, Judge Neff came down on the side of courts that invoke the exclusion because she found a “direct connection” between the company and the trust created by agreement with the creditors’ committee. The settlement agreement not only created the trust but also transferred all claims belonging to the company. In substance, she said, the settlement allowed the trust to “step into the proverbial shoes” of the company.
Judge Neff implied that the exclusion would not apply were the suit prosecuted by a trustee in chapters 7 or 11.
The opinion means that creditors intending to sue should petition for the appointment of a chapter 11 trustee to avoid the exclusion. However, allowing a chapter 11 trustee to sue when a liquidating trustee cannot suggests there should be a more sound rationale when deciding whether to invoke the exclusion.
Lurking in the background is the question of whether the creditors should have prosecuted the claims in the first place. The policy provided that the exclusion would not apply to a derivative action brought by security holders. Consequently, stockholders might have been able to sue for breach of fiduciary duty when creditors could not.