Transcript Slide 1

Issues for Directors, Officers
and their Attorneys
By: Kitt Turner
I. Selection of Appropriate D & O
Insurance and Policy Language
Issues that May Affect the
Availability of Coverage
Types of D&O Coverage
 Side
A Coverage
 provides coverage for defense costs and
liability payments to directors and officers
(for both judgments and settlements) for
any wrongful acts when the company
cannot indemnify them
 when obtaining Side A coverage, insureds
may wish to negotiate for a provision
whereby the insurer would pay any costs
that the company is obligated to pay, but
does not pay
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It is beneficial for a company to negotiate nonrescindable Side A excess coverage. This would
cover directors and officers when the underlying
policy is rescinded, exhausted or does not cover
a certain claim and, since none of the proceeds
are paid to the company, it is not effected by
the company declaring bankruptcy
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Side A coverage typically does not have a
deductible associated with it
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 Side
B Coverage
 coverage
for company’s own expenses
incurred when indemnifying those
covered by the policy when the company
is either required or permitted to
indemnify under state law and as per the
company by-laws
 usually a deductible/retention applies to
claims made under Side B coverage
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Side C Coverage
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otherwise known as entity coverage as it
protects the company itself against its wrongful
acts
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can either be broad or narrow to cover only
certain kinds of claims, most commonly
securities or employment claims
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usually a deductible/retention applies to claims
made under Side C coverage
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Key Language of D&O Policies That
May Affect Coverage
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Prior and Pending Exclusion
this language means that the policy will exclude
coverage for demands, suits etc against the
insured that were begun prior to the date set
forth in the declarations of the policy
 this exclusion precludes coverage when a claim
is made during the policy period that is either
“based upon or arises from the same or any
substantially similar fact, circumstance or
situation underlying or alleged therein.”
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Insured vs. Insured Exclusion
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this language means that coverage is not allowed on actions
brought by or on behalf of an insured
this language should be narrowed so that it does not include
actions brought by a bankruptcy trustee, examiners, liquidators or
receivers, creditors of the bankrupt estate or a trustee or trust that
has been established for the benefit of the creditors
this language should be qualified so that defense costs coverage is
preserved
this language should be narrowed so that it does not apply to suits
brought after a change in control
this language should be narrowed by adding an exception to this
exclusion “to the extent that an Insured Person is a member of a
class alleging Loss”
this language should be narrowed so that it does not apply to
claims by former directors or officers who have not served in such
capacity for at least a few years
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Deliberate Fraud Exclusion
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exclusion for liability arising from an insured’s fraud or
dishonesty
exclusion only applies after there has been a final
judicial determination that the individual committed an
intentional wrongdoing, and, therefore, the insurer must
still provide defense costs until this judicial
determination is made
since these cases are often settled and thus there is no
final adjudication, the insurer is required to fund a
reasonable settlement
Insurers are now revising language in their D&O policies
so that the exclusion is not only limited to when there
has been a final adjudication of wrongdoing, so insureds
must read the policy language carefully to see whether
this limitation is included
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Accounting of Profits Exclusion
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Side A coverage typically does not apply to
claims that seek an accounting of profits from
the sale of securities; however, it is preferable
for the policy to still include defense costs for
such claims, and this can be done by limiting
this exclusion to “Loss (other than Defense
Costs)”
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This exclusion is typically written to apply to
losses “on account of” a claim for accounting,
but it is preferable, instead, to limit this
exclusion “to the extent of” the accounting
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Personal Profit Exclusion
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D&O policies typically will not cover losses resulting from
an insured gaining personal profit to which she is not
legally entitled
it is important for insureds to read the relevant policy
language carefully. If “such” or a similar word is before the
phrase “directors or officers gaining in fact any personal
profit, advantage or remuneration to which they were not
legally entitled”, then this exclusion applies to only that
individual who received the profit. However, if “such” is
not included, then the exclusion may apply to all insureds,
regardless of whether they profited.
