NEW YORK, July 20 (Reuters) - A $50 million insurance policy is emerging as a key factor in efforts to resolve the bankruptcy of defunct law firm Dewey & LeBoeuf and avoid years of costly litigation.

The policy, which was taken out by Dewey in October 2011, covers claims of misconduct against former chairman Steven Davis and a handful of other former top executives at the firm, according to three former Dewey partners who are familiar with the policy and who spoke on the condition of anonymity.

As bankruptcy negotiations proceed, the estate, former partners and creditors are sorting out how the policy affects their different interests.

In a proposal put forward last week by the firm's estate, former partners were asked to contribute between $25,000 and $3 million each toward a $103.6 settlement pot and to forfeit any legal claims against the defunct firm and its officers. In exchange, the partners would be released from liability for the firm's $315 million debt.

Davis was pointedly left out of the deal, an arrangement which frees creditors to sue him in his capacity as the former chairman, and also personally. The $50 million insurance policy provides an incentive for creditors to go along with the proposal.

For former partners, on the other hand, the policy could be a disincentive because anyone who signs on is relinquishing the right to sue Davis and the others, including the recovery of back compensation that some former partners say they are owed.

Settlement talks involving the creditors, the estate and the former partners have been under way since late May, when Dewey filed for Chapter 11. The existence of the $50 million policy was acknowledged by Joff Mitchell, the chief restructuring officer for the Dewey estate, at a July 3 settlement meeting with lawyers for former Dewey partners.

"[The creditors] think that one benefit to them of this deal is that by having all the partners release their claims against other partners, there will be less competition to recover against that policy," wrote one lawyer who attended the July 3 meeting in a follow-up email to his clients. The contents of the email were later obtained and reviewed by Reuters.

Dewey & LeBoeuf, which once housed more than 1,000 lawyers in 26 offices worldwide, began unraveling earlier this year as the firm struggled with debt. Davis was removed from his post on April 29 amid an investigation by the Manhattan district attorney into allegations related to his management of Dewey. Davis has denied wrongdoing.

A lawyer and a spokeswoman for Davis did not respond to requests for comment.

The insurance policy was taken out on Oct. 2, 2011, and expires on the same date this year, according to bankruptcy court records. It could not be determined if the management liability policy renewed a pre-existing one or if it was a new policy. Even though the policy expires on Oct. 2, creditors -- or any other party afflicted by Dewey's collapse -- could sue Davis after that date and still be eligible to go after the $50 million. At least one former Dewey lawyer has already brought claims against the firm's management, alleging fraud, which means all related future claims would trace back and be filed in connection with that suit, according to two insurance experts.

The policy was listed as an asset in New York bankruptcy court on May 28, but five former partners contacted by Reuters were unaware of it and were unsure how or if it would affect their decision to participate in the settlement. Their reactions ranged from curiosity about the details to agreement that Davis should be shut out.

"There's no way to include him," said one former partner knowledgeable of the insurance policy. "There's insurance and there's assets."

Former members of Dewey's executive committee are also covered by the policy and theoretically could have been potential targets in litigation by creditors. But Mitchell, the restructuring officer, offered an exemption to any member of the committee who participates in the settlement. He also offered exemption to two other players who had coverage under the policy: Dewey's general counsel, Janis Meyer, and Stephen Horvath, who ran the firm in its final days as executive partner.

Former Dewey executive director Steve DiCarmine and former chief financial officer Joel Sanders were not offered an exemption, according to the three partners.

Ed Weisfelner, a lawyer representing the creditors committee, declined comment, as did Mitchell. Meyer and Al Togut, lead bankruptcy counsel for Dewey, did not respond to requests for comment.

That Dewey had management liability insurance at all is somewhat unusual, said Mike Santocki and Brian Dunphy, directors of the insurance brokerage firm Frank Crystal & Company. Fewer than half of all law firms typically carry that type of insurance, they said, though more firms have begun making inquiries about it in the wake of the Dewey collapse.

A handful of insurance companies carry Dewey's management liability policies, which cover claims of misconduct such as breach of fiduciary duty. They include XL Insurance of Dublin, Ireland, Minnesota-based OneBeacon Insurance Group and Bermuda-based Iron-Starr Excess, according to documents filed in New York bankruptcy court. Representatives for those companies either declined comment or did not return a request for comment.

To go forward with the settlement, which must be approved by the former partners and creditors, the Dewey estate has said it needs a minimum participation from former partners of $50 million. Former partners must decide by August 7 whether or not to opt in.

(Reporting by Casey Sullivan)

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