Discussing possible financial insolvency amid COVID-19

Author: Adnan Arain

In each month since the COVID-19 lockdown started in March 2020 across the U.S., the number of Chapter 11 bankruptcy filings has remained consistently greater than the prior year (see figure 1).1 Year-over-year filings saw a 48% increase for May and a 52% increase for July. What should Gallagher’s clients and prospects be considering if possible financial insolvency is on the horizon?

The second in a series, this paper is intended to spark internal discussions of some business issues in the context of possible insolvency within our client and prospect organizations. This paper approaches these issues from the standpoint of an insurance advisor, specifically with regard to the executive liability lines of coverage, especially Directors & Officers (D&O) Liability.

1. Ensure robust policy wording

From the insurance broker’s standpoint, the blocking-and-tackling basics start with policy wording. For example, consider the addition of creditors’ committees to the list of exceptions to the Insured vs. Insured exclusion. The Insured vs. Insured exclusion is intended to deter insureds from suing each other in order to recover under the D&O policy. D&O policies typically list exceptions to this exclusion, such as trustees during bankruptcy proceedings.

While technically the trustee stands in the shoes of the debtor insured and may be listed as an insured under the policy, claims by the trustee against individual insureds are fundamentally different than by the non-bankrupt entity. In most cases, while the bankruptcy trustee is defined to be an insured under the policy, its actions against the debtor are not encompassed in the Insured vs. Insured exclusion. The presence of that exception is what allows for the indemnification of an individual officer, director or employee under the policy when the trustee brings such an action.

Similarly, the party within the bankruptcy proceeding who is bringing the adversarial claim against the insured individuals may not be the bankruptcy trustee at all—it may be a creditors’ committee. While it is fairly commonplace to list the bankruptcy trustee as an exception to the Insured vs. Insured exclusion, some D&O policies still decline to list creditors’ committees as a specific exception to the exclusion. Carriers may acknowledge that the creditors, too, stand in the shoes of the insured entity, meaning that the individual director, officer or insured employee will not have the D&O policy available to respond to the adversarial action brought by the creditors’ committee.

2. Understand the insurance mechanics in the event of bankruptcy

One of the key aspects to understand for entities approaching insolvency is how it will affect executive liability insurance from an operational perspective. The following is a list of operational steps executives should be aware of as the entity approaches insolvency.2 The operational steps follow in order of occurrence. While none of these is required, we encourage the insured entity’s management to consider each of these insurance products.

Extension: Once it becomes clear the entity is entering into insolvency proceedings (either Chapter 7 or Chapter 11), the first operational step the entity should undertake is to extend the current executive liability policies for as long as the entity reasonably believes necessary.3 With the uncertainty of insolvency and a bankruptcy filing looming, shareholders may allege breach of fiduciary duty or other negligence against corporate leaders. The possibility of mounting claims may cause the entity to be at a disadvantage in negotiating a renewal and starting a new policy period. Insurers would see little upside to starting a new policy under these circumstances. Unlike the extended reporting period, the extension generally covers new acts of the insureds.

Extended reporting period: The client should next seek to invoke an extended reporting period, ideally for a preset premium,4 and ideally for an extended period of at least a year. The purpose of the extended reporting period is to cover any new claims that are made based upon acts occurring prior to the end of the policy period or, if applicable, the extended policy period. The entity should be wary of unnecessarily restrictive language regarding what acts will be covered under the extended reporting period.

Run-off: The entity should also consider purchasing run-off coverage for acts undertaken after the Chapter 7 dissolution has begun but before it has concluded. The entity should also consider run-off coverage in a Chapter 11 proceeding to handle the dissolution of the old entity after the reorganization plan is approved by the bankruptcy court.

Wind-down endorsement: Run-off coverage in Chapter 7 proceedings typically feature a specific wind-down endorsement. The wind-down endorsement sets forth the remaining covered person or persons, such as the CEO or CFO, and sets forth the specific acts of the remaining personnel as the entity winds down. Insurers favor the specificity of the wind-down endorsement as it defines the specific persons and activities to be covered in run-off. Additionally, insureds favor the wind-down endorsement because it specifically addresses the timing of wrongful acts during the run-off period.

Go-forward policy: Chapter 11 proceedings also generally include a new policy with retroactive date inception in the name of the entity newly formed in the reorganization (i.e., go-forward policy).

Operationally, there are a number of timing issues that must be considered in terms of quoting and binding each of the above insurance products. Gallagher will work with management to minimize the possibility of any gaps in coverage throughout the implementation of these steps. We will also ensure that the binding process leaves room for flexibility as needed; the entity may not have certainty regarding effective dates of filing for bankruptcy, or conducting final acts before reorganization or dissolution. Your Gallagher Management Liability broker will be able to provide guidance coordinating these dates and the process overall.

3. A note regarding the “zone of insolvency”

The COVID-19-induced recession has led many to comment on the zone of insolvency, and its potential to alter the fiduciary duties of directors and officers.5 Specifically, courts accepting the concept of a zone of insolvency have held that the directors and officers owe a fiduciary duty to the creditors of a corporation as the entity approaches insolvency.6

This concept is not widely accepted.7 For entities incorporated under Delaware law, the Delaware Supreme Court articulated the following bright-line rule: “... as a company approaches possible insolvency, fiduciary duties do not change; only after insolvency does the change occur.”8

When a solvent corporation is navigating in the zone of insolvency, the focus for Delaware directors does not change: “Directors must continue to discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interest of the corporation for the benefit of its shareholder owners.”9

After insolvency, directors still owe fiduciary duties to shareholders, but shareholders are joined by creditors.10 As part of the group to whom fiduciary duties are owed, creditors may bring suit against directors for breach of fiduciary duties, albeit only derivatively and not directly.11

Other courts have recognized the concept, however, finding that the fiduciary duty to creditors arises prior to actual insolvency.12

Unfortunately, the definition of insolvency does not adhere to a similar bright line. It may be difficult to define the exact moment when a company becomes insolvent, and we can expect to see litigation over this issue in some jurisdictions.13

4. For many businesses, the prospect of insolvency may be subsiding

Despite the year-over-year monthly increase in Chapter 11 filings, the number of filings in 2020 is still not as high as the corresponding months of 2012.14 Initially, the wave of bankruptcy filings seems to have occurred as predicted, with a 48% year-over-year increase for May and peaking with a 52% year-over-year increase in July.15 Yet unless one focuses on specific industries,16 the wave overall seems to have subsided in August (17% increase year-over-year); it remains to be seen whether this represents a temporary lull, or whether COVID-19 or other destabilizing factors may bring about another wave of increases.

