The financial crisis commencing in 2008 has led to the failure of an unprecedented number of financial institutions. Since September 2008, 443 banks have collapsed and been placed into the receivership of the Federal Deposit Insurance Corporation (FDIC). In turn, the FDIC, in its role as receiver, has sought to recover losses arising from such failures by initiating litigation against the directors and officers of the institutions who allegedly played a role in their financial demise.
Since July 2010, the FDIC has filed 32 lawsuits naming, in the process, 266 former directors and officers. Such lawsuits typically allege causes of action for negligence, gross negligence, breach of fiduciary duty and/or failure to supervise stemming from implementing risky business strategies, ignoring appropriate underwriting or investment guidelines, or otherwise generally failing to exercise sufficient institutional control.
The first half of 2012 has proven to be active for the FDIC in its pursuit of failed bank directors and officers; thus far, 14 lawsuits have been filed, a relatively large figure given that in all of the year prior, only 16 such lawsuits were commenced. Moreover, in light of the vast number of banks which folded in 2009, and given the three-year statute of limitations period applicable to such claims, it is entirely reasonable to expect a significant number of additional filings by the FDIC in the latter half of this year. In fact, the FDIC has indicated that it has currently authorized, but not yet filed, as many as 36 additional suits involving 310 directors and officers, with more presumed to follow.
An integral component of the FDIC’s litigation strategy is accessing the failed banks’ respective directors’ and officers’ (D&O) insurance policies. By suing the individual directors and officers (who remain covered under the banks’ D&O towers), the FDIC hopes to maximize its monetary recovery.
A similar approach was undertaken by the FDIC during the savings and loan (S&L) crisis of the 1980s, during which hundreds of S&L institutions met their financial demise. The FDIC, acting as receiver for the failed institutions, sued many of the institutions’ former directors and officers. Many insurers, however, refused to indemnify the directors and officers for the FDIC’s claims, relying on two policy provisions in particular: the “Regulatory” exclusions and the “Insured versus Insured” (l-v-I) exclusion.
The “Regulatory” Exclusion
Regulatory exclusions are specifically designed to preclude coverage for suits brought against directors and officers of a failed banking institution by the FDIC. The policy language at issue in FDIC v. Am. Cas. Co., 975 F.2d 677 (10th Cir. 1992) is illustrative: “It is understood and agreed that [the insurer] shall not be liable to make any payment for loss in connection with any claim made against the Directors or Officers based upon or attributable to: [...] any action or proceeding brought by or on behalf of the [FDIC]…including any type of legal action which [the FDIC has] the legal right to bring as receiver...”
During the wave of S&L litigation, insurers were modestly successful in invoking regulatory exclusions to preclude coverage for the FDIC’s claims. See, e.g., FDIC v. Zaborac, 773 F. Supp. 137, 140 (C.D. Ill. 1991) (holding that the policy interpretation advanced by the FDIC – that the regulatory exclusion applied only to suits brought by a third party against the S&L institutions’ directors and officers as a result of earlier action by the FDIC, rather than those brought directly by the FDIC – is “unreasonable”). See also Am. Cas. Co. v. FDIC, 944 F.2d 455, 460-61 (8th Cir. 1991) and Federal Sav. & Loan Ins. Corp. v. Shelton, 789 F. Supp. 1355, 1357 (M.D. La. 1992) (same).
Insurers also sought to rely on I-v-I exclusions to deny coverage. Such exclusions are not specific to claims brought by banking regulators. Instead, they are meant to preclude collusive lawsuits by obviating coverage for claims made by the insured against its own directors and officers. (Exceptions are usually made for shareholder derivative actions.)
Insurers sought to invoke I-v-I exclusions by arguing that the FDIC, in asserting claims on behalf of the failed S&L institution, simply stood in the failed institutions’ shoes. Therefore, all exclusions that applied to the failed bank also applied to the FDIC. In other words, because I-v-I exclusions would have prevented coverage for a suit in which the failed S&L institution sued its own directors and officers, so too must it prevent coverage where the FDIC seeks to sue those same directors and officers.
Courts were generally unreceptive to insurers’ attempts to invoke I-v-I exclusions. See, e.g., FDIC v. Am. Cas. Co., 814 F. Supp. 1021, 1026 (D. Wyo. 1991) (“…it is clear that the policy reasons for attaching such an endorsement do not apply in cases like the present. The potentiality which prompted the drafting of this exclusion, the directors and officers of the bank acting collusively and suing either themselves or the bank, does not exist once the FDIC has been appointed receiver. There is no dispute that the FDIC, as receiver, is a genuinely adverse party in this action.”); Fidelity & Deposit Co. of Maryland v. Zandstra, 756 F. Supp. 429, 432 (N.D. Cal. 1990) (holding that I-v-I exclusions are designed to prevent collusive lawsuits and that any semblance of collusion was eliminated when the FDIC took over the case”); Am. Cas. Co. v. Sentry Fed. Sav. Bank, 867 F. Supp. 50, 59 (D. Mass. 1994) (“The weight of opinions concerning ‘insured vs. insured’ exclusions in the receivership context…allow…coverage when receivers sue the former directors and officers of a failed institution.”). But see Powell v. Am. Cas. Co., 772 F. Supp. 1188 (W.D. Okla. 1990) (“Because the [I-v-I] exclusion specifically excludes any claims made by the ‘institution’…, it follows that the FDIC’s action is excluded.”).1
Modern FDIC Litigation
As indicated above, the FDIC has already filed 32 lawsuits against the directors and officers of banks that failed during the recent global financial crisis. Notably, the FDIC has named the failed banks’ D&O insurers as defendants in a number of these cases, including:
- FDIC v. Bryan, et al., 11-cv-2790 (N.D. Ga.);
- FDIC v. Galán-Alvarez, et al., 12-cv-1029 (D. PR);
- FDIC v. Stripes-Garcia, et al., 11-cv-2271 (D. PR);
- Federal Deposit Insurance Corporation v. Syndicate 2003 at Lloyd’s et al., 11-cv-2083 (D. Az.);
- FDIC v. OneBeacon Midwest Ins. Co., 11-cv-03972 (N.D. Ill.) (involving a financial institution bond).
The applicability of the regulatory and I-v-I exclusions will likely be the central coverage issue in many of these cases. While no substantive orders concerning these exclusions have been issued to date, decisions on coverage issues are very likely forthcoming in the coming months. In FDIC v. Bryan, et al., 11-cv-2790 (N.D. Ga.), for example, an excess carrier recently moved for judgment on the pleadings against the FDIC with respect to the applicability of the I-v-I exclusion. Both the FDIC and the excess carrier also have pending motions for judgment on the pleadings concerning the regulatory exclusion.2 In the cases pending in the United States District Court for the District of Puerto Rico, the insurers have either moved to dismiss (Stripes-Garcia) or answered (Galán-Alvarez).
The outcomes of these cases should be of considerable interest to all carriers on risks for failed banks.