US Coal: Directors Allowed Some D&O Proceeds in Pending Case

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By Daniel Gill

June 10 — Former directors and officers of bankrupt U.S. Coal Corporation (and its affiliates also in bankruptcy) could receive up to $1 million from the company's directors and officers (D&O) insurance policy for defending an action prosecuted by the Chapter 7 trustee on behalf of the bankrupt company, a bankruptcy court in Kentucky ruled June 6 ( In re Licking River Mining, LLC, 2016 BL 183399, Bankr. E.D. Ky., No. Jointly Administered, 6/6/16 ).

Judge Tracey N. Wise of the United States Bankruptcy Court for the Eastern District of Kentucky entered an order authorizing the insurer to make the partial disbursement on account of the $15 million D&O policy in the name of U.S. Coal Corp.

In her ruling, the judge declined the trustee's request to review the reasonableness of the defense counsel's fees. The order also allows for the officers and directors to request further disbursements in the future.

Judge Wise also reserved for a later date any question as to whether and to what extent the policy proceeds might be property of the bankruptcy estates.

Claims Against Insiders

In one of the major cases in the recent trend of coal company insolvencies, U.S. Coal Corporation and nine affiliated companies became debtors in involuntary Chapter 11 cases commenced by the companies' creditors in the summer of 2014. The bankruptcy cases were consolidated and are being jointly administered under the caption of “Licking River Mining, LLC.” The cases were converted to Chapter 7 on April 24, 2015 (27 BBLR 620, 4/30/15).

Chapter 11 allows companies (or individuals) to enjoy protections from creditors while they seek to reorganize their debt or liquidate pursuant to a plan which must be approved by the bankruptcy court. In Chapter 7, a debtor's assets are liquidated by a trustee, and the proceeds are distributed to creditors.

One month prior to the cases' conversion, the Official Committee of Unsecured Creditors filed actions against former officers and directors Keith Goggin and Michael Goodwin and related business entities, seeking recovery on behalf of the bankrupt estates for the directors' alleged breach of fiduciary duties, as well as to avoid preferential transfers, for fraudulent transfers and other claims.

After the cases were converted and the trustee was appointed to oversee the administration of the estates, she was substituted as the plaintiff in the action.

Perils of a ‘Wasting' Insurance Policy

U.S. Coal is the named entity for a directors and officers insurance policy with National Union Fire Insurance Company of Pittsburgh, Pa.

Subject to exceptions and conditions, the policy covers losses of individual insureds (the company's officers and directors) from claims made for any wrongful act of the individual insured. The policy also covers certain claims against the company.

The coverage is what's known as a “wasting policy,” which means that defense costs paid to or on account of the insured persons or entities are deducted from the total coverage available under the policy (here, $15 million). That means the pool is reduced for whatever judgment might ultimately be awarded to a claimant, or for claims or costs that might arise in actions related to other events or involving other officers or directors.

Chapter 7 Trustee Phaedra Spardlin asserted that she, on behalf of the bankrupt companies, had an interest in the insurance policies, and she was opposed to any payments that might diminish the policy limit before she could establish the estates' interest in those funds.

There was no dispute that the directors, Goggin and Goodwin, were covered under the policy for the claims being prosecuted by the trustee, the court said.

Needing a ‘Comfort Order.'

Before National Union would make a payment to the directors for defending the claims, it insisted that the directors obtain a “comfort order” from the court, establishing that making such a payment would not run afoul of the automatic stay protecting the bankruptcy estates. Section 362 of the Bankruptcy Code (11 U.S.C. §362(a)(3)) protects estate property from “any act to obtain possession” or “exercise control” of such estate property.

Comfort orders are typically sought by parties who believe that their actions do not in fact implicate estate property but who are concerned that a court might believe to the contrary. Parties wilfully violating the automatic stay may be subject to financial penalties, so the cautious interested party will seek an order from the court establishing that the subject act is not in fact barred by the automatic stay (such an action differs from a motion for relief from the automatic stay which can be granted by the court to allow a party to take an action notwithstanding the application of the automatic stay).

If it were determined that the policy proceeds are property of the estate, the motion sought an order granting relief from the automatic stay to allow National Union to deliver funds for the benefit of the directors.

Is It Property of the Estate?

Noting that courts are in disagreement over whether the proceeds of a liability insurance policy (as opposed to the policy itself) are property of the estate, the bankruptcy court relied heavily on In re Allied Digitial Techs. Corp., 306 B.R. 505 (Bankr. D. Del. 2004) , in her analysis. That court explored the tensions between proceeds earmarked to protect the non-debtor directors and those which would protect the debtor company from exposure for the same events: “when there is coverage for the directors and officers and the debtor, the proceeds will be property of the estate if depletion of the proceeds would have an adverse effect on the estate to the extent the policy actually protects the estate's other assets from diminution” (such as from a negative judgment against it).

The court framed the question this way: “will the payment of Movants' defense costs have an adverse effect on the bankruptcy estates' other assets?”

The court performed an extensive analysis of the different ways the trustee, on behalf of the bankrupt companies, could claim an interest in the proceeds of the D&O policy. These included as the plaintiff interested in recovering from the policy if she prevails in the action; as a co-defendant to the extent that the debtors are liable for the acts of its officers; and for indemnification claims which the companies might have for legal fees paid on behalf of the directors in an unrelated lawsuit.

Split Decision

After considering the claims and the different ways the bankrupt companies could claim an interest in the policy proceeds, the court determined that “it is premature to make a determination of the extent of the Debtors' interest in the Policy proceeds,” and it denied the motion to the extent it sought a determination that the proceeds were not part of the estate.

Instead, the court considered whether it would be appropriate to grant relief from stay for cause under Section 362(d)(2).

The court noted that the trustee argued that the debtors' claims to the coverage might total $11.3 million, and that “this does not exhaust the $15 million in Policy proceeds.” On the other hand, the court found that the directors “may suffer substantial harm if prevented from exercising their contractual, bargained-for rights to defense costs.”

Based on these findings, the court decided it would be appropriate to allow the directors to receive payment of $1 million for legal costs incurred in the defense of the trustee's action, which had been pending for more than a year. Noting that the trustee is the plaintiff in the action, the judge denied her request that she be allowed to review the costs, instead ruling only that the directors must file a report setting forth the date, amount and payee of any policy proceeds disbursements.

The court also took care to limit any preclusive effect from the order. It expressed the following limitations of its order:

  •  The trustee was not prohibited from discussing or negotiating with National Union on behalf of the debtors as the insureds or owners of the policy;
  •  The directors were not barred from later seeking further distributions of the policy proceeds; and
  •  Absent further proceedings, including an evidentiary hearing, there would be no findings as to whether or to what extent the proceeds are property of the bankruptcy estates.

 

Briefs were filed by Taft A. McKinstry, Lexington, Ky., on behalf of the directors, and for the trustee by C.R. Bowles, Jr., Bingham Greenebaum Doll LLP, Louisville, Ky. and Geoffrey S. Goodman, Foley & Lardner, LLP, Chicago.

To contact the reporter on this story: Daniel Gill in Washington at dgill@bna.com

To contact the editor responsible for this story: Jay Horowitz at jhorowitz@bna.com