Typically the personal profit exclusion will apply to
settlements and a judicial determination of personal gain is
not required. Therefore, to minimize the exclusion,
companies should seek to include a “final adjudication”
modification so that the exclusion only applies to situations
where there is a final adjudication of illegal personal profit.
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Presumptive Indemnification
The Presumptive Indemnification provision
assumes that the company will indemnify the
directors and officers where permitted to do so.
As such, the provision prevents the company
from refusing to indemnify, and therefore
manipulating the deductible by forcing the
insurer to pay for what would normally be
within the deductible.
 directors and officers should seek to exclude
this provision from their policy so that the
insurer would be obligated to indemnify the
directors and officers if the company fails to do
so, and then the insurer itself would be able to
pursue a claim against the company
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Settlement
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D&O policies typically provide that the insured cannot
settle a claim before first obtaining insurer’s consent
insureds should narrow this so that the insurer’s
consent to a settlement cannot be “unreasonably
withheld”
Some D&O policies contain a provision that if an insured
does not agree to a settlement that is proposed by the
insurer, then the insurer will not be liable for any
amount above that proposed settlement amount
this provision is known as the “hammer clause” because
it allows the insurer to force a settlement
companies should try to delete this provision from their
D&O policies or at least limit the application to only
when the insured was unreasonable in not consenting
to the settlement
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Defense
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D&O policies generally do not specifically state that the insurer
must pay the defense costs of the insureds. Instead, policies
typically say that the insurer is obligated to pay all losses that the
insured is obligated to pay, and this includes attorneys’ fees for
defending against a legal action
Insurers generally agree to pay defense costs as they are incurred,
however some include a provision in their policies whereby they
will not be obligated to pay defense costs until after the underlying
litigation is concluded. Therefore, insureds should read the policy
carefully to ensure that defense costs will be paid in a timely
manner
Some D&O policies require that the directors and officers use preapproved counsel. Therefore, a company should seek to make sure
that its preferred counsel is on the approved counsel list at the
outset of the policy negotiations, so that this is not a fight down
the road
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 Allocation
of Loss
 most
D&O policies have an allocation
provision whereby there is a preset
allocation of benefits between covered
and uncovered claims and covered and
uncovered persons, the result of which is
a form of co-insurance
 for example, some provisions provide that
the insurer will pay 75% of defense costs
and the insured will pay 25% of such
costs
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Severability/Rescission
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to protect innocent insureds, a D&O policy should have a severability clause
applicable to representations made in the process of applying for D&O insurance
process. This way, protection is preserved for those innocent insureds and the
insurer cannot rescind the policy as to these insureds
there are different kinds of severability clauses
Full severability clause means that the application for insurance is deemed a
separate application for each insured and that the knowledge of one insureds is not
imputed to another insured
Limited severability clause means that the knowledge of the person signing the
application, or the knowledge of certain officers, is imputed to all insureds and can
provide cause to rescind the policy. However, knowledge of other insureds are not
imputed.
A company should negotiate for express policy language that specifically details the
only situations where rescission is possible
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for example, some policies state that Side A coverage is not rescindable at all
another possibility is stating that Side A coverage can be rescinded but only as to those
individuals who knew of the misstatements in the application
yet another possibility is allowing for full severability for insureds for Side A coverage, but
no severability for the company. Under this scenario, an insured’s knowledge can be
imputed to the company and rescission would be possible under Side B and C coverage
Companies must be aware of any statutes and state case law regarding rescission.
Policy language that makes rescission more difficult that set forth in a statute will be
enforceable; however, language that makes rescission less difficult than the statute
will likely not be enforced.
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Claim
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definition of “claim” is extremely important as it defines
the policy – the broader the definition of “claim” is, the
broader the insurance coverage will be
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most policies have a definition of “claim” that includes “written
demand for money” and a “civil proceeding”
A broader definition will include the following: (1) lawsuits; (2)
written or verbal demands for either monetary or non-monetary
relief; and (3) administrative, arbitration, criminal or investigative
proceedings
most insurers have a provision whereby the insured must
notify the insurer of a claim within a certain time period,
usually “as soon as practicable” or between 30-90 day
post-policy period
insureds must be sure to monitor for potential claims
since D&O policies typically require an insured to provide
the insurer with “circumstances likely to give rise to a
claim or potential claim”
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Damages and Loss
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D&O policies provide coverage for losses
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“Loss” is typically defined as including damages, judgments,
settlements and defense costs
Some D&O policies limit covered defense costs to “reasonable” costs.
