During the course of the wave of failed bank litigation following in the wake of the global financial crisis has been a raft of related coverage litigation addressing the question of whether coverage for claims by the FDIC as receiver of the failed bank against the bank’s former directors and officers is precluded by the D&O insurance policy’s Insured vs. Insured exclusion. A number of courts have found the exclusion to be ambiguous and therefore that the exclusion does not preclude coverage for the FDIC-R’s claims (for example, refer here), while other courts have found the specific exclusions at issue to unambiguously preclude coverage (refer for example here). In the most recent court decision to address these issues, the Ninth Circuit, in a short unpublished October 19, 2016 per curiam opinion (here) affirmed the holding of the district court finding the Insured vs. Insured exclusion applicability to claims brought by the FDIC as receiver is ambiguous, and therefore the exclusion cannot be applied to preclude coverage for the FDIC’s claims against the former directors and officers of the failed Pacific Coast National Bank.
Pacific Coast National Bank of San Clemente, California failed on November 13, 2009. In November 2012, the FDIC, as the failed bank’s receiver filed a civil action against five of the bank’s former directors and officers, alleging negligence, gross negligence and breaches of fiduciary duty in relation to various loans the bank had made ad that allegedly resulted in millions of dollars of losses to the bank. The individual defendants sought coverage for the claims under the bank’s D&O insurance policy. The D&O insurance carrier, in turn, filed an action seeking a judicial declaration that there was no coverage under the policy for the FDIC’s claims. The FDIC moved for summary judgment in the coverage litigation and the individual defendants jointed in the FDIC’s motion. The insurer filed a cross-motion for summary judgment.
In denying coverage, the insurer relied on two policy provisions, the Insured vs. Insured Exclusion and the Unpaid Loan Carve-Out. The Insured vs. Insured Exclusion provided in pertinent part that the policy does not provide coverage for any claim against an Insured “brought by or on behalf of any Insured or Company [including the Bank] in any capacity.” The Unpaid Loan Carve-Out provides that the Loss as defined in the policy does not include “any unrepaid, unrecoverable or outstanding loan, lease or extension of any credit to any Affiliated Person or Borrower.”
The District Court Opinion
As discussed here, in an October 8, 2014 Opinion, Central District of California Judge Andrew Guilford denied the insurer’s motion for summary judgment and granted the motion for summary judgment of the FDIC and of the individual directors and officers. Judge Guilford held that the two policy provisions on which the insurer relied are ambiguous and therefore cannot serve as a basis to deny coverage. A copy of Judge Guilford’s opinion can be found here.
With respect to the Insured vs. Insured Exclusion, Judge Guilford said that the fact that the exclusion is ambiguous when applied to the FDIC in its capacity as receiver of a failed bank “is evidenced by the fact that courts considering this exclusion have reached varying conclusions.” Noting the many decisions that have similarly concluded that the exclusion is ambiguous, Judge Guilford said that “there can be little doubt that repeated disputes over the Insured vs. Insured Exclusion have placed insurers on notice that it is ambiguous.”
Judge Guilford went on to note that “the insurance company has the ability, as a repeat party to these contracts, to ensure that ambiguities are eliminated over time.” The insurer “had the opportunity to make clear in the Policy that the Insured vs. Insured Exclusion applied to the FDIC-R, and it could have done so with a simple statement.” Judge Guilford noted that, in fact, the carrier “provides an optional regulatory exclusion – not included on the policy here – that explicitly names the FDIC.”
The D&O insurance carrier appealed Judge Guilford’s ruling
The Ninth Circuit’s Opinion
In an unpublished October 19, 2016 per curiam opinion for a unanimous three judge panel, the Ninth Circuit affirmed the district court’s rulings. The appellate court concluded that the district court “properly held” that the exclusion is “ambiguous as applied to the FDIC as receiver and therefore must be construed in favor of coverage.” In concluding that the exclusion’s applicability to claims by the FDIC-R is ambiguous, the court noted that “the FDIC as receiver represents a number of interests and does not operate as a normal successor in interest.” The court also noted that the exclusion does not refer to claims brought by the FDIC as receiver and that the policy did not contain a regulatory exclusion.
The Court concluded that the insurer bears the burden to phrase exclusion in “clear and unmistakable language” and of establishing that a claim is specifically excluded. The appellate court concluded that the insurer had failed to carry that burden, “despite having notice that similar exclusions had been deemed ambiguous by other courts.”
Finally, the appellate court also affirmed the district court’s conclusion that the unrepaid loan carve-out was also ambiguous and did not preclude coverage for this claim.
As I noted at the outset, during the course of the current bank failure wave, a number of courts have addressed the question of whether or not the Insured vs. Insured exclusion precludes coverage for claims brought by the FDIC as receiver of a failed bank against former directors and officers of the bank. Among these rulings, certain generalizations can be made.
