(Article from Insurance Law Alert, November 2019)
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A Michigan federal district court ruled that an insurance policy was an executory contract and that an otherwise applicable bankruptcy exclusion constituted an unenforceable ipso facto clause. In re Cmty. Mem’l Hosp., 2019 WL 3296994 (E.D. Mich. July 23, 2019).
At the time of its bankruptcy filing, Community Memorial Hospital (“CMH”) was insured under a D&O policy issued by National Union. Following its bankruptcy petition, CMH renewed the policy. At CMH’s request, the renewal policy included a “tail” endorsement that provided coverage for claims made during the three-year period following the wind-down. When a trust, acting as assignee of CMH’s rights, sued former directors and officers, National Union denied coverage. The insurer argued that coverage was barred by Endorsement 10 to the policy, which excluded coverage for loss in connection with a claim “alleging, arising out of, based upon, attributable to, or in any way involving . . .any Wrongful Act which is alleged to have led to or caused . . . bankruptcy.” Thereafter, the trust filed suit, seeking a ruling that Endorsement 10 was an unenforceable ipso facto clause—i.e., “a provision in an executory contract that provides for termination or modification based on the filing of a bankruptcy petition.” Such clauses are prohibited under federal bankruptcy law. See 11 U.S.C. § 365(e)(1).
As a preliminary matter, the court addressed whether the insurance policy was an “executory contract,” because the prohibition on ipso facto clauses applies only to such contracts. Under bankruptcy precedent, courts have defined “executory contract” to mean a contract “so far unperformed that failure of either [party] to complete performance would constitute a material breach excusing performance of the other.”
National Union argued that the tail coverage at issue constituted a policy distinct from the pre-bankruptcy insurance policy and was therefore not subject to the Bankruptcy Code prohibitions relating to executory contracts. In contrast, the trust asserted that the tail coverage was merely a continuation of the pre-petition policy and was part of that original, unperformed contract. The court agreed with the trust, explaining that the tail coverage was “an appendage to the 2012 policy,” with “pre-petition roots that make it part of an executory contract.”
Having deemed the policy an executory contract, the court also concluded that Endorsement 10 was an unenforceable ipso facto clause. As to this point, the court noted that it had held in a previous ruling that the ipso facto prohibition may be triggered even if the challenged clause invalidates only part of a contract, rather than the entire contract.
The decision is significant in its finding that the pre- and post-petition insurance policies at issue were “essentially the same” for purposes of the executory contract analysis. However, the court expressly distinguished cases involving “distinctively different” insurance policies issued before and after the bankruptcy and cases in which the debtor entered into a new policy with a different insurer post-petition, such that there was no continuing relationship between the parties. In those instances, courts have not deemed insurance policies to be executory contracts.