Insureds should negotiate with the insurer for the inclusion of
language that specifies what “reasonable” is, for example “all costs
incurred pursuant to a written budget from counsel and which do not
vary by more than 15 percent of these costs are deemed reasonable”
or “all costs incurred consistent with the company’s litigation guidelines
are deemed reasonable”
Insureds should also seek to have the definition of “defense costs”
include the cost of counsel that is retained to advise an individual
insured in connection with a claim
Insureds may not be a specific target of an investigation but may still
wish to retain counsel, and insureds should seek to have this cost be
included in the definition of “defense costs”
D&O policies generally will carve out certain damages that will not
be covered under the policy. These typically include certain fines,
punitive damages, multiplied damages, and damages that are
uninsurable under law
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 Order
of Payments
a
way to ensure that the policy limit isn’t
exhausted by payments to the
corporation under Side C coverage is to
include a provision in the policy that Side
A coverage is paid before Side B and C
coverage
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Definition of “Insured”
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should be broad enough to include general
counsel, as well as all appropriate employees
and subsidiaries or other related companies.
This is important to ensure that there are no
gaps in coverage when a company acquires
another company or merges with another
company
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should be an exception for innocent insureds
such that coverage will not be defeated as to
these innocent insureds in cases of fraud or
dishonesty
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 Definition
of “wrongful acts”
 D&O
policies cover wrongful acts, but
different policies define what a wrongful
act is differently, so this language must be
read very carefully
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Criminal Indictment/Subpoena
Since the typical D&O policy only covers claims,
and not costs associated with pre-claim
expenses, insureds may wish to determine the
cost for obtaining additional coverage that will
cover such costs, including those costs incurred
when responding to government subpoenas
 The typical D&O policy does not cover the
defense costs associated with defending a
criminal case; however, some policies do include
coverage for criminal matters. Insureds should
read the policy language carefully to determine
whether their policy does include such costs,
and, if not, what such additional coverage
would cost
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Miscellaneous Coverage Issues
Under a D&O Policy
when a claim is asserted against a covered
person or the company during the policy
period, the coverage is triggered
 all claims related to one factual situation are
typically (1) subject to one policy limit and
(2) assigned to that policy period in which
the first in the series of such claims is
asserted
 there typically is a single policy limit for Side
A and B coverage for all insureds
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D&O Policies usually afford the ability to lock in
coverage before claims are made against the
policy when circumstances that will give rise to
claims arise during the policy period and the
insured provides a special form of notice to the
insurer during that policy period. If such notice is
given, then all claims subsequently asserted will
be deemed asserted during the policy period. In
this case, any policy that would otherwise cover
these claims exclude coverage for these claims.
Most D&O policies are “wasting policies”, which
means that defenses costs reduce the amount of
money available for coverage
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If the company goes into bankruptcy, the
bankruptcy trustee may treat the policy as
property of the estate if the policy provides
entity coverage (Side C Coverage)
 D&O policies are typically a claims made
policy – the policy only covers claims made
against the insured during the policy period.
The policy specifies a retroactive date, and
all claims based on acts occurring prior to
the retroactive date are excluded.
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II. Fiduciary Duty of Officers
and Directors
Typical duties
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Care
Loyalty
Good faith (application of this undefined/vague duty
questioned by the recent Delaware Supreme Court Disney
decision)/fair dealing
Not owed to creditors
Business Judgment Rule will typically cover acts
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informed decision
reasonable effort to inform itself of relevant facts
D or O reasonably believed act was in the best interests
Disinterestedness
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Zone of Insolvency / Insolvency
 Definition
 Tests
for insolvency:
 Balance
 Cash
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Sheet
Flow / equity
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Zone of Insolvency / Insolvency
 Duties
shift to include creditors
 Reasoning
for shift
 Split
between whether in “zone” there is a
shared duty to creditors and shareholders
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Zone of Insolvency / Insolvency
 D&O
responsibilities
 Maximize
corporations long term wealth
creating capacity (easier said than done!)
