Aon | Financial Services Group
Release Date: March 2023
D&O Considerations in a Chapter 7 Liquidation or Chapter 11 Restructuring
2022’s steady drumbeat of challenging macroeconomic and geopolitical developments have increased attention on a potential up-tick of corporate bankruptcy filings.
Corporate debtors going through financial distress can choose different routes to settle with creditors, depending on their needs and strategy. For example, they can have their assets liquidated by an appointed Trustee under Chapter 7, restructure debt to continue operations in a Chapter 11 reorganization or sell the company’s assets in a Chapter 11 Section 363 asset sale.
This article summarizes each approach, with a focus on publicly traded companies and the implications of their chosen bankruptcy route on the firm’s directors & officers (D&O) liability insurance policy. D&O policies can be an important risk transfer tool for public companies and their D&Os. In a distressed environment, the policy accrues even more value to management, shareholders, and creditors.
D&O policies are intended to insure the litigation risk arising from corporate decision making and these policies remain important when a company files for bankruptcy. Importantly for stakeholders, this coverage continues through the conclusion of the applicable bankruptcy process. D&O policies are also designed to go into runoff whenever there is a change in control of the company. When a policy is in runoff, it generally only provides insurance for actions that took place prior to the change in control with this limited runoff coverage ending upon expiration of the policy period.
To make claims after expiration, the debtor should purchase an Extended Reporting Period (ERP), preferably for a period of 6 years to track the applicable statutes of limitations. Then, the focus should be on making sure that the policy’s change-of-control provision is triggered at the appropriate time – when management is no longer acting on behalf of the debtor corporation.
The main purpose of a Chapter 7 bankruptcy is to “liquidate the debtor’s assets in order to satisfy the debtor’s creditors”.1 The company will typically cease all operations and dissolve at the end of Chapter 7. The process is controlled by a Trustee, tasked with, among other things, collecting debtor property, selling it, distributing the proceeds to creditors, and closing the estate.2
For a Chapter 7 bankruptcy, it is important that the D&O policy continues, via extension, if necessary, until the debtor is completely dissolved.
Chapter 11 – Reorganization
Chapter 11 provides a path to reorganize a company and restructure its debt so that it can continue to operate. The debtor corporation continues to operate under management control (rather than a trustee) during Chapter 11 reorganizations, necessitating continued D&O policy coverage.
In these cases, the change-of-control provision of the policy is typically triggered upon the company’s emergence from a Chapter 11 reorganization. The pre-emergence policy should go into runoff / ERP, and a new D&O policy should incept upon emergence from bankruptcy.
One potential challenge is that a complex Chapter 11 reorganization can take years and a typical D&O policy is for a specific year. Keeping a D&O insurance program together for the duration of the process may be difficult. Alternative structures can be considered, such as putting the pre-bankruptcy policy into runoff / ERP and purchasing a debtor-in-possession (DIP) policy specific to the duration of the reorganization process.
Chapter 11 – 363 Asset Sale
Partially due to its relative speed and efficiency, an increasingly common bankruptcy process is where the debtor-in-possession (rather than a trustee) conducts bulk sales of assets under Chapter 11, Section 363 of the bankruptcy code. The sales are conducted via auction, with the ability to select a “stalking horse” buyer early to settle assets quickly. Coordination with both bankruptcy counsel and your insurance broker to make sure that the policy goes into runoff at the appropriate time in the sales process is important.
1 - Congressional Research Service – Bankruptcy Basics: A Primer (2018)
2 - Congressional Research Service – Bankruptcy Basics: A Primer (2018)
If you have questions about your coverage or are interested in obtaining coverage, please contact your Aon broker. This article can be discussed with Financial Services Group professional Razeeb Hossain.
Vice President and Director