D&O Insurance in Bankruptcy: Just Another Business Contract

Introduction In July 2008, bankruptcy courts across the nation prepared themselves for a busy season.1 As many as 5,664 companies sought to liquidate or restructure that month alone, a 57% increase from the prior year.2 Just two months later, the largest corporate bankruptcy yet hit the world financial markets hard and swept away the lifetime investments of millions of businesses and individuals. The Lehman Brothers Chapter 11 bankruptcy case is valued at an astonishing $6.9 billion,3 nearly matching the GDP of the Republic of Chad, and exceeding the GDPs of approximately sixty-one other countries.4 When the company's CFO, Richard S. Fuld Jr., stood before a Congressional panel on October 6, 2008, a Representative of Florida made the $700 billion statement: "People want to know if you defrauded investors."5 Fraud, greed, and deception are common accusations with which investors stone the directors and officers ("D&Os") of failed corporations. After all, they were the ones who had run their companies into the ground, so should they not also bear the responsibility? This Note looks behind the shield of D&O insurance and examines its treatment under the Bankruptcy Code (the "Code"). Part I provides an overview of the duties of directors and officers of a corporation, as well as the protections they receive under the business judgment rule and indemnification contracts. Part II explains the three different "sides" of D&O insurance policies. Part III discusses basic bankruptcy concepts including directors' and officers' duties in bankruptcy, automatic stay, and property of the estate provisions of the Code, as well as the treatment of contracts in bankruptcy. Part IV examines how bankruptcy law treats directors and officers, with a particular focus on the classification of D&O insurance policies and proceeds as property of the bankruptcy estate. Part V argues that D&O insurance should be treated as a business contract, the terms of which should not change the distribution scheme in bankruptcy, and that D&O insurance policies and proceeds should be included in the bankruptcy estate for the benefit of the creditors. This approach would not undermine the protections afforded directors and officers, who must feel comfortable taking business risks, because the business judgment rule will still afford them the necessary protections. I. DIRECTORS AND OFFICERS: THEIR DUDES AND PROTECTIONS The Duties of Directors and Officers Directors and officers owe fiduciary duties of due care, good faith and loyalty6 to me corporations tiiey serve7 as well as to the shareholders of those corporations.8 The duty of care requires directors and officers to conduct themselves as ordinary prudent persons would in similar situations.9 The duty of good faim requires directors and officers to act "in the honest belief that the action taken was in the best interests of the company."10 The duty of loyalty calls upon directors and officers to avoid conduct that may injure the corporation or its shareholders.11 Furthermore, it prohibits directors and officers from engaging in conduct mat is solely in the interests of the directors or officers or omer third parties.12 In addition to these duties, mere is also a duty of disclosure, which requires mat the corporation "disclose fully and fairly all material information within the board's control . . . ."'3 The Business Judgment Rule To determine whether directors and officers have satisfied their duties, courts apply the business judgment rule, which is a "presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faim and in the honest belief mat the action taken was in the best interests of the company."14 It is the shareholders' burden to rebut mis presumption when they challenge a decision made by the board of directors. 15 The shareholders must provide evidence that the directors breached "any one of the triads of their fiduciary duty good faith, loyalty or due care. …