Relying on Insolvency Exclusion, Second Circuit Finds That D&O Insurer Not Required to Defend Professional Manager Overseeing Operations of Distressed Company That Filed for Chapter 7 Bankruptcy

The United States Court of Appeals for the Second Circuit, applying New York law, affirmed a trial court’s denial of a preliminary injunction seeking to require a D&O insurer to defend a professional manager hired to oversee a distressed company that later filed for Chapter 7 bankruptcy. Daileader v. Certain Underwriters at Lloyds London Syndicate 1861, No. 23-690, 2024 WL 1145347 (2d Cir Mar. 18, 2024). The court held that the insured failed to show a likelihood of success on the merits because the policy’s Insolvency Exclusion appeared to apply.

The owner of an affiliated group of healthcare companies entered into a criminal plea agreement related to violation of the Anti-Kickback Statute. The companies subsequently defaulted on several loans, and their lenders appointed a professional manager as an independent director to oversee the companies’ day-to-day operations. Notwithstanding the manager’s efforts, the companies ultimately filed for bankruptcy under Chapter 7.

During the bankruptcy proceeding, the trustee initiated an adversary proceeding against the manager alleging that he breached his fiduciary duty to the companies by failing to file for Chapter 11 restructuring prior to filing for Chapter 7 liquidation. The manager sought coverage under the companies’ D&O insurance program. The primary insurer agreed to defend the manager in the adversary proceeding. However, when the primary policy was exhausted, the first excess insurer denied coverage.

The excess follow-form insurer relied on an exclusion in the primary policy providing that “[t]he Insurer shall not be liable to make any payment for Loss under this policy in connection with any Claim made against the Insured: 1. Alleging, arising out of, based upon, attributable to, or in any way involving, directly or indirectly, in whole or in part, any Wrongful Act that is alleged to have caused, directly or indirectly, in whole or in part: a. The bankruptcy or insolvency of the Insured Organization; [or] b. The Insured Organization’s filing of a petition, or a petition being filed against the Insured Organization pursuant to the federal Bankruptcy Code or any similar state law” (the “Insolvency Exclusion”). The insured manager sought a preliminary injunction ordering the excess insurer to defend him in the adversary proceeding. The United States District Court for the Southern District of New York denied the manager’s motion.

The Second Circuit affirmed. The court agreed that the insured was unlikely to succeed on the merits because the Insolvency Exclusion appeared to bar coverage for the adversary proceeding. The insured argued that, if the policy provided coverage for any of the causes of action in the adversary proceeding, then the insurer had a duty to defend the entire action. The court, however, determined that the entire adversary proceeding fell within the ambit of the Insolvency Exclusion. As an initial matter, the court reasoned that the policy defined “Claim” as an entire civil proceeding rather than individual causes of action. Additionally, the court observed that all of the causes of action in the adversary proceeding were “[a]lleging, arising out of, based upon, attributable to, or in any way involving, directly or indirectly, in whole or in part any Wrongful Act that is alleged to have caused, directly or indirectly, in whole or in part… [t]he bankruptcy or insolvency of the Insured Organization.” Finally, the court rejected the argument that the Insolvency Exclusion was an unenforceable ipso facto clause prohibited by the Bankruptcy Code. In this regard, the court determined that the insured failed to show that the proceeds of the excess policy (versus the policy itself) were likely to be property of the bankruptcy estate because it was speculative whether the estate would ever be entitled to all of the proceeds.

See our previous post on this case.


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