Key Insurance Considerations for Companies Facing Bankruptcy

Andrew Pendergast


March 31, 2023

insurance measures for companies facing bankruptcy

The past few weeks have been extremely tumultuous, with the collapse of two major banks stressing the already challenged economic environment. Along with this economic uncertainty, the Federal Reserve's efforts to combat inflation by raising interest rates and banks implementing stricter credit requirements create a highly challenging environment for businesses to navigate. As a result, companies are left wondering how to prepare for worst-case scenarios like bankruptcy. Fortunately, there are various risk transfer and insurance optimization strategies available for all businesses and their leaders to secure their personal and corporate assets in the case of a bankruptcy or distressed sale.

The following pre- and post-distress risk transfer solutions can be used to the address the impact of personal and corporate liabilities in a bankruptcy scenario, and can help increase the value of those considering a sale of corporate assets, either pre-petition or via the bankruptcy process.

Protect Key Stakeholders with Directors and Officers Insurance

The most common allegation against a company filing bankruptcy is that leadership mismanaged corporate assets and breached a fiduciary duty owed to the company. What is often overlooked by directors and officers is that, in the event of insolvency, many jurisdictions will hold that your fiduciary duty extends beyond just the interest of shareholders and includes creditors as well. This raises the pool of potential claimants for a lawsuit, and increases the potential severity of a settlement—and commensurate defense costs. Because company funds are unlikely to be available to meet claims and indemnify individuals, directors and officers liability insurance (D&O) can be a source of protection for both the company and—critically—the individual insured’s personal assets, but only if properly structured policies are in place. As is the case with all insurance contracts, the devil is in the details, and base policy forms in today’s marketplace will need to be addressed and amended to make sure that coverage is afforded in these special situations.

  • First and foremost, it is critical to amend the D&O policy to affirmatively state that individuals will be reimbursed before the company for defense costs and settlements they are liable. Other key policy enhancements include:
  • Ensuring the policy is not captured by the automatic stay and remains available to pay individual insureds during the bankruptcy process
  • Incorporating affirmative language stating that bankruptcy does not relieve the insurer of its obligations
  • Amending the insured versus insured or entity versus insured exclusion to carve back coverage for claims brought by trustees, receivers and debtor-in-possession
  • Adding affirmative language that the policy is non-cancellable by any trustee or receiver

These amendments typically need to be requested and negotiated prior to the placement or renewal of your D&O program. However, in some circumstances, coverage enhancements can be made mid-term. Right now, organizations should be having proactive conversations with their broker to determine whether or not these provisions are included to head off issues in the future.

Restructure Inefficient Casualty Programs to Identify and Recover Trapped Cash

D&O liability is not the only insurance policy that should be examined in the event of a bankruptcy or distressed sale. Many insureds have historically elected to purchase large deductible casualty insurance programs, including general liability, workers’ compensation and commercial auto. This results in the insurer requiring the company to post collateral, typically in the form of an evergreen letter of credit.

If an issue with solvency is on the horizon or bankruptcy has been filed, this “trapped cash” could help the company satisfy its current and ongoing obligations. By focusing on the right financial levers and restructuring historically overcollateralized or inefficiently collateralized programs, meaningful amounts of this trapped cash can be returned to the company and provide liquidity for other uses.

To achieve these objectives, insureds should consider the following:

  • An independent and objective claims and actuarial analysis to identify over-securitized bands and frame negotiating positions with current and legacy counterparties to release excess collateral held by insurers
  • Program cross-collateralization to improve capital efficiency
  • Establishing contact with insurance company decision-makers to drive rational responses on the release of collateral
  • Employing proven alternative risk strategies such as captives to reduce or eliminate future collateral obligations
  • Post-restructuring, assess ways to reduce insurance program expenses, including TPA agreements, claims mitigation strategies, ROI-based safety and loss control directives, retention optimization and alternative captive implementation

Utilize Representations and Warranties Insurance to Enhance Deal Value

In the event that a company in distress is being sold, either in the form of an asset sale purchase from a bankruptcy or pre-petition asset sale, the issue that arises is sellers being able to provide potential buyers with a form of indemnity to backstop the representations and warranties made within any purchase and sale agreement.

This is why representations and warranties insurance (R&W) is vital. The coverage increases efficiency (and potentially value) by creating a pool of indemnity—assumed by insurers—that a debtor or distressed seller would not be able to provide either at all or with sufficient credit quality to protect buyers.

Additionally, fraudulent conveyance and successor liability insurance policies can be utilized to protect distressed asset buyers against claims by aggrieved creditors and from court-imposed liability despite contractual limitations.

Do Not Overlook Post-Restructuring Planning

Post-restructuring, to help ensure prior solvency issues are not reencountered, it is important to optimize all go-forward insurance program costs based on facts and deep technical analysis to account for reduced business revenues, employee count or market cap.

Organizations should consider various carrier management strategies, including establishing relationships with the insurance company’s executive team and chief credit officer; streamlining or eliminating TPA, external risk management and other insurance service provider costs; and implementing new risk management strategies to include more cost-efficient retention structures.

Moving Forward with Security

Ultimately, there is no single thing companies can do to mitigate the challenges of bankruptcy. However, by focusing on several high-impact insurance coverage areas, companies and individuals can mitigate their exposure and drive up post-bankruptcy value. Take advantage of the expertise, benchmarking, analytics, and executive-level relationships your broker offers to make informed decisions before issues arise.

Andrew Pendergast is managing director and special purpose acquisition company (SPAC) and general partner liability (GPL) practice leader at NFP.