Why it matters

A federal court in Illinois ruled that an insured v. insured exclusion in a directors and officers liability policy barred coverage in a lawsuit filed by the named insured, a bank, against the bank’s chairman, also an “insured,” because neither Illinois law nor the policy required a showing of collusiveness for the exclusion to apply. The decision reflects the struggles of courts to apply the insured v. insured exclusion in the wake of the financial crisis and litigation by and against failed banks, often with the FDIC as a receiver. Decisions have varied from a finding that the exclusion 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 to a ruling where the court said the exclusion was inapplicable because the FDIC was not suing on behalf of an “insured” but rather the bank’s depositors and accountholders. On the other end of the spectrum, however, a California court held that the exclusion did apply in a suit brought by the FDIC against former bank directors.

Detailed Discussion

Andrew Bernhardt, the former CEO, president, and chairman of Town Center Bank (TCB), was the subject of a negligence and breach of fiduciary duty lawsuit filed by the bank in 2013. The bank alleged that during Bernhardt’s tenure he accepted and approved 26 questionable, high-risk commercial loans but failed to follow the applicable underwriting and lending policies and procedures. The loans subsequently went into default and TCB claimed it lost in excess of $3 million as a result.

Bernhardt, as an insured under a policy issued by Travelers Casualty and Surety Company, submitted a claim for coverage, but Travelers rejected the tender, asserting that the insured v. insured exclusion, among others, applied.

Bernhardt argued that the bank must allege a collusive suit in order for the insured v. insured exclusion to apply, but the court disagreed. The court acknowledged that such exclusions arose to prevent liability insurance from being used as business-loss insurance when a company tried to recover for losses resulting from directors’ or officers’ business mistakes, but clarified that the historical context did not impose a duty on the insurer to prove collusiveness without policy language to that effect.

“Here, the language of the insured-versus-insured exclusion is clear and unambiguous and there is no requirement pursuant to the terms of the policy (or in Illinois law) that requires a showing of collusiveness for the exclusion to preclude coverage,” the court wrote.

The court granted Travelers’ motion for summary judgment that the insurer owed no duty to provide Bernhardt with a defense.

This opinion reinforces the fundamental principle of policy interpretation that extrinsic evidence should not be used to disturb policy language that the parties bargained for and that is unambiguous on its face.

To read the opinion in Travelers Casualty and Surety Co. v. Bernhardt, click here.