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Zone of Insolvency / Insolvency
 Business
Judgment Rule (“BJR”) takes
on higher scrutiny
 Some
courts do not permit use of BJR
when corporation is in the zone.
 “Entire Fairness” often applied
 Courts may apply hindsight view
 Best to assume you will be found in the
zone of insolvency and act accordingly
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Protecting Directors and Officers
When Corporation is Insolvent or
in the Zone; Checklist for
Directors and Officers
Determine the Potential
Insolvency of the Corporation
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Review corporate ratios and competition ratios.
Investigate and assess the value of the
corporation’s assets (including deferred assets).
Investigate and assess the corporation’s
contingent and off balance sheet liabilities.
Retain professionals to value assets.
Compare the corporation’s business plan
projections and assumptions, historical
performance, the expected performance of
competitors, and industry trends.
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Review the business. Know the current
conditions and external competitive factors that
will impact its operations and financial
performance.
Review current market conditions affecting the
corporation’s sources of funding (including
equity markets, debt markets, and interest
rates).
Test the sensitivity of the corporation’s financial
projections with respect to revenue variations,
margin variations, and interest rate changes.
Determine the corporation’s liquidity and free
cash flow levels under the projection scenarios.
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 Evaluate
covenant compliance
under the projection scenarios.
 Evaluate the equity cushion
available to the company under
each of the projection scenarios.
 Evaluate the safety margin of the
cash flows under each projection
scenario.
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Comply with Fiduciary Duties
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If the corporation is in the vicinity or zone of
insolvency, evaluate whether corporate decisions
benefit the corporation, its shareholders, and/or
creditors. The analysis must ensure that the
decision maximizes the valuation of the
corporation.
Make sure that directors and officers possess all
material information relating to each business
decision.
Evaluate the impact of the business decision on
the corporation’s stakeholders.
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Board may wish to create or farm issues to
subcommittees for review, along with the
advice of qualified experts inside and
outside of the corporation.
 Maintain very detailed minutes of each
board meeting, which describes everything
that the board considered before making its
decision
 Maintain detailed written reports and
memoranda regarding the materials
reviewed and discussed in connection with a
business decision.
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 Review
and apply any applicable legal
“safe harbor” provisions.
 Limit or avoid transactions with insiders
and other conflicts of interest.
 Avoid preferential treatment of
insiders, and do not accept personal
benefits for supporting or opposing a
particular transaction.
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Minimize Liability Arising From
Corporate Transactions
 Ensure
that any insider transactions
are fair to the corporation.
 Adhere to regulations concerning the
payment of dividends and regarding
stock redemptions.
 Avoid transfers by the corporation that
may be seen as an attempt to hinder,
delay, or defraud creditors. View such
transfers from the outside looking in.
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 Avoid
transfers by the corporation
where it does not receive reasonably
equivalent value in exchange
 Establish and document a record for
the decisions underlying these
transactions including the fairness of
the transaction. Remember that all
decisions will be reviewed in hindsight
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Avoid Personal Liability Resulting
From the Corporation’s Violation of
Law
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Ensure that the corporation continues to pay all
taxes as they come due.
Ensure that the corporation continues to comply with
environmental laws and regulations.
Ensure that the corporation continues to comply with
labor and employment statutes and regulations,
including ERISA an the Fair Labor Standards Act
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Protect D&O Insurance Coverage in
the Event of the Corporation’s
Bankruptcy
 Review
and understand the corporation’s
D&O insurance policies to ensure that
directors and officers are covered if the
corporation files for bankruptcy. Consult
experts if necessary. Review alternatives
and D&O insurance.
