In the recent decision of Indian Harbor Ins. Co. v. Zucker, 860 F.3d 373 (6th Cir. 2017), the Sixth Circuit Court of Appeals held that a liquidation trustee’s suit against the debtor’s former directors and officers (D&Os) falls within the “insured-versus-insured” exclusion in the debtor’s liability insurance policy.
The liquidation trustee sued the D&Os for $18.8 million, alleging breach of fiduciary duties. The insurance company filed a suit for a declaratory judgment that it had no obligation to cover any damages from the lawsuit because the trustee’s claims fell within on the “insured-versus-insured” exclusion, which excluded from coverage “any claim made against an Insured Person . . . by, on behalf of, or in the name or right of, the Company or any Insured Person,” except for derivative suits by independent shareholders and employment claims. The District Court held that exclusion applied. The Circuit Court affirmed.
The Sixth Circuit held that, “[a]s a voluntary assignee, the Trust stands in [debtor] Capitol’s shoes and possesses the same rights subject to the same defenses. Just as the exclusion covers a lawsuit ‘by’ Capitol, it covers a lawsuit ‘by’ the Trust ‘in the . . . right’ of Capitol.”
The fact that the debtor became a new entity – a debtor in possession – upon filing for bankruptcy did not change the result because “this new-entity argument surely would not work before bankruptcy. Capitol could not have dodged the exclusion by transferring a mismanagement claim to a new company – call it Capitol II – for the purpose of filing a mismanagement claim against the [D&Os]. No matter how legally distinct Capitol II might be, the claim would still be ‘by, on behalf of, or in the name or right of’ Capitol. The same conclusion applies to a claim filed after bankruptcy.”
The Sixth Circuit acknowledged that the purpose of the “insured-versus-insured” exception was to prevent people within the insured company from “push[ing] the costs of mismanagement onto an insurance company just by suing (and perhaps collusively settling with) past officers who made bad business decisions.” Nevertheless, it mattered not that the bankruptcy court approval of the plan transferring the causes of action provided “a safeguard against the collusive suits that insured-versus-insured exclusions seek to prevent” because it did “not eliminate the practical and legal difference between an assignee and a court-appointed trustee that receives the right to sue on the estate’s behalf by statute.”
Carl D. Neff is a partner with the law firm of Fox Rothschild LLP. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.