Case Doc 765 Filed 04/20/10 Page 1 of 13. IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF MARYLAND (Baltimore Division)

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1 Case Doc 765 Filed 04/20/10 Page 1 of 13 IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF MARYLAND (Baltimore Division) In re: * Chapter 11 TMST, INC. * Case No (DWK) f/k/a Thornburg Mortgage, Inc., et al., 1 * (Jointly Administered) Debtors. * Larry A. Goldstone Clarence G. Simmons, III * Movants v. * Joel I. Sher, Chapter 11 Trustee for * TMST, Inc. f/k/a/ Thornburg Mortgage, Inc., et al. * Respondents * * * * * * * * * * * * * * MOTION FOR RELIEF OF STAY TO ALLOW PAYMENT OF DEFENSE COSTS UNDER D&O POLICY Larry A. Goldstone ( Goldstone ) and Clarence G. Simmons, III ( Simmons, and with Goldstone, the Movants ), by and through their undersigned attorneys and pursuant to Local Bankruptcy Rule , hereby respectfully move for an Order allowing payment of Movants incurred defense costs under the Directors, Officers and Corporate Liability Insurance Policy # 14-MGU-08-A16632 (the Policy ) issued by U.S. Specialty Insurance Company ( U.S. Specialty ), and in support thereof rely on the Declaration of Mark A. Salzberg in Support of Motion for Relief of Stay to Allow Payment of Defense Costs Under D&O Policy (attached 1 The Debtors in these chapter 11 cases are (i) TMST, Inc., f/k/a Thornburg Mortgage, Inc., (ii) TMST Acquisition Subsidiary, Inc., f/k/a Thornburg Acquisition Subsidiary, Inc., (iii) TMST Home Loans, Inc., f/k/a Thornburg Mortgage Home Loans, Inc., and (iv) TMST Mortgage Hedging Strategies, Inc., f/k/a Thornburg Mortgage Hedging Strategies, Inc. 8744

2 Case Doc 765 Filed 04/20/10 Page 2 of 13 hereto as Exhibit 1, and referred to herein as the Salzberg Decl. ), and further state as follows: 2 I. BACKGROUND On or about May 1, 2008, TMST, Inc. (then known as Thornburg Mortgage, Inc.) ( TMST ) purchased the Policy. A true and correct copy of the Policy is attached to the Salzberg Decl. as Exhibit A ( Salzberg Decl. Exh. A ). 3 The Policy was in effect from May 1, 2008 to May 1, 2009 and contained a Discovery Period clause, extending coverage for claims asserted against the Policy s insureds for an additional 365 days beyond the Policy s May 1, 2009 expiration. On May 1, 2009, TMST commenced its Chapter 11 bankruptcy case by filing a voluntary petition for relief pursuant to Chapter 11 of the Bankruptcy Code in this Court. An Official Committee of Unsecured Creditors (the Committee ) entered its appearance in these proceedings on May 12, 2009 [Docket No. 83] and, although TMST initially was managing its affairs as a debtor-in-possession pursuant to 11 U.S.C and 1108, a Chapter 11 Trustee (the Chapter 11 Trustee ) was appointed on October 28, [Docket No. 506]. A. The Policy s Relevant Provisions The Policy defines Insured Person to include any past, present or future director or officer of [TMST]. Salzberg Decl. Exh. A, p. 3 of 11. Policy. 2 Unless otherwise defined herein, all capitalized terms shall have the meaning ascribed to them in the 3 Counsel for the Debtors previously took, and the Chapter 11 Trustee now takes, the position that the Policy is confidential, a position disputed by Movants. Nonetheless, based upon said position and based upon a confidentiality agreement which the Debtors mandated before production of the Policy, Movants are concurrently filing an Unopposed Motion to File Exhibit A to the Salzberg Decl. Under Seal. The provisions of the Policy cited to herein do not, in any way, implicate the expressed confidentiality concerns