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III. Leading Issues in D & O
Litigation
Deepening Insolvency
 Certain
courts have addressed whether
deepening insolvency is a valid cause
of action and/or a valid theory of
damages for negligence. Courts have
been tackling this issue recently, and
there is currently a split in courts. A
sampling of the cases is below.
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Pennsylvania
Official Committee of Unsecured Creditors v. R.F. Lafferty & Co., Inc., 267 F.3d 340 (3d Cir. 2001)
First case in which the Third Circuit recognized the independent tort of deepening insolvency and
predicted that the Pennsylvania Supreme Court would adopt this cause of action
The Third Circuit based this finding on the following: “First and foremost, the theory is essentially
sound. Under federal bankruptcy law, insolvency is a financial condition in which a corporation's debts
exceed the fair market value of its assets. 11 U.S.C. § 101(32). Even when a corporation is insolvent,
its corporate property may have value. The fraudulent and concealed incurrence of debt can damage
that value in several ways. For example, to the extent that bankruptcy is not already a certainty, the
incurrence of debt can force an insolvent corporation into bankruptcy, thus inflicting legal and
administrative costs on the corporation. See Richard A. Brealey & Stewart C. Myers, Principles of
Corporate Finance 487 (5th ed. 1996) ("By issuing risky debt, [a corporation] gives lawyers and the
court system a claim on the firm if it defaults."). . . . Aside from causing actual bankruptcy, deepening
insolvency can undermine a corporation's relationships with its customers, suppliers, and employees.
The very threat of bankruptcy, brought about through fraudulent debt, can shake the confidence of
parties dealing with the corporation, calling into question its ability to perform, thereby damaging the
corporation's assets, the value of which often depends on the performance of other parties. See
Michael S. Knoll, Taxing Prometheus: How the Corporate Interest Deduction Discourages Innovation
and Risk-Taking, 38 Vill. L. Rev. 1461, 1479-80 (1993). In addition, prolonging an insolvent
corporation's life through bad debt may simply cause the dissipation of corporate assets.” Id. at 34950.
Third Circuit recognized that in pari delicto is a defense to a deepening insolvency claim such that the
action of Lafferty in fraudulently increasing the debt of the corporation barred the Committee (in the
shoes of the debtor) from seeking damages from Lafferty. Id. at 360
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Seitz v. Detweiler, Hershey and Assocs., P.C. (In re Citx Corp.,Inc.), 448 F.3d 672 (3d Cir. 2006)
Trustee brought claim against the debtor’s accounting firm for, among other things, deepening
insolvency See id. at 674.
Most recent Third Circuit case on deepening insolvency
District Court granted summary judgment in favor the accountants and dismissed the claims See id.
Third Circuit affirmed. See id.
In so affirming, the Third Circuit addressed three issues: (1) is deepening insolvency a viable theory
of damages for negligence; (2) is negligence sufficient to support a deepening insolvency cause of
action and (3) can deepening insolvency be a cause of action under 11 U.S.C. § 544, or 11 U.S.C. §
541
As to (1), the Third Circuit cited to its prior decision on deepening insolvency (Lafferty), in holding
that deepening insolvency is not a viable theory of damages for negligence:
“Although we did describe deepening insolvency as a ‘type of injury,’ and a ‘theory of injury,’ we never
held that it was a valid theory of damages for an independent cause of action. Those statements in
Lafferty were in the context of a deepening insolvency cause of action. They should not be
interpreted to create a novel theory of damages for an independent cause of action like malpractice.”
Id. at 677.
As to (2), the Third Circuit noted that Lafferty “holds only that fraudulent conduct will suffice to
support a deepening insolvency claim under Pennsylvania law” and ultimately held that “[w]e know
no reason to extend the scope of deepening insolvency beyond Lafferty’s limited holding. To that
end, we hold that a claim of negligence cannot sustain a deepening insolvency cause of action.” Id. at
681.