Commentators cite the cumulative effect of corporate tax cuts,17 the Federal Reserve’s monetary policy18 and stimulus legislation such as the CARES Act19 as factors that have helped businesses avoid insolvency. Companies have also weathered the financial storm by taking specific measures designed to ensure their survival. Early on, at the onset of the lockdown, certain contributors within the legal community explored whether COVID-19 stay-at-home orders triggered force majeure provisions in commercial contracts.20

More recently, the commercial environment has presented other avenues to salvage cash flow, including taking advantage of low interest rates21 and renegotiation of commercial leases.22 Some commentators are cautiously optimistic that systemic knowledge from recent banking crises has averted a larger tidal wave of insolvency filings.23

The ultimate effect of the above may be to forestall the prospect of insolvency, and clients and prospects should consult outside attorneys and other experts in considering all avenues for financial relief, including in dealings with lenders or other counterparties. From an insurance advisor standpoint, Gallagher brokers and claims advocates remain available to offer guidance on claims and potential claims that may arise from undertaking any of the above courses of action.

Author Information:


1 American Bankruptcy Institute. Bankruptcy statistics. “August 2020 Bankruptcy Statistics- Commercial Filings.”; LaCroix, Kevin. . “Guest Post: The Impending Bankruptcy Surge and Insured Vs. Insured Exclusion Considerations.” The D&O Diary. July 27, 2020.
2 Arain, Adnan. “D&O Insurance Policies in Bankruptcy Proceedings.” Gallagher. August 2020.
This assumes that the limits have not been exhausted on the existing policy.
4 Over the past decades, insurers regularly offered one-, three- and six-year ERP options at preset premiums. Due to the hardening market, however, the insurance market is currently trending away from preset pricing for extended reporting periods in management liability policies. See, for example, Mark Geoghegan’s The Voice of Insurance podcast, episode 48, “D&O: The hardest market of all time with David Ritchie of Gallagher UK” October, 13, 2020. Apple Podcast app.
5 Scheler, Brad Eric. Kaplan, Gary L. Rodburg, Jennifer L. “Directory Fiduciary Duty in Insolvency.” Harvard Law School Forum on Corporate Governance. April 15, 2020.; LaCroix, Kevin. “Cash-Crunched Companies Face Insolvency; Will Directors Face Claims?” The D&O Diary. March 30, 2020.
6 Ibid.
7 Ibid.
8 North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007).
9 Ibid at 101.
10 LaCroix, Kevin. “Cash-Crunched Companies Face Insolvency; Will Directors Face Claims?” The D&O Diary. March 30, 2020. Citing “The Director’s Dilemma: An overview of Director Fiduciary Duties when Insolvency Looms.” Stinson. March 26, 2020.
11 LaCroix, Kevin. “Cash-Crunched Companies Face Insolvency; Will Directors Face Claims?” The D&O Diary. March 30, 2020.
12 See Floyd v. Hefner, No. H-03-5693, 2006 U.S. Dist. LEXIS 70922 (S.D. Tex. Sep. 29, 2006), citing Carrieri v. Jobs.com, Inc., 393 F.3d 508 (5th Cir. 2004).
13 “Insolvency.” Legal Information Institute. Cornell.
14 American Bankruptcy Institute. Bankruptcy statistics.
15 Ibid.
16 Jones, Chuck. “Three Industries That Are Being Decimated by the Coronavirus.” Forbes. March 28, 2020.
17 Udland, Myles. “Tax cuts are going to keep being to the shareholder class.” Yahoo Finance. January 18, 2018.
18 Cheng, Jeffrey. Powell, Tyler. Skidmore, Dave. Wessel, David. “What’s the Fed doing in response to the COVID-19 crisis? What more could it do?” Brookings. December 11, 2020.; Fox, Matthew. “Investors ‘must still buy the dip’ because of the Fed’s easy monetary policies act as a ‘backstop’ for the stock market, Fundstrat’s Tom Lee says.” Business Insider. September 11, 2020.
19 15 U.S.C. 116 et. seq.; see “May Commercial Chapter 11s Increase 48 Percent over the Last Year, Total Filings Down 42 Percent.” American Bankruptcy Institute. June 4, 2020.
20 “Contract Implications Amid COVID-19 Concerns: Force Majeure, Impossibility, and Frustration of Purpose.” McGuireWoods. March 18, 2020.
21 Brooke, David. “Lower middle market strategies flourish amid private credit boon.” Reuters. March 3, 2020.
22 Szumilo, Nikodem. Wiegelmann, Thomas. “How Struggling Businesses Can Renegotiate Rent.” Harvard Business Review. May 5, 2020.; Leffler, David. Jacoby, David. “The Third Ground: Renegotiating Office Leases Post-COVID.” Law.com. June 19, 2020.
23 Caldwell, Preston. Compton, Eric. “Avoiding a Long-Term Financial Crisis After COVID-19.” Morningstar. August 31, 2020.


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