The Ninth Circuit’s ruling that the applicability to FDIC-R claims is ambiguous is consistent with the Eleventh Circuit’s December 2014 ruling in a case involving the failed Community Bank & Trust of Cornelia, Georgia, in which the Eleventh Circuit held that the Insured vs. Insured exclusion’s applicability to the FDIC’s claims against the failed bank’s former directors and officers to be ambiguous (as discussed here).
Seemingly on the other side of this question, in August 2015, the Tenth Circuit held the Insured vs. Insured exclusion at issue in that case to unambiguously preclude coverage for the FDIC’s claims against the former directors and officers of the failed Columbian Bank & Trust of Topeka, Kansas.
However, on closer review, the Tenth Circuit’s decision does not conflict with the rulings of the Eleventh and Ninth Circuit, owing to differences in the exclusionary language involved. As discussed here, the exclusionary language at issue in the case before the Tenth Circuit – by contrast the exclusionary language involved in the cases in the Eleventh and Ninth Circuits – expressly precluded coverage for claims brought by a “receiver of a company.”
From my perspective, there is now ample case authority from which certain conclusion can be drawn about these issues.
First, if an insurer intends to preclude coverage for claims brought by the FDIC as receiver against the former directors and officers of a failed bank, the surest and most effective way to do so is by the inclusion of a regulatory exclusion (about which refer here). The insurer must understand that in the absence of a regulatory exclusion its attempts to argue that the policy nevertheless precludes coverage for FDIC-R claims will be challenged and likely will be unsuccessful.
Second, the insurers should understand that there are now two federal circuit court opinions standing for the proposition that the applicability of the Insured vs. Insured exclusion to FDIC-R claims is ambiguous. The insurers are, as the Ninth Circuit said, “on notice” about this ambiguity. As Judge Guilford said at the district court level in this case, “the insurance company has the ability, as a repeat party to these contracts, to ensure that ambiguities are eliminated over time.” Clearly, the Insured vs. Insured exclusion alone is not a reliable basis on which the insurers can rely to try to preclude coverage for FDIC-R claims.
Third, if the insurers nevertheless intend to rely on the Insured vs. Insured exclusion to try to preclude coverage for FDIC-R claims – even in the absence of a regulatory exclusion – the insurers should include language of the type at issue in the Tenth Circuit decision, in which the exclusion expressly precluded coverage for claims “brought by a receiver of a company.” In the absence of this type of language, an insurer arguably would lack a substantial basis on which to argue that the Insured vs. Insured exclusion unambiguously precludes coverage for FDIC-R claims.
It is worth noting that we went through all of these issues about the Insured vs. Insured exclusion years ago, during the Savings and Loan crisis. We have now gone through all of these issues again 25 years later, following the global financial crisis. If a couple of decades ahead we have to go through yet another banking crisis and the insurers find themselves besieged by FDIC-R claims against their insured banks, if the insurers want to try to preclude coverage for those claims, they will likely depend on whether or not the insurers have included a regulatory exclusion in their policies. In the absence of regulatory exclusions, the Insured vs. Insured exclusion alone is not going be enough for the insurers to preclude coverage for the FDIC-R claims.
An October 2016 memo from the Hunton & Williams law firm discussing the Ninth Circuit’s opinion can be found here. The Wiley Rein law firm’s October 28,2016 memo about the Ninth Circuit’s decision can be found here. Special thanks to a loyal reader for sending me a copy of the Hunton & Williams law firm memo.
Insured vs. Insured Exclusion in Other Jurisdictions: The Insured vs. Insured exclusion is a frequent source of insurance coverage disputes. That is not only true in the U.S., it is true in other jurisdictions as well. As discussed in a November 1, 2016 memo from the Israeli law firm, Leviton Sharon & Co. (here), Israeli Supreme Court recently addressed the question of the applicability of the Insured vs. Insured exclusion to a claim brought by a court-appointed “operating manager” against the directors of an organization that provided services for mentally handicapped adults.
Following concerns at the organization, certain petitioners had previously successfully sought to have a court appoint an operating manager for the organization. The court-appointed operating manager subsequently filed claims against the organization’s former CEO and four other organization directors, as well as against the organization’s D&O insurer. The D&O insurer disputed coverage on a number of grounds, including the Insured vs. Insured exclusion. The lower court ruled that the exclusion did not apply, and the claimants appealed.
On appeal, the Israel Supreme Court overturned the lower court’s ruling with respect to the Insured vs. Insured exclusion. The Supreme Court’s ruling depended on the carve-back within the Insured vs. Insured exclusion, which preserved coverage for claims filed by a liquidator, receiver, or authorized administrator appointed by a competent authority.
In concluding that the underlying came within the exclusion’s coverage carve-back, the court said the purpose of appointing the operating manager had been similar to that of appointing an administrator to the company. Even though the court had not granted the operating manager the full powers of a liquidator or receiver, the essence of his role had been similar to that of an administrator. As a result, the claim came within the coverage carve-back and policy coverage applied.