As to (3), the Third Circuit held that deepening insolvency cannot be brought under section 544:
“Because deepening insolvency claims are brought on behalf of the debtor corporation, deepening
insolvency can only be a claim under Bankruptcy Code § 541 (which deals with property of the
debtor’s estate).” Id. at 676 n. 6. In so finding, the Third Circuit clarified that the cause of action of
deepening insolvency does not belong to the creditors of the company.
Third Circuit is clear that its Lafferty opinion is only applicable to Pennsylvania cases . See id. at 680
n. 11
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Delaware/New Jersey
In Re: LTV Steel Co. Inc., 333 B.R. 397 (Bankr. N.D. Ohio
2005)
The Administrative Claimants Committee (ACC) brought a
motion seeking authorization to bring suit against LTV Steel
Company’s officers and directors for deepening insolvency.
The court granted the motion, stating that Delaware or
New Jersey law would apply, and, therefore, Lafferty is
controlling.
The court defined deepening insolvency to be “where the
defendants conduct, either fraudulently or even
negligently, prolongs the life of a corporation thereby
increasing the corporation’s debt and exposure to
creditors.” Id. at 421.
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Washington DC
Alberts v. Tuft (In re Greater Southeast Community Hosp.
Corp., 333 B.R. 506 (Bankr. D.D.C. 2005)
Court does not recognize deepening insolvency as an
individual cause of action
Court recognizing that deepening a corporation’s
insolvency is harmful; however, the Court notes that
“recognizing that a condition is harmful and calling it a tort
are two different things. The District of Columbia courts
have not yet recognized a cause of action for deepening
insolvency, and this court sees no reason why they should.”
Id. at 517.
Court dismissed deepening insolvency claims on the basis
that they were a mere “repackaging” of the breach of
fiduciary claims with respect to D & O defendants and
malpractice claims with respect to attorneys. Id. at 517.
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Louisiana
Hannover Corp. of America v. Beckner, 211 B.R. 849 (M.D. La 1997)
A suit was filed by a debtor corporation’s receiver against an attorney, who
represented the corporation in a suit by the SEC, asserting malpractice and
negligence claims for increasing the insolvency of the corporation. Id. at 854.
The attorney/defendant filed a motion for dismissal stating that the
corporation lacked standing to bring such an action via the doctrine of in pari
delicto. Id. at 852.
The court rejected the motion and found that there was standing. Id. at 860.
The court established that there was a distinct injury to the corporation
resulting from the malpractice, specifically the “aggravation of insolvency and
artificial extension of [the debtor corporation's] life.” Id. at 854.
The court further noted that a receiver “was not bound by the formers
corporate officers’ or directors’ fraud” making any in pari delicto claim against
granting standing moot. Id. at 858 n. 10 (internal citation omitted).
Although the terminology of deepening insolvency was not used in this
opinion, the court noted that in pari delicto may be an affirmative defense to a
deepening insolvency claim. Id. at 859.
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Indiana
Marwil v. Grubbs, 2004 U.S. Dist. Lexis 20250 (S.D. Ind. 2004)
The receiver of a church corporation brought a breach of fiduciary duty
claim against the officers and directors of the corporation. Id. at 4. The
directors and officers filed Fed. Rule of Civ. Proc. 12(b)(1) and 12(b)(6)
motions claiming lack of subject matter jurisdiction and failure to state
a motion upon which relief can be granted. Id. at 5.
The court, relying on Schaht v. Brown, 711 F.2d 1343 (7th Cir. 1983),
found that Marwil’s claim for “exacerbate[ing] [the] corporations
insolvency and artificially prolong[ing] its life” was “actionable.” Id.
The directors and officers asserted that the “business judgment rule”
shielded them from liability. Id. at 24. However, the court noted that
the business judgment rule only shields officers and directors when
their decisions are informed ones. Id. The court found that the
complaint properly alleged that the officers and directors were not
familiar with the recommendations made to them by their accounts
and attorneys and thus did not dismiss this claim. Id.
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Arkansas
Robertson v. White, 633 F. Supp. 954 (W.D. of Ark. 1986).
The trustee and noteholders of a bankrupt corporation filed suit
against the former director and officers of the corporation under a
variety of theories including “wrongfully prolonging operations of the
[corporation] and misleading government authorities.” Id. at 969.
