D&O Policy ‘Bankruptcy Exclusion’ Held To Be an Unenforceable ‘Ipso Facto’ Clause

New York Law Journal (NYLJ)

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PUBLISHED ON: September 23, 2019

This new decision is significant because lawsuits against former (and current) officers and directors of debtors commonly are brought by trustees, creditors’ committees so-empowered by bankruptcy court orders, or, as here, by trusts established under plans of reorganization. Because insurance policies often are the only viable source of recovery for the claims asserted in such lawsuits, this decision potentially opens a pathway to creditor recovery in other similar matters. 

Among the more mundane aspects of Chapter 11 bankruptcy analysis—whether pre-petition planning by a prospective debtor or post-petition evaluation by creditors—is the review of contracts which may be deemed “executory” under 11 U.S.C. §365. This is because a debtor, pursuant to that statute’s subsection (a), and subject to certain restrictions not relevant here, may “assume” valuable contracts or “reject” those which are financially disadvantageous.

As a predicate to such assumption, a debtor must either “cure” or provide “adequate assurance” that it will “promptly cure” any defaults in existence at the time that assumption is proposed. 11 U.S.C. §365(b)(1)(A). If a contract provides that simply being in bankruptcy is a default, although such cure would seem to be impossible to accomplish, the Bankruptcy Code solves for this problem by providing that the cure obligation “does not apply to a default that is a breach of a provision relating to (A) the insolvency or financial condition of the debtor … [or] (B) the commencement of a [bankruptcy] case … .” 11 U.S.C. §365(b)(2). These disfavored provisions generally are referred to (although not in the statute) as “ipso facto clauses.”