On March 31, 2014, the First Circuit reaffirmed the breadth of an insurer’s duty to defend. In W Holding Co., Inc. v. AIG Ins. Co.-Puerto Rico, No. 12–2008, 2014 WL 1280246 (1st Cir. Mar. 31, 2014), the appellate court ruled that AIG Insurance Company (“AIG”) must advance defense costs to former directors and officers of Westernbank of Puerto Rico in the Federal Deposit Insurance Corporation’s (“FDIC”) $176 million lawsuit against them. In doing so, the court rejected AIG’s argument that coverage was barred under its policy’s “insured versus insured” exclusion because the FDIC stood in the shoes of one insured, Westernbank, in its suit against other insureds, the former directors and officers. Because the FDIC’s complaint alleged it was bringing claims on behalf of the bank’s depositors and account holders, which were not insureds under the AIG policy, there existed the “likelihood of a remote possibility of coverage,” triggering AIG’s duty to defend. The opinion is an important reminder of the value of defense cost benefits that may inure to D&O policyholders and the relatively low threshold to obtaining those benefits.

Westernbank was one of Puerto Rico’s leading banks until the late 2000s, when regulators ordered it closed and appointed the FDIC receiver.  After investigating, the FDIC concluded that certain bank directors and officers breached their fiduciary duty by jeopardizing the bank’s financial soundness, and claimed that these breaches caused millions of dollars in losses to the bank. The directors and officers notified AIG of the FDIC’s claims and asked AIG to confirm coverage under the bank’s D&O policy.

AIG denied coverage, relying on the policy’s “insured versus insured” exclusion. AIG argued that the FDIC, “as receiver,” had stepped into Westernbank’s shoes, such that any claims it had against the directors and officers of the bank are “on behalf of” or “in the right” of Westernbank and thus constituted a claim by one insured under the AIG policy against another insured.

The directors and officers sued AIG seeking a determination of coverage for the $176 million the FDIC sought in damages purportedly suffered by the bank. The FDIC intervened in the suit, filing a complaint that accused the directors and officers of violating their fiduciary duties to the bank. The complaint stressed that the FDIC had “succeeded to all of the rights and assets of Westernbank, including its rights and claims against its former officers and directors, and its rights, interests and claims in and to the policies against [AIG].”  The FDIC later amended its complaint in intervention, asserting that it not only succeeded to the rights of Westernbank, but also to the rights and claims of the bank’s stockholders, members, account holders and depositors.

In the meantime, the directors and officers moved the judge to order AIG to advance their costs to defend against the FDIC’s claims under the policy’s “advancement provision,” which obligated AIG to advance covered defense costs until the claim was finally disposed. AIG opposed. Because the claim was excluded under the “insured versus insured” provision, AIG argued, it had no duty to advance defense costs.

The trial court rejected AIG’s argument and ordered the insurer to advance the costs. AIG appealed the trial court’s order, but fared no better before the First Circuit. The appellate court agreed with the trial court’s determination that the policyholders had met the very low threshold to trigger AIG’s duty to advance defense costs. The directors and officers only needed to show a “‘likelihood’ of a ‘remote possibility’ of coverage.” They had done so, the First Circuit concluded, because the FDIC did not allege that it was suing only “on behalf of or in the right of” Westernbank, but also had alleged that it succeeded to the rights of Westernbank’s depositors and account holders. “These allegations made it likely possible – even if only remotely so – that the FDIC is suing on these non-insureds’ behalf.”

The First Circuit acknowledged that courts that have addressed the “insured versus insured” exclusion in cases involving the FDIC have come out on both sides of the issue, but held that this “classic battle of dueling case law” hurts AIG. “With no controlling authority … with nonbinding cases pointing in different directions; and with our obligation to resolve any doubts in the insured’s favor … [AIG’s] suggestion that there is zero likelihood of a remote possibility of coverage falls flat.” Because the directors and officers only had to show a “likelihood” of coverage, “not actuality or probability,” they were entitled to an order requiring AIG to advance their defense costs.

As it often is the case that an insurer’s duty to defend (or advance defense costs) arises if there is a mere “possibility” of coverage, the First Circuit’s decision in W Holding Co., Inc. is a useful reminder of the breadth of that duty, especially where there is a lack of controlling authority on the insurer’s coverage defenses.

Read the First Circuit’s full opinion in W Holding Co., Inc. v. AIG Ins. Co.-Puerto Rico here.