Lessons of Enron: what the Enron bankruptcy means for your D&O insurance coverage.

• Author: Weiss, Stephen J.
• Position: D&O Insurance Update - Directors' and officers' liability insurance - Brief Article - Column

BY NOW, you've got to be sick of hearing about Enron. While I'm sure you're tempted to tune out the coverage completely, I suggest you fight that urge if your company is about to purchase or renew its D&O insurance policy. In this column, I discuss two major insurance issues that have already surfaced in the Enron bankruptcy proceedings: how a bankruptcy can affect the insureds' ability to use D&O policy proceeds to pay their defense costs, and under what circumstances an insurer can rescind its D&O policy for application fraud.

Bankruptcy Issues. When a company files a bankruptcy petition, it creates an "estate' which includes all of the property interests of the debtor corporation as of the commencement of the bankruptcy. A key question is whether the proceeds of a D&O policy should be treated as a part of the bankruptcy estate. If the proceeds are considered property of the estate, they will be subject to the bankruptcy court's jurisdiction and may not be available to pay the defense costs of the directors and officers.

In the Enron bankruptcy, a war is raging over this issue. The Official Committee of Unsecured Creditors ("Committee") of Enron opposed the outside directors' motion in the U.S. Bankruptcy Court in New York seeking payment from their D&O insurer of millions of dollars of legal fees to defend themselves against a barrage of lawsuits, including class actions alleging violations of the federal securities laws. The Committee said in its court filings that the D&O policy proceeds are property of the estate and, as such, should be preserved to satisfy the Committee's own claims against certain Enron directors and officers. In sharp contrast, the outside directors argued that even though the D&O policies also insure the corporation, they were obtained primarily for the protection of management and thus the policy proceeds are not the property of the estate. To support this argument, the outside directors relied heavily on an endorsement to Enron's primary D&O policy that provides a first-priority payment to directors and officers before any payment may be made to Enron.

In an oral ruling from the bench on April 11, 2002, the Bankruptcy Court sided with the outside directors, thus allowing payment by AEGIS, Enron's lead D&O insurer, of millions of dollars to cover defense costs. (The Committee appealed this ruling on May 28; it will be months before there is a decision and that decision, in turn, can be appealed.) Although no...