Bankruptcy: How it Affects Coverage, Underwriting, and Claims

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1 Bankruptcy: How it Affects Coverage, Underwriting, and Claims PLUS Texas Chapter Dallas September 21, 2016 Houston September 22, 2016 Your source for professional liability education and networking.

2 Bankruptcy: How it Affects Coverage, Underwriting, and Claims MODERATOR: Amy Elizabeth Stewart, Managing Principal, Amy Stewart Law Amy Elizabeth Stewart, Managing Principal, Amy Stewart Law PANELISTS: Teri L. Martin, Broker, AmWINS Brokerage of Texas William L. Medford, Partner, Lewis Brisbois Bisgaard & Smith LLP Daniel Navarro, Regional Manager, AIG 2

3 Teri L. Martin Broker, AmWINS Brokerage of Texas 3

4 William L. Medford Partner, Lewis Brisbois Bisgaard & Smith LLP 4

5 Daniel Navarro Regional Manager, AIG 5

6 Why Talk about Bankruptcy? Texas surpassed California as the state that generated the highest percentage of overall bankruptcies in Q2 and YTD QUARTERLY REPORT OF BUSINESS BANKRUPTCY FILINGS BankruptcyData, a division of New Generation Research, Inc. 6

7 Why Talk about Bankruptcy? Largest Bankruptcies of COMPANY ASSETS 2 ($MIL.) FILING DATE SunEdison, Inc. 11,500 4/21/2016 Peabody Energy Corp. 11,021 4/13/2016 LINN Energy, LLC 9,977 5/11/2016 Arch Coal, Inc. 8,429 1/11/2016 Breitburn Energy Partners, LP 4,872 5/15/2016 Energy XXI Ltd. 4,691 4/14/2016 Republic Airways Holdings, Inc. 3,494 2/25/2016 Paragon Offshore plc 3,253 2/14/2016 SandRidge Energy, Inc. 2,991 5/16/2016 China Fishery Group Limited 2,653 6/30/2016 RCS Capital Corp. 2,467 1/31/2016 CHC Group Ltd. 2,252 5/5/2016 Seventy Seven Energy, Inc. 1,903 6/7/2016 Noranda Aluminum Holding Corp. 1,318 2/8/ Through 6/30/16 2 Assets at fiscal year-end prior to filing 7

8 Roadmap Everything you never wanted to know about bankruptcy Overview of the bankruptcy process what happens, how does it work How bankruptcy affects underwriting D&O policies Impact of financial distress and bankruptcy on D&O underwriting How bankruptcy affects D&O coverage How bankruptcy affects claims handling in the D&O context Sufficiency of limits, priority of payments, settlement obligations, exclusions, privilege issues 8

9 Everything You Never Wanted to Know about Bankruptcy 9

10 Everything You Never Wanted to Know about Bankruptcy First Things First - Who is your insured? Debtor Creditor When did claim arise? When was bankruptcy filed? 10

11 Everything You Never Wanted to Know about Bankruptcy Chapter 7 vs Chapter 11 Who do you represent? Who do you pay? Chapter 7 No corporate discharge No ongoing business absent order Trustee appointed immediately Chapter 11 Claims may be discharged in plan Business continues No Trustee unless court ordered 11

12 Everything You Never Wanted to Know about Bankruptcy The Automatic Stay and You 11 U.S.C. 362 Stays all actions against the Debtor until lifted, case closed, or plan confirmed Does not stop Debtor from pursuing claims No stay for co-defendants Best practice: seek severance of Debtor or relief from bankruptcy court to proceed Any party can alert court of stay Stay doesn t apply to post-petition actions, i.e. claim arose after the bankruptcy case was filed. 12

13 Effect on Underwriting Do not pass Go, do not collect $200! 13

14 Effect on Underwriting Financials Due Diligence Balance Sheet Breach of debt covenants Cash on hand Loan in forbearance Income statement Consecutive net losses along with negative operating cash flows Significant EBITDA or Operating income change 14

15 Effect on Underwriting Underwriting Concerns Type of bankruptcy (Chapter 7 vs Chapter 11) If Chapter 11, what is the plan of reorganization? How much debt? How many creditors? Secured v Unsecured Shareholder exposure Claims 15