3 Case Doc 765 Filed 04/20/10 Page 3 of 13 Loss is defined by the Policy to mean Defense Costs and any damages, settlements, judgments, pre-judgment interest, post-judgment interest or other amounts (including punitive or exemplary damages and the multiplied portion of any multiplied damage award, if and where insurable by law) that: (1) an Insured Person is legally obligated to pay as a result of any Claim, or (2) the Company is legally obligated to pay as a result of any Securities Claim. Salzberg Decl. Exh. A, as amended by Endorsement No. 1. The Policy defines Defense Costs to mean reasonable fees, costs and expenses consented to by the Insurer resulting from the investigation, adjustment, defense or appeal of a Claim against an Insured Person (or, with respect to Securities Claims, against any Insured), but excluding salaries, wages, benefits or overhead expenses of directors, officers or employees of the Company. Salzberg Decl. Exh. A, p. 2 of 11. Pursuant to the Policy s Insuring Agreement (A), U.S. Specialty agreed to pay to or on behalf of the Insured Persons Loss arising from Claims first made during the Policy Period or Discovery Period against the Insured Persons for Wrongful Acts, except when and to the extent that the Company has paid such Loss to or on behalf of the Insured Persons as indemnification or advancement. Salzberg Decl. Exh. A, p. 2 of Under Insuring Agreement (B), U.S. Specialty agrees to pay to or on behalf of TMST Loss arising from: (1) Claims first made during the Policy Period or the Discovery Period (if applicable) against the Insured Persons for Wrongful Acts, if the Company has paid such Loss to or on behalf of the Insured Persons as indemnification or advancement, and/or (2) Securities Claims first made during the Policy Period or the Discovery Period (if applicable) against the Company for Wrongful Acts. Salzberg Decl. Exh. A, p. 2 of

4 Case Doc 765 Filed 04/20/10 Page 4 of 13 The Policy defines Wrongful Act to include an actual or alleged act, error, misstatement, misleading statements, neglect, omission or breach of duty. Salzberg Decl. Exh. A, p. 4 of 11. With respect to payment of Defense Costs, the Policy provides that U.S. Specialty: will pay covered Defense Costs on an as-incurred basis. If it is finally determined that any Defense Costs paid by the Insurer are not covered under this Policy, the Insureds agree to repay such non-covered Defense Costs to the Insurer. Salzberg Decl. Exh. A, p. 7 of 11. The Policy also contains a Priority of Payments clause, which requires that: If the Insurer is obligated to pay Loss, including Defense Costs, under more than one INSURING AGREEMENT, whether in connection with a single Claim or multiple Claims, the Insurer will first pay any Loss payable under INSURING AGREEMENT (A) and, if the Insurer concludes that the amount of all Loss, including Defense Costs, is likely to exceed the Insurer s Limit of Liability, the Insurer shall be entitled to withhold some or all of any Loss payable under INSURING AGREEMENT (B)(1) or (B)(2) to ensure that as much of the Limit as possible is available for the payment Loss under INSURING AGREEMENT (A). If no Loss is payable under INSURING AGREEMENT (A), or if the Insurer s obligations under INSURING AGREEMENT (A) have been satisfied, then, subject to the Insurer s Limit of Liability as set forth in Item 3 of the Declarations, the Insurer will pay such Loss as it is required to pay under INSURING AGREEMENT (B)(1) or (B)(2) in such manner and, in the event of multiple Claims, apportioned among such Claims as the Named Corporation shall direct in writing. Salzberg Decl. Exh. A, p. 8 of 11. B. The Claims TMST is the Named Corporation under the Policy. Messrs. Goldstone and Simmons, as former officers of TMST, meet the Policy s definition of Insured Person. Salzberg Decl. Exh. A, p. 3 of 11 (Definition F(1)). Messrs. Goldstone and Simmons are and/or were involved in the following claims:

5 Case Doc 765 Filed 04/20/10 Page 5 of The Committee s Investigation In connection with the bankruptcy proceedings before this Court, the Committee requested leave of the Court to conduct discovery of SAF Financial, Inc., pursuant to 11 U.S.C. 105(a) and 1103(c) and Federal Rule of Bankruptcy Procedure [Docket No. 351]. In its motion, the Committee asserted that Messrs. Goldstone and Simmons may be made subject to a Rule 2004 investigation because of their alleged contemporaneous high-level positions held at TMST and SAF. The Committee s requested leave was for an order authorizing and directing discovery from SAF, its directors, officers and employees concerning alleged use or appropriation of TMST s assets, opportunities or property, transfers or transactions involving TMST s assets, the use of [TMST s] agents, employees or professionals and other matters relevant to the Committee s suspicions about the impropriety of Messrs. Goldstone s and Simmons alleged activities (the Committee s Investigation ). 2. The First Adversary Proceeding Messrs. Goldstone and Simmons were named defendants in an adversary proceeding commenced by TMST (Adv. No ), which asserted claims against them for breach of duty of loyalty, corporate waste, unjust enrichment/constructive trust, violation of Maryland law imposing the duties of good faith and care upon TMST s directors, civil conspiracy and other claims arising out of the alleged misconduct of Messrs. Goldstone and Simmons (the First Adversary Proceeding ). On November 13, 2009, the Chapter 11 Trustee dismissed the First Adversary Proceeding without prejudice

6 Case Doc 765 Filed 04/20/10 Page 6 of The TMAC Adversary Proceeding Messrs. Goldstone and Simmons and SAF were named defendants in an adversary proceeding commenced by Thornburg Mortgage Advisory Corporation ( TMAC ) (Adv. No ), which asserted claims against them for breach of fiduciary duty and unjust enrichment (the TMAC Adversary Proceeding ). 4. The Second Adversary Proceeding Messrs. Goldstone and Simmons were named defendants in an adversary proceeding commenced by the Chapter 11 Trustee (Adv. No ), which asserted claims against them for turnover of property which the Chapter 11 Trustee asserted constituted property of the estate (the Second Adversary Proceeding ). On March 23, 2010, the Chapter 11 Trustee dismissed the Second Adversary Proceeding without prejudice. 5. The Third Adversary Proceeding Messrs. Goldstone and Simmons and SAF, and four other individuals or corporate entities, were named defendants in an adversary proceeding commenced by the Chapter 11 Trustee (Adv. No ), which asserted claims against them for breach of duty of loyalty, corporate waste, unjust enrichment/constructive trust, violation of Maryland law imposing the duties of good faith and care upon TMST s directors, civil conspiracy and other claims arising out of the alleged misconduct of said defendants (the Third Adversary Proceeding ). Messrs. Goldstone and Simmons have incurred substantial Defense Costs in their defense of the Committee s Investigation, the First Adversary Proceeding, the TMAC Adversary Proceeding, the Second Adversary Proceeding and the Third Adversary Proceeding, to which they are entitled to payment on an as-incurred basis

7 Case Doc 765 Filed 04/20/10 Page 7 of 13 The Policy s Insurer, U.S. Specialty, agrees that the First Adversary Proceeding and the Third Adversary Proceeding (collectively, the Covered Claims ) assert Claims for Wrongful Acts and that Messrs. Goldstone and Simmons are entitled to payment of their Defense Costs incurred to date, and to be incurred in the future, as a result of the Covered Claims. 5 U.S. Specialty stands ready and willing to advance those Defense Costs upon the Court s issuance of a comfort order declaring that such payments are not prohibited. For the reasons discussed more fully herein, because the Defense Costs payable to the officers and directors under the Policy cannot be considered bankruptcy estate assets, Messrs. Goldstone and Simmons respectively request that this Court issue an Order allowing U.S. Specialty to make such payments. In the alternative, even were the amounts payable under the Policy to be deemed bankruptcy estate assets, the Court should nevertheless issue an Order lifting the automatic stay applicable to such assets as provided by Local Bankruptcy Rule , so that U.S. Specialty may pay those Defense Costs that Messrs. Goldstone and Simmons are contractually entitled to under the Policy. II. ARGUMENT & AUTHORITIES A. The D&O Policy Proceeds are Not Bankruptcy Estate Assets The Policy proceeds to which Messrs. Goldstone and Simmons have a contractual right are not bankruptcy estate assets and are otherwise not subject to the automatic stay in place in connection with TMST s bankruptcy proceedings. The relevant question is not who owns the policies, but who owns the liability proceeds. In re Louisiana World Exposition, Inc., 832 F.2d 5 U.S. Specialty has taken the position that neither the Committee s Investigation, the TMAC Adversary Proceeding, nor the Second Adversary Proceeding constitutes covered Claims. Messrs. Goldstone and Simmons dispute U.S. Specialty s position with respect to said investigation and adversary proceedings, and nothing in this motion shall be deemed to constitute a waiver of Messrs. Goldstone s or Simmons claims for coverage under the Policy for said investigation or adversary proceedings

