A prior acts exclusion in a bank holding company’s D&O insurance policy precludes coverage for claims based on allegedly fraudulent transfers made to a banking subsidiary during the policy period, because the transfers arose out of wrongful acts that occurred prior to the policy’s past acts date, according to a recent decision by the Eleventh Circuit, applying Florida law. The appellate court reasoned that, though the transfers occurred during the policy period, what made the transfers fraudulent was the company’s insolvency, which arose from officer misconduct that took place prior to the policy’s past acts date. The case provides an interesting example to consider past acts coverage in claims made policies.
In September 2008, BankUnited Financial Corporation, a bank holding company, reported in a regulatory filing that unless its subsidiary, a federally chartered bank, raised $400 million, the OTS would downgrade its capitalization rating. That same month, the holding company and the bank entered agreements with the OTS stipulating that they “had engaged in unsafe and unsound practices that … resulted in the [subsidiary] being in an unsatisfactory condition.”
At about this same time, the holding company’s incumbent D&O insurer declined to renew the company’s D&O insurance policy. The holding company obtained an insurance proposal from a different insurer. The new insurer provided two options, one without past acts coverage (that is, providing coverage only for wrongful acts taking place after policy exception), and another providing full past acts coverage, at a significantly higher premium. The bank holding company selected the lower cost option without past acts coverage and applied the savings to purchase higher limits. The past acts exclusion precluded coverage for wrongful acts occurring prior to November 10, 2008.
In January and March 2009, officers of the parent company authorized the proceeds of tax refund checks from the U.S. Treasury to the parent company to be transferred to the banking subsidiary. The two checks totaled approximately $46 million.
In May 2009, the OTS closed the subsidiary bank and appointed the FDIC as receiver. The next day, the parent company filed for bankruptcy. The committee of unsecured creditors subsequently filed an adversary proceeding against several officers of the bank. The creditors’ complaint contained multiple counts, alleging, among other things breach of fiduciary duty. The complaint also contained a separate count alleging that the transfer of the holding company’s tax refund checks violated Florida’s Uniform Fraudulent Transfers Act. The holding company’s D&O insurer denied coverage for the lawsuit in reliance on the policy’s past acts exclusion.
The fraudulent transfer claim ultimately was settled for $15 million, with the settlement amount to be paid either by the D&O insurer or the individual defendants. The individuals assigned their rights under the D&O insurance policy to the bankruptcy administrator, who filed a breach of contract lawsuit against the insurer. The administrator and the insurer filed cross-motions for summary judgment. The district court granted the insurer’s summary judgment motion, holding that the policy’s past acts exclusion precluded coverage for the settlement. The administrator appealed.
The prior acts exclusion provides that:
In consideration of the premium charged, it is agreed that the Insurer will not be liable to make any payment of Loss in connection with a Claim arising out of, based upon or attributable to any Wrongful Act committed or allegedly committed, in whole in or in part, prior to [November 10, 2008].
The policy defines the term “Wrongful Act” to mean any
(1) actual or alleged act, error, misstatement, misleading statement, commission or breach of duty: (a) by an Insured Person in his capacity as such, including in an Outside Capacity; or (b) with respect only to Securities Claims, by the Company; or
(2) matter claimed against an Insured Person solely by reason of his or her service in such capacity or in an Outside Capacity.
The May 16 Decision
In a May 16, 2017 opinion written by Chief Judge Ed Carnes for a unanimous three-judge panel, the Eleventh Circuit affirmed the district court’s summary judgment grant, agreeing with the district court that the policy’s past acts exclusion precludes coverage for the settlement.
In reaching its decision, the appellate court relied on Florida case law interpreting the phrase “arising out of” in insurance policy exclusions. The phrase, the Florida courts held and the appellate court observed is not ambiguous and has a broad meaning; the Florida cases, the appellate court said, “show that the ‘arising out of’ standard is not difficult to meet.”
In light of the Florida courts’ broad interpretation of the “arising out of” standard, the appellate court concluded that concluded that the parent company’s insolvency arose out of wrongful acts that occurred before November 10, 2008. The operative complaint in the underlying lawsuit alleged that corporate officers committed wrongful acts, some of them before November 2008, that harmed the company financially. The wrongful conduct of the corporate officers “contributed to the insolvency that made the 2009 tax refund transfers fraudulent under Florida law.”