16 Effect on Underwriting Ordinary Course of Business How was the bankruptcy conveyed to employees, customers, vendors, suppliers, creditors, etc? Layoffs Ordinary Course of Business and Section 363 Chapter 11 Debtors cannot operate during case Cannot operate outside ordinary course of business without court order including Settling claims Obtaining new financing 16

17 Effect on Underwriting Endorsements Creditor exclusion Bankruptcy exclusion Major shareholder exclusion Suits-only language Fully-earned premium endorsement Limits Lower limits Premium 17

18 Effect on Underwriting Creditor Exclusion National Union (1996) CREDITOR S/DEBT HOLDER S EXCLUSION In consideration of the premium charged, it is hereby understood and agreed that the Insurer shall not be liable for any Loss in connection with any claim or claims made against the Directors and Officers brought by or on the behalf of any creditor or debt holder of the Company, or arising out of any liability (whether alleged or actual) to pay or collect accounts, including but not limited to claims alleging misrepresentation in consideration for the extension of credit or purchase of a debt instrument or any deterioration in the value of the debt. 18

19 Effect on Underwriting Creditor Exclusion Markel (2013) EXCLUSION BANKRUPTCY AND CREDITORS The insurer shall not be liable to pay any Loss on account of, and shall not be obligated to defend, any Claim brought or maintained by or on behalf of [a]ny creditor of a Company or Organization in the creditor s capacity as such, whether or not a bankruptcy or insolvency proceeding involving the Company or Organization has been commenced. 19

20 Effect on Underwriting Creditor Exclusion AIG (2016) Insurer shall not be liable for any Loss under the Private D&O Coverage Section in connection with any Claim against any Insured: BI(b) brought by or on the behalf of any creditor or debt-holder of an Organization, or arising out of any liability (whether alleged or actual) to pay or collect accounts, including but not limited to Claims alleging misrepresentation in connection with the extension of credit or purchase of a debt instrument, or Claims alleging any deterioration in the value of the debt as a result of (wholly or in part) the bankruptcy or insolvency of an Organization, or 20

21 Effect on Underwriting Bankruptcy / Insolvency Exclusions (AIG cont.) Insurer shall not be liable for any Loss in connection with any Claim BI(a) alleging, arising out of, based upon, attributable to, or in any way involving, directly or indirectly: (1) any Wrongful Act which is alleged to have led to or caused, directly or indirectly, wholly or in part, the bankruptcy or insolvency of an Organization, or to an Organization filing a petition, or a petition being filed against an Organization, pursuant to the federal Bankruptcy Code or any similar state law, or an Organization assigning its assets for the benefit of its creditors; or 21

22 Effect on Underwriting Bankruptcy / Insolvency Exclusions (AIG cont.) (2) an Organization having sustained a financial loss due, directly or indirectly, wholly or in part, to a Wrongful Act of any Insured, but only if such Claim is made after the Organization has been determined to be insolvent, or has filed a petition for bankruptcy, or a petition has been filed against it, or the Organization has assigned its assets for the benefit of its creditors; or BI(c) in any bankruptcy proceeding by or against an Organization. 22

23 Effect on Underwriting Survival of the Company New Corporate structure Plan of Reorganization Proforma financials 23

24 Effect on Insurance Coverage Premium Finance In order to continue in Bankruptcy, must seek court approval of all secured financing Minimum insurance required for Debtors operating in Chapter 11 24

25 Effect on Insurance Coverage Estate s interest in the policy proceeds who owns the policy? Case Study: In re MF Global Holdings Ltd. $225M D&O program Amid creditor objections, bankruptcy court initially permitted D&O insurers to advance defense expenses subject to a soft cap of $30M [r]ather than give the Individual Insureds unfettered access to the policy proceeds No determination regarding whether policy proceeds were part of the bankruptcy estate 25