The officers and directors filed a Fed. Rule Civ. Proc. 12(b)(6) motion
to dismiss, which a magistrate judge had dismissed, the court here
heard an appeal on the motion. Id. at 958.
The court citing Schacht v. Brown, 711 F.2d 1343 (7th Cir.), allowed the
claim to go forward on behalf of the noteholders because: “[t]he
operation of a corporation beyond the point of its insolvency works a
fraud upon creditors and investors, at least to the extent that they
have been misinformed as to the true status of the corporation’s
affairs.” Id. at 969. The court also allowed the trustee on behalf of the
corporation to maintain this claim. Id. at 970.
August 10, 2006
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





Texas
In re Vartec Telecom, Inc., 335 B.R. 631 (Bankr. N.D. Tex. 2005)
Court addressed question of “whether ‘deepening insolvency’ may be plead as
a separate cause of action or whether it is treated only as a breach of a
separate duty under state tort law or as a theory of damages.” Id. at 633.
After noting that other courts have recognized deepening insolvency as a
separate cause of action, the Court noted that “[t]he words ‘deepening
insolvency’ are neither contained in the Bankruptcy Code, nor do they arise
from other federal law, so the courts that consider the theory of ‘deepening
insolvency’ to be an actionable tort do so by predicting how their respective
state courts would rule when adopting a new cause of action.” Id. at 638.
As such, the Court looked to Texas state law, and concluded that the Texas
Supreme Court would not recognize deepening insolvency as a separate tort
“because the injury caused by the deepening of a corporation’s insolvency is
substantially duplicated by torts already established in Texas.” Id. at 644.
The Court further noted that “as the case law in this area has shown, for a
plaintiff to assert a valid claim for damages under a theory of ‘deepening
insolvency’ the plaintiff must show that the defendant has committed some
other tort.” Id.
August 10, 2006
52

Tennessee

In re Del-Met Corp., 322 B.R. 781 (Bankr. M.D. Tenn. 2005)

Court addressed whether Tennessee Supreme Court would
recognize a tort of deepening insolvency and concluded
that “if presented with compelling facts, the Tennessee
Supreme Court would recognize deepening insolvency as
an actionable breach of duty to a corporation.” Id. at 815.
August 10, 2006
53
Aiding and Abetting Fraud


Stanziale v. Pepper Hamilton LLP (In re Student
Finance Corp.), 335 B.R. 539 (D. Del. 2005)
Court discussed whether Pennsylvania Supreme
Court would recognize tort of aiding and abetting
a breach of fiduciary duty and concluded that
“there is an insufficient basis to conclude that the
Pennsylvania Supreme Court would decide that
aiding and abetting breach of fiduciary duty is a
valid cause of action under Pennsylvania law.” Id.
at 551.
August 10, 2006
54



In re Del-Met Corp., 322 B.R. 781 (Bankr. M.D.
Tenn. 2005)
Court noted that New York, Delaware and
Tennessee all recognize the cause of action of
aiding and abetting a breach of fiduciary duty
Court stated the elements of such a cause of
action: “‘a showing that there (1) existed a
fiduciary relationship, (2) was a breach of the
fiduciary’s duty, (3) was a knowing participation
[sic] in the breach by a defendant who is not a
fiduciary and (4) that damages are proximately
caused by the breach.’” Id. at 816.
August 10, 2006
55
In re Scott Acquisition Corp., 2006 Bankr.
LEXIS 1123 (Bankr. D. Del. June 23,
2006)
 Trustee brought an action against the
former officers and directors of the debtor
alleging, among other things, that each
aided and abetted each others breach of
fiduciary duties. The Court concluded that
the Trustee had provided sufficient basis for
its action, such that it denied the
defendants’ motion to dismiss.

August 10, 2006
56
Counsel’s Exposure




Courts have held that a cause of action of deepening
insolvency can be brought against counsel for the
company.
