Wednesday, November 02, 2011

The challenges associated with prioritizing payments under insurance programs with insufficient limits continue to surface in financial crisis litigation.  Claims arising out of the Lehman Brothers bankruptcy, seeking billions of dollars in damages, recently forced consideration of this difficult issue. 

In August 2011, former directors and officers of failed financial giant Lehman Brothers Holdings Inc. (LBHI), including ex-CEO Richard Fuld, agreed to pay $90 million to settle a single securities class action lawsuit.  As documented, the settlement was to be funded entirely by insurance proceeds, with no personal contribution from the alleged wrongdoers.  In their motion seeking approval of the settlement, the LBHI D&Os referenced the “Priority of Payments” provisions in the policies.  These provisions provide that when competing claims for coverage are made under Insuring Agreement A (non-indemnifiable loss) and Insuring Agreement B (loss indemnified by the company), the insurer is required to pay the Insuring Agreement A claims first.  As such, the policies “expressly subordinate any potential rights of the [d]ebtors to proceeds payable under the [policies] to the rights of the individual Insureds.”  LBHI D&Os’ Mot. Dismiss ¶ 26 (In Re Lehman Bros. Holdings, Inc., et al, No. 08-13555 (S.D.N.Y. filed Sept. 14, 2011)). 

Coupled with astronomical defense costs, the funding of this settlement will nearly exhaust the remainder of the company’s $250 million insurance program (comprised of $20 million in primary limits and sixteen layers of excess insurance).  See Kevin LaCroix, What to Watch Now in the World of D&O, D&O Diary, Sept. 7, 2011.  Not surprisingly, in September 2011, executives of Lehman’s Structured Asset Securities Corporation (SASCO) filed an objection to the settlement, seeking to “prevent the [LBHI defendants] from expending a disproportionate and inequitable portion of the available [D&O] insurance for their own benefit[.]”  SASCO Def.’s Objection to Equity/Debt Def.’s Mot. ¶ 1 (In Re Lehman Bros. Holdings, Inc., et al, No. 08-13555 (S.D.N.Y. filed Sept. 14, 2011)).   In their motion, the SASCO executives argued that use of the insurance funds to settle the Lehman Brothers class action would erode the policies to such an extent that they would be unable to settle separate securities litigation pending against them.  The SASCO objection asserted that:

[p]ermitting one class of insureds to use such tactics to divert a disproportionate share of insurance proceeds for their own benefit to the exclusion of other classes is inequitable, contrary to the purpose of the available D&O insurance and would have an adverse economic impact on the Debtors’ estates. 

SASCO Def.’s Objection to Equity/Debt Def.’s Mot. ¶ 1 (In Re Lehman Bros. Holdings, Inc., et al, No. 08-13555 (S.D.N.Y. filed Sept. 14, 2011)).   On October 19, 2011, the bankruptcy court approved the $90 million settlement, apparently overruling the SASCO executives’ objections.  Nick Brown, Judge OKs Insurance Payout to Settle Lehman Case, REUTERS, Oct. 19, 2011.  Notably, however, the bankruptcy court’s order modifying the automatic stay to permit payment of the LBHI settlement specifically states that the parties to the insurance policies reserve all rights and defenses with respect to the policies, preserving any coverage issues for separate resolution.

Although the outcome may seem inequitable, there may be no real alternatives.  Any “equitable” allocation of policy proceeds would undoubtedly leave individual insureds with a share of the insurance that is woefully inadequate to resolve pending and future claims.  Particularly where the interests of various defendant groups are not aligned, the early settlements may be funded, leaving remaining claims uninsured once the policies are eroded.  As a practical matter, the exhaustion of insurance tends to impact the longevity of remaining civil claims.  If there is no viable payor, the claims may be abandoned.  Individual insureds who face potential exposure for claims brought by the SEC or DOJ, on the other hand, have very real concerns about preserving policy limits for defense costs in those proceedings.  And the absence of remaining insurance money rarely impacts the prosecution of governmental investigations and enforcement actions.  Although not a solution for catastrophic claims, where damages far exceed the available insurance, obtaining separate policies for various classes of D&Os, including separate Side A-only coverage, or priority of payment provisions may mitigate against some of these concerns by specifically reserving coverage for individual D&Os.  See In re Enron Corp., Case No. 01-16034 (Bankr. S.D.N.Y. Apr. 11, 2002) [Docket No. 3278] (holding that priority of payment provision was an enforceable contractual right).