Over a blistering dissent, a divided panel of the Sixth Circuit held that a liquidating trust and a corporate debtor are functionally the same for insurance purposes, absolving a provider of directors and officers’ liability insurance from responsibility for covering a breach of fiduciary duty suit as the result of a so-called insured vs. insured exception in the policy.
The dissent says that the majority has waded into a split of circuits and contravened the circuit’s own authority holding that a debtor and chapter 11 debtor in possession are distinct entities. The dissent says the majority opinion will prove costly for creditors by forcing them to abjure consensual plans forming litigation trusts and instead force them to pursue appointment of a chapter 11 trustee or propose a plan of their own.
The Liquidation Trust and the Policy
After negotiations with creditors, the corporate debtor confirmed a chapter 11 plan creating a liquidating trust specifically charged with suing officers and directors for breach of fiduciary duty. The creditors agreed to collect only from insurance, not from officers and directors personally.
After the trust sued, the provider of D&O coverage initiated a declaratory judgment action contending that the insured vs. insured provision in the policy gave it no obligation to cover damages in the trust’s suit.
The pivotal provision in the policy excluded coverage for “any claim . . . made by, or on behalf of, or in the name or right of, the Company.” The policy did provide coverage for derivative suits.
The district court decided that the insurance company had no liability because the exclusion applied. The trust appealed.
The Majority Opinion
The majority opinion on June 20 written by Circuit Judge Jeffrey S. Sutton said that the Bankruptcy Code does not support the notion that the prebankruptcy debtor and debtor in possession are “necessarily distinct legal entitles – at least for purposes of the insurance contract.”
Judge Sutton’s majority opinion barring the trust from recovery on the policy relies in significant part on the trust’s status as a “voluntary assignee of the company.” Because the company could not sue its own officers, the “outcome remains the same” when the company turned the right to sue over to the litigation trust, Judge Sutton said.
Because the company voluntarily transferred the claim, Judge Sutton said it was therefore filed “on behalf of” or “in . . . the right of” the company.
Although much of Judge Sutton’s opinion intimates that a suit by a chapter 11 trustee would be exempt from the exclusion, he said “it’s not even clear that a court-appointed trustee or creditors’ committee could collect on the policy.” Not taking “sides on this debate today,” he “only” held “that a voluntary assignee like the trust, which stands in [the company’s] shoes,” was precluded from collecting under the policy because it was filing suit “‘by, on behalf of, or in the name or right of’ the debtor in possession.”
The Noisy Dissent
Not mincing words, Circuit Judge Bernice B. Donald dissented. She said, “Many cases cited by the majority have held that court-appointed trustees are exempt from the insured-versus-insured exclusion because there is no risk of collusion.”
She accused the majority of concluding, without citing authority, that “an assignee trustee is different than a court-appointed trustee.” Judge Donald said she had found no case law supporting the distinction.
“In fact,” she said, there is a split among the circuits on whether suits by a debtor in possession, creditors’ committee or liquidating trustee trigger the exception. She relied heavily on a Delaware district court decision finding the exclusion inapplicable and holding that the debtor’s estate and the debtor are separate entities.
In addition, Judge Donald argued that the “plain meaning” of the policy itself recognized a distinction between the company and the “debtor in possession or other estate representative.”
Judge Donald contended that the majority ignored the circuit’s own authority holding that “a bankruptcy estate and a debtor are separate legal entities.”
By Judge Donald’s reckoning, the weight of authority holds that a court-appointed trustee is exempt from the exclusion. Because they are “similarly situated,” she believes that an independent liquidation trustee or liquidation committee “should likewise be exempt.”
If the “majority’s decision becomes settled precedent,” she said the “cost in terms of professional fees and judicial resources cannot be overstated” because creditors with valuable claims against management will be compelled to seek appointment of a trustee or propose their own plan.
The majority opinion is surprising in view of the Sixth Circuit’s decision less than a year ago in Bash v. Textron Financial Corp. (In re Fair Finance Co.), 834 F.3d 651 (6th Cir. Aug. 23, 2016), where the appeals court removed some of the barriers to a suit when a trustee is met with the in pari delicto defense. In Bash, the Sixth Circuit declined to follow the Second Circuit’s 1991 decision in Shearson Lehman Hutton, Inc. v. Wagoner.
Although Bash and the new case involve different principles, they both deal with barriers that creditors encounter when filing suit based on management misconduct. To read ABI’s discussion of Bash, click here.