Lafferty - Plaintiff asserted deepening insolvency claim
against counsel to the debtor
Hannover - The court established that there was a distinct
injury to the corporation resulting from the malpractice,
specifically the “aggravation of insolvency and artificial
extension of [the debtor corporation's] life.” that can be
asserted against the attorney. Id. at 854.
Del Met - “The action [of deepening insolvency] has
morphed both in form – from a breach of statutory duty
claim to a form of common law tort liability – and in scope
– now reaching lawyers . . .” Id. at 812.
August 10, 2006
57
IV: Treatment D&O Insurance
in Bankruptcy
Policies vs. Proceeds
 Most
courts find these to be severable
concepts
August 10, 2006
59
Policies
 Usually
estate
found to be property of the
 Broad
definition of section 541 includes
policy interests
August 10, 2006
60
Proceeds
 More
complex and divided question.
Typically arises in two arenas:
 Whether
D&Os may be advanced defense
costs or other payments
 Are
policy proceeds property of the estate
and therefore subject to the automatic stay
August 10, 2006
61
Advancement of Defense Fees/Costs
to Directors and Officers


Safest route for insurer is to bring a motion (or
require that the parties wishing to be paid bring a
motion) before the Bankruptcy Court before
issuing any payment.
Potentially objecting parties are: bankruptcy
trustees, creditors and/or creditors committees,
shareholder plaintiffs. Basically arguing proceeds
are property of the estate since payment of
defense costs typically drain the overall recovery
pool under the policy.
August 10, 2006
62
Argument for proceeds being
property of the estate
 Expansive
 Debtor
claims
 Policy
August 10, 2006
view of 541
has made indemnification
provides entity coverage
63
Argument against proceeds being
property of the estate
 Not
property where there was no
advancement of funds by the estate
due to indemnification obligations in
company’s charter or bylaws (the
argument that it may become a
reimbursement due to the estate is too
premature and tenuous)
August 10, 2006
64
Other ways to get D&O defense
costs paid
 priority
of payment provision
 even
where entity coverage - limited
relief from stay for D&O costs where
contract provided advancement of
defense costs.
August 10, 2006
65
Will insurance protect D&Os and pay
D&O coverage and defense costs
post-petition
 Insured
vs. Insured problem. Typically
this exclusion from coverage exists in
most D&O policies. The exclusion bars
coverage for claims brought by or
brought by or on behalf of one insured
against another insured.
August 10, 2006
66
Does Debtor, Trustee or Committee
amount to an insured?
Argued to be standing in the shoes of the
pre-petition debtor, who is an insured along
with the directors and officers.
 Catch-22; arguably these parties are the
only parties with standing and/or knowledge
to bring these actions.
 Trustees and Committees argue that prepetition debtor and Trustee/Committee are
legally separate entities and the insured vs.
insured exclusion is not implicated.

August 10, 2006
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Application of the Automatic Stay
 Section
362 prohibits actions against
the debtor or the debtor’s property,
however it does not typically extend to
actions against the debtor’s officers or
directors. Often, actions against a
debtor and its directors and officers as
joint defendants will be stayed only as
to the debtor itself.
August 10, 2006
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Application of the Automatic Stay

Unusual circumstances may extend the
automatic stay such as where there is an
undisputed absolute indemnity provided by
the company to the director or officer.
However, even in that circumstance, most
courts treat such an indemnity as a claim
held by the director/officer against the
estate, not a shield from pending actions.
August 10, 2006
69
Application of the Automatic Stay
 As
noted above, those courts which
hold the proceeds are not property of
the estate are far more apt to find that
the automatic stay applies.
August 10, 2006
70
Rescission

the bad acts that often lead to a company
having to file bankruptcy often times include
misrepresentations that the company made
to the insurer in order to procure insurance.
The filing of bankruptcy shines a light on
these misrepresentations. The issue then
becomes, do the misrepresentations made
by the company provide sufficient basis for
the insurer to rescind the insurance policy,
thus leaving the debtor without insurance.
August 10, 2006
71