8 Case Doc 765 Filed 04/20/10 Page 8 of , 1399 (5 th Cir. 1987); see also In re Equinox Oil Co., Inc., 300 F.3d 614, 618 (5 th Cir. 2002) ( The central question when determining whether insurance proceeds associated with a policy are property of the bankruptcy estate is whether, in the absence of the bankruptcy proceeding, the proceeds of the policy would belong to [the] debtor when the insurer pays a claim. ); In re Stevens, 130 F.3d 1027, 1029 (11 th Cir. 1997) ( The fact that the insurance policy is property of the estate, however, does not necessarily mean that the proceeds from that policy are also property of the estate ); In re Edgeworth, 93 F.2d 51, 55 (5 th Cir. 1993) ( [O]wnership of a policy does not inexorably lead to ownership of the proceeds. ); In re Doug Baity Trucking, Inc., No , 2005 WL , at *4 (Bankr. M.D.N.C. Apr. 21, 2005) ( Owning an insurance policy...is far different from owning the proceeds of that policy. ); In re Air South Airlines, Inc., No W, W, 1999 WL , at *5-*6 (Bankr. D.S.C. Nov. 19, 1999) (court held that simply because debtor was the owner of the insurance policy did not mean that it had an interest in the insurance proceeds). Here, the Policy at issue promises payment of defense costs incurred by the Policy s directors and officers in defending claims potentially falling within the Policy s coverage. U.S. Specialty acknowledges its promise, which it has already agreed to fulfill to Messrs. Goldstone and Simmons. As the Policy s language makes clear, Messrs. Goldstone s and Simmons rights to the defense costs payable under the Policy supersede any rights that TMST owns, as the Named Corporation. Indeed, the Policy specifically addresses these superseding rights in its Priority of Payments clause, in which U.S. Specialty expressly promises that any Defense Costs payable under the Policy as the result of a Claim against any Insured(s) will first be paid to TMST s Officers and Directors under Insuring Agreement (A). Even in the circumstance of a Claim against TMST, the Policy allows U.S. Specialty to withhold payment of any Defense

9 Case Doc 765 Filed 04/20/10 Page 9 of 13 Costs payable to TMST so as to ensure that sufficient amounts remain for Defense Cost payments to the Officers and Directors. Of course, here, there does not exist any Claim against TMST for which TMST is contractually entitled to the payment of Defense Costs. That is, there is no existing Claim that falls within Insuring Agreement (B) because TMST (1) has paid no Loss to or on behalf of [its Officers and Directors] as indemnification or advancement, and because there exist no Securities Claims for which TMST is currently incurring any Defense Costs. See Salzberg Decl. Exh. A, p. 2 of 11. But even were TMST incurring Loss payable under the Policy s Insuring Agreement (B), the above Priority of Payments clause allows U.S. Specialty s payment of such Loss only to the extent that no Loss is payable [to TMST s Officers and Directors] or [ ] the Insurer s obligations [to TMST s Officers and Directors] have been satisfied. Id. Courts dealing with similar D&O policies have recognized that [t]he [corporate entity s] right to receive proceeds, as well as the right of the directors and officers to the payment of defense costs, are subject to the contractual provisions and restrictions of the insurance policy. In re GB Holdings, Inc., No /JHW, 2006 WL , at *3 (Bankr. D.N.J. Sept. 21, 2006); In re First Central Fin. Corp., 238 B.R. 9, (Bankr. E.D.N.Y. 1999) (noting that D&O policies are obtained for the protection of individual directors and officers and indemnification coverage for the corporate entity does not change this fundamental purpose. ). Indeed, this Court, in United States v. Oncology Assoc., P.C., 269 B.R. 139 (Bankr. D. Md. 2001), recognized this principal in refusing to approve a bankruptcy trustee s proposed settlement with a D&O insurer in order to protect the officers and directors rights under the policy. In so holding, this Court concluded: The Insurance Settlement which extinguishes the rights which Colkitt and other officers and directors might have in the policies

