Why it matters

In the latest decision to weigh in on the scope of the Insured v. Insured exclusion, a California court has held that it is ambiguous as applied to suits brought by the FDIC, and therefore does not preclude coverage for the directors and officers of a failed bank.

This is an encouraging decision in light of other courts that have found that the exclusion did apply. In fact, the court here noted the inconsistent results nationwide and held that those decisions put carriers on notice that the exclusion was, in fact, ambiguous, and it should have been made more clear in order to apply to an action brought by the FDIC. Compare (finding exclusion did not apply) with (Insured v. Insured exclusion applies).

Detailed discussion

In November 2009 the Office of the Comptroller of the Currency closed the Pacific Coast National Bank and the FDIC was appointed as receiver. Three years later the FDIC sued six former directors and officers of the bank for negligence, gross negligence, and breaches of fiduciary duty, alleging they approved various loans that resulted in millions of dollars of losses to the bank.

St. Paul Mercury Insurance, the bank’s directors and officers liability insurer, refused to defend the suit, relying upon the policy’s Insured v. Insured exclusion, which, in this case, precluded coverage for claims “brought or maintained by or on behalf of any Insured or Company [including the Bank] in any capacity. . . .” (Emphasis added.) The exclusion also contained a giveback of coverage for any claim that is a “derivative action brought or maintained on behalf of the Company by one or more persons who are not Directors or Officers and who bring and maintain such Claim without the solicitation, assistance or active participation of any Director or Officer.”

St. Paul filed a declaratory judgment action seeking an order that it was not required to defend the FDIC’s lawsuit and both parties filed summary judgment motions.

Finding the exclusion ambiguous, U.S. District Court Judge Andrew J. Guilford granted the insureds’ summary judgment.

Courts considering the Insured v. Insured exclusion in coverage disputes over FDIC lawsuits on behalf of failed banks have reached varying conclusions, the court noted, lending weight to the conclusion that the phrase “on behalf of” is ambiguous when applied to the FDIC. “There can be little doubt that repeated disputes over the IvI [Insured v. Insured] Exclusion have placed insurers on notice that it is ambiguous,” the judge wrote.

St. Paul “had the opportunity to make clear in the Policy that the IvI exclusion applied to [the FDIC], and it could have done so with a simple statement,” the court said. “Indeed, [St. Paul] provides an optional regulatory exclusion – not included in the policy here – that explicitly names the FDIC. It could have included similarly clear language in the IvI exclusion. Having failed to meet its burden ‘to phrase exceptions and exclusions in clear and unmistakable language,’ [St. Paul] cannot now benefit from the ambiguity.”

While the FDIC “steps into the shoes” of the bank when it takes over as receiver, the agency plays a multitude of roles and the insurer should have been more explicit in the policy, Judge Guilford wrote.

Even if the IvI exclusion did apply to the FDIC, the court added that the Shareholder Exception contained in the provision would bring the lawsuit back within the scope of policy coverage. The FDIC also represents the interests of the bank’s shareholders, the judge said, because under the Financial Institutions Reform, Recovery, and Enforcement Act, the FDIC as receiver succeeds to the rights not only of the failed bank, but also “of any stockholder, member, [or] accountholder . . . of such institution.”

“The Policy at issue here provides coverage for claims by shareholders, even for derivative actions brought by the shareholders on behalf of the Bank,” Judge Guilford said.

Although the complaint was not filed as a derivative action, the court asked, “On whose behalf does [the FDIC] bring these claims? The Shareholder Exception ‘evidences an intent to place on insurer the risk for actions against the D&Os based upon allegations of mismanagement, waste, fraud, or abuse of the failed institution. The Policy should therefore cover these claims if [the FDIC] pursues them under its authority to recover losses on behalf of shareholders. This is true even if the procedure by which [the FDIC] asserts the claims differs from the derivative action available to shareholders.”

The court also rejected St. Paul’s contention that an Unrepaid Loan Carve-Out in the policy barred coverage. Just because the FDIC complaint requested damages in the amount of certain unrepaid loans, the exclusion did not “unambiguously apply to cases where tortious conduct results in damages that might happen to be in the amount of unrepaid loans,” the judge wrote.

To read the order in St. Paul Mercury Insurance Co. v. Hahn, click here.