The FDIC has closed over 400 banks since the financial crisis began in 2008. And when the FDIC closes a bank, it may very well decide to pursue former officers and directors to recoup losses suffered by the institution (and by the FDIC). For bank officers and directors, D&O insurance is a lifeline to the prevention of personal disaster. For the FDIC, it is another source of funding claims. This latter point caused the FDIC to recently issue an advisory statement to FDIC-supervised banks, warning their directors and officers of some of the insurance pitfalls, and two in particular, that lurk in these policies: the insured vs. insured exclusion and the regulatory exclusion. Regardless of its source and the motivation behind it, the message is important, and we wanted to pass it on to our financial institution clients.
We'll start with the “insured vs. insured” exclusion. In the wake of the Savings and Loan crisis of the 1980s, D&O policies increasingly began to exclude situations in which an insured bank brought suit against an insured director or officer. Insurance companies sought these exclusions out of a fear of collusive situations where insurance coverage allowed banks to litigate disputes against their directors with no regard to cost. The crisis also popularized “regulatory exclusions,” which deny insurance coverage to assist for losses connected with an insured officer’s fights with the FDIC and other regulatory agencies.
The FDIC’s warning is important: Insurance companies have repeatedly tried to use “insured vs. insured” exclusions to deny coverage for suits by the FDIC (as receiver for a bank) against the bank’s officers and directors. Directors and officers do have some advantages in these fights: First, if they can convince a court that the exclusion’s applicability to FDIC suits is at least ambiguous, they will typically secure coverage, because most courts will resolve ambiguous policies against the insurer. Also, some courts can be convinced that the insurance companies’ position is a stretch: The insured vs. insured exclusion was originally intended to combat collusive behavior, and such collusion simply isn’t very likely between the FDIC and officers of a company in receivership. Furthermore, the FDIC frequently is not bringing suit from a position identical to that of the bank; it has the power to bring suit on behalf of parties that the bank cannot, such as the bank’s creditors and shareholders and the bank’s depositors (as subrogee). So, the argument that, because the FDIC is in the exact same position as the bank, suits by the FDIC trigger the same policy exclusions that a suit by the bank would is far from airtight.
However, a recent case from the United States District Court of Kansas illustrates the risks officers may face: A group of officers purchased a D&O policy that contained both an insured vs. insured exclusion and a regulatory exclusion. They later paid to have the regulatory exclusion removed by endorsement. See BancInsure, Inc. v. McCaffree, 2014 WL 791159 (D. Kan. 2014). But when the bank was subsequently closed and placed into receivership, and the officers sought coverage for an anticipated FDIC lawsuit, they were denied coverage. The insurance company insisted that the insured vs. insured policy language specifically excluded claims brought by any “receiver” and the FDIC was acting as the bank’s “receiver.”
The officers sued, arguing that that the insurance company’s interpretation rendered meaningless the regulatory exclusion they had paid dearly to remove. The court sided with the insurance company, reasoning that regardless of what the regulatory exclusion had said, the “insured vs. insured” language was unambiguous: The exclusion applied to suits brought by “receivers,” and the FDIC was undisputedly acting as the bank’s receiver (even if it also happened to be a regulator). End of story.
Currently, BancInsure seems to be an outlier — it is relatively uncommon for insured vs. insured exclusions to expressly bring the bank’s “receivers” within the exclusion’s ambit. Indeed, BancInsure likely added the language in response to several previous lawsuits finding exclusions ambiguous where they merely excluded suits “by or on behalf of” the bank. Directors and officers should be on guard for renewed efforts by the insurance company to tighten up the language in these exclusions, and should ensure that any concessions to the insurance companies in this area come with a price.
Similar caution must be exercised when an insurer wants to add a regulatory exclusion. (Such exclusions are not necessarily standard, and are therefore subject to negotiation.) If your policy has a regulatory exclusion, obtaining coverage in the face of a lawsuit by the FDIC as receiver will be difficult. Several federal appellate courts have enforced these exclusions in FDIC cases, finding the exclusions to be consistent with public policy and the Financial Institutions Reform, Recovery, and Enforcement Act. Insureds have also had little success convincing courts that the exclusions tend to be ambiguous with regard to whether they cover suits brought by the FDIC, instead of just suits that third parties bring in the wake of regulatory action; courts have repeatedly held that the exclusion clearly applies in both situations (in cases reviewing exclusions denying coverage for claims “based on or attributable to” actions brought by regulatory agencies).
While the regulatory exclusion is still vulnerable to the same attacks that all exclusions are — for instance, the exclusion could be invalidated if it were added without sufficient consideration — it is safe to say that financial institutions and their individual officers and directors will face an uphill battle in obtaining coverage for FDIC litigation under policies containing such an exclusion. The real lesson here lies in avoiding the exclusion in the first place, at the procurement stage — or at least understand that it’s there and will need to be accounted for in managing your D&O risk. In that regard, one final point is in order: Federal law flatly prohibits directors and officers from being indemnified against civil money penalties imposed by a federal banking agency, meaning the potential for such penalties should not be considered when deciding whether to accept a regulatory exclusion since coverage for such penalties will be denied in either event.