10 Case Doc 765 Filed 04/20/10 Page 10 of 13 at issue cannot be approved by the Court. Since rights under the policies may belong to the officers and directors and not to EquiMed, the Trustee was not entitled to bargain away those rights in return for a payment to the estate from the insurers. Id. at 160. The Policy here contains separate insuring agreements with respect to the corporateentity insured and its directors and officers, and, [t]hus, both the bankruptcy estate and the directors and officers may look to the D&O Policy for applicable coverage. GB Holdings, 2006 WL , at *3. However, the Policy here specifically requires a priority of payments first, to the officers and directors and, second (only to the extent the insurer s obligation to the officers and directors has been satisfied), to the corporate insured. And though payment of such defense costs to the officers and directors will reduce the limit of liability available to pay any other insured s potential claims under the Policy, the Policy contemplates such a result and, in any event, that fact alone cannot elevate the trustee s interest in the policy proceeds above the interest of the other insureds, the [ ] directors and officers. Id. at *4 (citing In re Gagnon, 26 B.R. 926, 928 (Bankr. M.D. Pa. 1983) ( [T]he estate s legal and equitable interests in property rise no higher than those of the debtor. )); In re Edgeworth, 993 F.2d 51, (5 th Cir. 1993) ( [W]hen the debtor has no legally cognizable claims to the insurance proceeds, those proceeds are not property of the estate. ); see also In re Pintlar Corp., 124 F.3d 1310, 1311 (9 th Cir. 1997) (holding that the side-a portion of a D&O policy that did not contain direct entity coverage was not property of the estate, such that litigation concerning its scope must be stayed during the debtor s bankruptcy proceedings). This is consistent with the Policy s specific requirement that defense expenses are to be paid to insured directors and officers as they are incurred. Salzberg Decl. Exh. A, p. 7 of 11 (promising to pay covered Defense Costs on an as-incurred basis. ). But even where the

11 Case Doc 765 Filed 04/20/10 Page 11 of 13 precise as-incurred language is not contained within a D&O policy, other courts have required as-incurred defense costs payments to insured directors and officers. For example, the United States District Court for the Southern District of New York reached this conclusion in In re Worldcom, Inc. Securities Litigation Master File, 354 F. Supp. 2d 455 (S.D.N.Y. 2005), also dealing with a D&O policy that contained a duty to pay defense expenses both to the corporateentity insured and its directors and officers (but which did not contain a Priority of Payments clause similar to that contained in the Policy here). The Worldcom court granted a preliminary injunction requiring the advancement of defense costs to the insured officers and directors of Worldcom during the pendency of the proceedings against them, holding that under a D&O policy with a duty to pay defense costs provision, the insurance company s obligation to reimburse the directors attaches as soon as the attorneys fees are incurred. [ ] to hold otherwise would not provide insureds with protection from financial harm that insurance policies are presumed to give. Id., at 465; see also Executive Risk Indemnity, Inc. v. Integral Equity, Inc., No. 3:03-CV-0269, 2004 WL , at *14 (N.D. Tex. March 10, 2004) (acknowledging that an insured incurs liability upon receipt of a bill for legal fees, thus triggering the right to immediate disbursement from the policy). For these reasons, Messrs. Goldstone and Simmons respectfully request that this Court confirm that the Policy proceeds to which they are contractually entitled as Defense Costs do not constitute bankruptcy estate assets, and to further confirm that U.S. Specialty s payment of Messrs. Goldstone s and Simmons defense costs incurred in defending the various Claims asserted against them will not violate the automatic stay in place in connection with TMST s bankruptcy proceedings

