Insured v. Insured Exclusion Bars Coverage for Bankruptcy Trustee’s Claims Where Policy Defines “Insured” to Include Trustees and Debtors-in-Possession

The United States Bankruptcy Court for the Northern District of Illinois, applying Illinois law, has held that an insured v. insured exclusion in a D&O policy bars coverage for a trustee’s claims against a bankrupt insured condominium association’s former officers and board members where the policy defined “Insured” to include bankruptcy trustees and debtors-in-possession. Avellone v. U.S. Liab. Ins. Co. (In re Ford City Condo. Ass’n), 2023 WL 5624581 (Bankr. N.D. Ill. Aug. 31, 2023).

After the condo association filed for bankruptcy, the bankruptcy trustee issued a demand letter to the association’s D&O insurer requesting coverage for alleged breaches of fiduciary duty and mismanagement by the association’s former officers and board members. The insurer denied coverage based on the insured v. insured exclusion. In the ensuing adversary proceeding, the insurer argued that, because the trustee is the association’s bankruptcy trustee and was also appointed as a trustee-in-possession, the trustee was part of the association’s “Organization,” triggering the exclusion.

The court held that the insured v. insured exclusion barred coverage for the trustee’s claims. The exclusion precluded coverage for claims “against the Insured arising out of, directly or indirectly resulting from or in consequence of, or in any way involving … any claim by, at the behest of, or on behalf of the Organization and/or any Individual Insured.” The policy defined “Organization” to include “any person or entity while acting in the capacity of receiver, bankruptcy trustee, or debtor in possession,” and “Insured” was defined to include the Organization and its members. The court held that “from the unambiguous text of the policy, the parties’ intention was to exclude bankruptcy trustees and debtors-in-possession from coverage.”

The court further held that two policy provisions did not circumvent the insured v. insured exclusion. First, the court held that the trustee failed to explain how the policy term providing that the “[b]ankruptcy or insolvency of the insured … shall not relieve [the insurer] of its obligations hereunder” impacted the exclusion. Second, the court held that an exception to the insured v. insured exclusion for a derivative action “brought and maintained totally independent of, and without the solicitation, assistance, participation or intervention of any of the Insureds” did not apply given the definitions of “Insureds” and “Organization,” which expressly encompassed bankruptcy trustees and debtors-in-possession.

The court also held that the exclusion did not constitute an unlawful ipso facto clause and was therefore enforceable. The court declined to follow Yessenow v. Executive Risk Indemnity, Inc., 953 N.E.2d 433 (Ill. App. Ct. 2011), where an Illinois appellate court found that a similar exclusion was an unenforceable ipso facto clause under 11 U.S.C. § 541(c)(1) because it was “conditioned on the commencement of [a] bankruptcy case.” The bankruptcy court reasoned that: (i) the lower court in Yessenow distinguished cases where trustees and debtors-in-possession were “insureds” under the policy; (ii) the policy at issue did not create a “forfeiture, modification, or termination of the debtor’s interest in property” under 11 U.S. C. § 541(c)(1); and (iii) Yessenow did not cite any supporting case law nor “discuss whether a judgment as to a defendant’s liability is necessary to establish a plaintiff’s property interest in the defendant’s insurance proceeds.”

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