Claim Brought by Lenders Against Officers Based on Company’s Misstated Financials Barred by Bankruptcy and Creditors Exclusion

Applying Texas law, the United States Court of Appeals for the Fifth Circuit has held that an exclusion barring coverage for any claim brought or maintained by or on behalf of any creditor of the company precluded coverage for claims by lenders against company officers alleging that they misrepresented the financial condition of a company.  Markel Am. Ins. Co. v. Verbeek, 2016 WL 5400412 (5th Cir. Sept. 27, 2016)

Two individuals were owners and officers of a large wholesale flower distributor.  In 2012, the company refinanced its debt by entering into a series of loan agreements.  Later, the company defaulted on its loans and filed for bankruptcy.  The lenders later sued the two officers alleging that they misrepresented the company’s financial condition, including by overvaluing its inventory, and that those misrepresentations hid the company’s true financial condition.  The officers tendered the suit under a D&O policy, but the insurer denied coverage pursuant to the policy’s “Bankruptcy and Creditors” exclusion, which barred coverage for “Loss on account of … any Claim brought or maintained by or on behalf of … [a]ny creditor of a Company … in the creditor’s capacity as such.”  The insurer also filed a declaratory judgment action, and the district court ruled that the insurer had no duty to defend or indemnify because the exclusion barred coverage in its entirety.

On appeal, the court affirmed that the Bankruptcy and Creditors exclusion applied.  First, the court rejected the officers’ argument that the parent company of one of the underlying creditors was an “investor” and “administrative agent” and not a “creditor” for purposes of the exclusion.  The court reasoned that the factual allegations in the litigation “indicate that all damages originate from the loans the [officers] and others fraudulently induced the [claimants] to extend” to the company, and that because all alleged damages stemmed from the claimants’ roles as defrauded creditors, the exclusion applied.  Second, the court rejected the officers’ argument that the bankruptcy court’s approval of a liquidation plan rendered the exclusion inoperative because, after that ruling, the plaintiffs were no longer “creditors.”  The court noted that the exclusion barred coverage for “any Claim brought or maintained by” a creditor, and because the plaintiffs were creditors at the outset and the exclusion was written in the disjunctive, the exclusion applied.