12 Case Doc 765 Filed 04/20/10 Page 12 of 13 B. Even were the Policy proceeds to somehow constitute property of the bankruptcy estate, a lift of the automatic stay is proper in order to allow payment of Defense Costs to Messrs. Goldstone and Simmons. Where, as here, an insurance policy explicitly provides for payment of defense costs first to the insured directors and officers, and then (and only to the extent any policy proceeds remain after the insurer s obligations to those directors and officers have been fulfilled), to the corporate insured, such policy s proceeds do not constitute part of the bankruptcy estate. But even were this Court to conclude otherwise, [i]t is not uncommon for courts to grant stay relief to allow payment of defense costs or settlement costs to directors and officers, especially when there is no evidence that the direct coverage of the debtor will be necessary. In re Allied Digital Techs. Corp., 306 B.R. 505, 509 (D. Del. 2004) (quoting In re Vitek, Inc., 51 F.3d 530, 533 (5 th Cir. 1995)); see also In re Laminate Kingdom, LLC, 2008 WL (Bankr. S. D. Fla. March 13, 2008) (granting relief from stay in order to permit insurer to advance defense costs to insured directors and officers); In re Boston Reg l Med. Ctr. Inc., 285 B.R. 87 (Bankr. D. Mass 2002) (same); In re CyberMedica, Inc., 280 B.R. 12, (Bankr. D. Mass. 2002) (granting relief from stay because directors and officers would suffer irreparable harm if prevented from exercising their rights to defense payments under D&O policy). The Bankruptcy Court for the Southern District of New York has even gone so far as to warn that bankruptcy courts should be wary of impairing the contractual rights of directors and officers where the policies provide entity coverage. In re Adelphia Comm. Corp., 285 B.R. 580, 598 (Bankr. S.D.N.Y. 2002). To the extent any claims have been or are brought against TMST or any of its subsidiaries, those claims are stayed by operation of 11 U.S.C. 362(a) and are likely to be discharged by operation of the terms of a reorganization or liquidation plan. As such, there is no evidence that TMST or any of its insured subsidiaries will incur Loss payable under the Policy

13 Case Doc 765 Filed 04/20/10 Page 13 of 13 Thus, [t]he automatic stay, to the extent applicable, therefore should be modified to permit the payment of [Messrs. Goldstone s and Simmons ] Defense Costs. In re RC Liquidating Co., No C-11, 2007 WL , at *2 (Bankr. M.D.N.C. Jan. 31, 2007); In re Arter & Hadden, L.L.P., 335 B.R. 666, 674 (Bankr. N.D. Ohio 2005). III. CONCLUSION For the foregoing reasons, Messrs. Goldstone and Simmons respectively request that this Court issue an Order allowing U.S. Specialty to pay the Defense Costs, both already incurred, and to be incurred in the future, arising from or related to the Covered Claims to which they are contractually entitled under the Policy. In the alternative, to the extent the automatic stay is applicable, Messrs. Goldstone and Simmons request such stay be modified to permit the payment of their Defense Costs, both already incurred, and to be incurred in the future, arising from or related to the Covered Claims to which they are contractually entitled under the Policy. Dated: April 20, 2010 Respectfully Submitted, /s/ Samuel Rosenthal, Esquire. Samuel Rosenthal (6170) Mark A. Salzberg (pro hac vice) PATTON BOGGS LLP 2550 M Street, NW Washington, DC Telephone No.: (202) Facsimile No.: (202) srosenthal@pattonboggs.com Counsel for SAF Financial, Inc., Larry A. Goldstone and Clarence G. Simmons, III