26 Effect on Insurance Coverage Case Study: In re MF Global Holdings Ltd. No determination regarding whether policy proceeds were part of the bankruptcy estate The answer to that question was far from clear because the D&O Policies were not identical and implicated different property interests. Requests to advance defense costs came early in the bankruptcy cases, and before it was clear what claims could or would be made against the policy proceeds Court fashioned an interim solution balancing the interests of the parties Cap later raised to $43.8M 26

27 Effect on Insurance Coverage Case Study: In re MF Global Holdings Ltd. Years later, individual D&Os asked the bankruptcy court to remove the cap Argued that bankrupt entities were unlikely to be subject to claims that would trigger the D&O policies entity coverage and debtors indemnity obligations were not likely to give rise to a claim under the policies Court agreed: [A]t least with respect to insurance policies to which the Debtors have no direct claims to policy proceeds, the Court has no legal basis to limit or restrict claims by the Individual Insureds that are within the coverage. 27

28 Effect on Insurance Coverage Case Study: In re MF Global Holdings Ltd. Court focused on benefit of the bargain MF Global struck when it purchased the policies Priority of Payment provision required the insurers to (1) pay non-indemnified loss first and (2) if the total loss including defense costs is likely to exceed the policy limit, to withhold some or all of loss payable on behalf of the insured entity to ensure that funds are available to pay nonindemnified loss 28

29 Effect on Insurance Coverage Case Study: In re MF Global Holdings Ltd. Allowed D&O insurers to pay defense fees without limitation, subject to $13.06M reserved for reimbursement of future indemnification payments by the bankruptcy estate Court expressed concern about staggering defense costs eroding policy limits $48M incurred before the first deposition had been taken(!) Noting the concern, the judge determined that the bankruptcy court does not function as the overseer of defense costs. 29

30 Effect on Insurance Coverage MF Global court was concerned about staggering defense costs eroding policy limits. $48M incurred before the first deposition had been taken! Noting the concern, the judge determined that the bankruptcy court does not function as the overseer of defense costs. 30

31 Effect on Insurance Coverage Rescission and Severability Based on representations in the application Severability impacts coverage when statements are false in application If no severability provision, coverage for ALL insureds may be non-existent Insurers may have the right to deny claim or rescind policy completely Rescission remedy may be subject to statutory or common law restrictions 31

32 Effect on Insurance Coverage Extended Reporting Periods and Tail Coverage Extend time during which insured may report new claims Wrongful acts that occur prior to the policy s expiration can be added to coverage To obtain the most favorable premium cost, negotiate during policy placement 32

33 Effect on Insurance Coverage Forced Mediation Processes Plan/Order can require mediation Claimant can object if raised timely Arbitration Clauses Enforceable in bankruptcy 33

34 Effect on Claims Handling Competing claims to policy limits When the insured is in bankruptcy, insurance policy proceeds may be only available assets Limits may be insufficient to pay all claims Limits usually reduced by defense costs 34

35 Effect on Claims Handling Settling with Debtor in bankruptcy Make sure to negotiate with decision maker Settlements need court approval Exception confirmed plan may allow settlement authority 35

36 Effect on Claims Handling Distributing proceeds Estate s interest in proceeds may be controlled by: CRO Chapter 7 Trustee Creditors Prior to plan confirmation, need court approval to distribute proceeds After plan confirmation distributions should be made according to plan terms 36

37 Effect on Claims Handling SIRs and Bankruptcy Claim Distributions Bankruptcy can impact contract rights Estate can treat SIR and deductible as claims When claim arose impacts treatment Consult policy and Bankruptcy Code Valuation of SIRs and Deductibles Bankruptcy dollars Real dollars 37

38 Additional Tips Consulting With counsel Call early Call often Willful violation of stay = sanctions against lawyers and clients 38

39 Questions? 39

AMERICAN INTERNATIONAL SPECIALTY LINES INSURANCE COMPANY 175 Water Street Group, Inc. New York, NY 10038

AIG COMPANIES AIG MERGERS & ACQUISITIONS INSURANCE GROUP SELLER-SIDE R&W TEMPLATE AMERICAN INTERNATIONAL SPECIALTY LINES INSURANCE COMPANY 175 Water Street Group, Inc. New York, NY 10038 A Member Company