Insurance Company Cannot Deny D&O Coverage for Acts Causing Bankruptcy

The Bottom Line

In CMH Liquidating Trust v. National Union Fire Insurance Company of Pittsburgh, PA, Case No. 16-cv-14434 (E.D. Mich. 2019) (“CMH”), the District Court for the Eastern District of Michigan held that an insurance policy that was renewed post-petition was still an executory contract, and thus, a provision denying coverage for acts leading to bankruptcy was a prohibited ipso facto clause.

What Happened?

After filing for bankruptcy, Community Memorial Hospital (“CMH”) renewed its existing directors and officers liability insurance policy (“D&O Policy”) for a period of one year. Subsequently, CMH decided to liquidate, and thus, purchased tail or run-off coverage to extend the D&O Policy for three years. Defendant National Union Fire Insurance Company of Pittsburgh, PA (“National Union”), issued the coverage. Plaintiff CMH Liquidating Trust, the trust to which CMH’s rights were assigned (the “Trust”), later filed suit against former directors and officers of CMH, asserting claims for breach of fiduciary duty and negligence.

National Union denied coverage based on an endorsement, which stated that National Union would not be liable for “any Wrongful Act which … led to or caused … the bankruptcy or insolvency.” In response, the Trust filed an adversary proceeding, seeking a determination that the endorsement was not enforceable on the grounds that it was an ipso facto clause — i.e., a prohibited provision in an executory contract that provides for termination or modification based on the filing of a bankruptcy petition or the financial condition of the debtor. See 11 U.S.C. § 365(e)(1).

On appeal, the District Court for the Eastern District of Michigan affirmed the Bankruptcy Court and held that the endorsement was a prohibited ipso facto clause. The court began by analyzing whether the insurance policy should be deemed an “executory contract.” National Union argued that “because the tail coverage did not exist pre-petition, it could not possibly constitute an executory contract against which ipso facto provisions are unenforceable.” CMH, at 6. In opposition, the Trust argued that the court should look to the “contractual relationship” between the parties and determine whether the tail coverage “was continuous and essentially unchanged from the pre-petition period through the post-petition period, such that the same contractual relationship and the same contract can and should be deemed to have been extant pre-petition.” Id. The court agreed with the Trust, explaining that except for the time frames and the premium amounts, the policies in effect pre- and post-petition were “functionally the same.” Id. at 7. Moreover, tail coverage is not a separate policy, but instead is an endorsement on an existing, pre-petition contract. Accordingly, the court held that National Union’s denial of coverage “impeded an executory contract” and violated the Bankruptcy Code’s prohibition against ipso facto provisions. 

Why This Case Is Interesting

This case is interesting because it clarifies what constitutes an executory contract in the insurance context. The court explains that even though the contract was entered into post-petition, it was an appendage to a pre-petition agreement. Moreover, because of the continuous and unchanged relationship of the contractual parties, which began before the bankruptcy filing, the contract is still executory. Moreover, this case demonstrates that insurance companies cannot refuse coverage for acts leading to or causing bankruptcy or insolvency, as such provisions in coverage policies are prohibited ipso facto clauses.