The court agreed with the bankruptcy administrator that insolvency itself is not a wrongful act, but “what matters here is that an essential element of his claim – the Parent Bank’s insolvency – has a connection to some prior wrongful acts of the Parent Bank’s officers and directors that occurred before the policy’s effective date.” Given that, the fraudulent transfer claims “do ‘share a connection’ with wrongful acts covered by the Prior Acts exclusion.”
While the court agreed that the claimant in the underlying claim did not have to prove that the officers engaged in misconduct in order to prevail on the fraudulent transfer claim, that “does not, however, mean that there was no causal connection between the officers’ deeds and the demise of the Parent Bank.” Rather, “the misconduct was a significant contributing cause of the Parent Bank’s vulnerability to the 2008 financial crisis.” For that reason, the appellate court said, “it is plain that [the] fraudulent conveyance claims ‘arose from’ wrongful acts that predate November 10, 2008 and therefore fell within the scope of the Prior Acts exclusion.”
Finally, the appellate court rejected the bankruptcy administrator’s claim that the enforcement of the prior acts exclusion renders coverage under the policy illusory. The prior acts exclusion, the court said, “excludes a lot of coverage but not all coverage.” The court added that the parent company entered into the contract “with its eyes open and its wallet on it mind.” The company was offered, as a materially higher cost, a policy that provided full past acts coverage, but it chose the option with the exclusion, using the premium savings to buy increased limits. “In hindsight, that decision did not work out well, but it was the decision of a sophisticated, fully informed party.” The court added that “prior acts exclusions serve valid purposes when agreed to by consenting parties.”
My initial take on this decision based on my first cursory read was concern that the appellate court was applying the past acts exclusion for conduct – the transfer of the tax refunds to the subsidiary bank – that clearly took place during the policy period (and therefore after the past acts date).
On closer read, I can see that what mattered here was the exclusion’s use of the broad “arising out of” preamble language. Florida’s courts, like most courts in general, interpret these provisions very broadly. What made the fraudulent transfers illegal under Florida law was that the parent company was insolvent at the time of the transfers. What made the company insolvent was the misconduct of the company’s directors and officers, some of which took place before the past acts date. So claim arose out of wrongful acts that occurred before the past acts date, and therefore the claim was excluded.
If nothing else, this case underscores the importance of the past acts date. Ordinarily, when coverage moves from one carrier to another, the insurance buyer will be able to preserve full continuity of coverage as well as full (or at least equivalent) past acts coverage. Unfortunately for the holding company here, the company was going through the throes of the 2008 financial crisis at the moment when it needed to renew its D&O insurance coverage. At a critical moment, the bank had to decide whether or not to pay an extraordinary premium in order to secure full past acts coverage.
At things turned out, it is easy to say that the bank should have purchased the full past acts option. The bank decided to buy the lower cost option, with the past acts exclusion, and use the savings to buy increased limits. It is clear from details in the appellate decision that the company hoped it could protect itself from claims based on acts that occurred prior to the past acts date by purchasing extended discovery coverage from the predecessor insurer. The problem for the company is that the actual fraudulent transfers took place during the subsequent policy period, so the predecessor carrier would argue that its discovery coverage did not apply to the fraudulent transfer claim, even if the fraudulent transfer claim did, as the court found here, arise out of, prior wrongful acts.
For those of us where were around and working on this kind of stuff at the time of the financial crisis (which is now somehow getting to be a while ago), we recall that the difficulty that troubled banks were having then getting their D&O policies renewed with full (or at least equivalent) past acts coverage. This bank at least had an option to secure full past acts coverage. In hindsight, it is easy to say that the bank should have chosen the option that offered full past acts coverage. Those kind of hindsight judgments disregard how complicated these kinds of situations can be.
For me, I won’t criticize or even question the choice the bank made. I recall all too well how difficult the process was for troubled banks at that time, and how there were many difficult decision to make. While we can’t turn back the hands of time or change the decision that the bank make, the rest of us can now at least benefit from the lessons that this case provides.
The fact is that full past acts coverage is important, and that without it, there is a risk of coverage gaps. Indeed, as this case shows, the gaps can arise even where, as here, the bank tried to provide itself with a measure of prior acts coverage by purchasing extended reporting coverage from the predecessor carrier. The real threat comes from circumstances that allege wrongful acts whose timing straddles the past acts date. To be sure, there may be times when full past acts coverage simply isn’t available, but where it is available, full past acts coverage is going to be the better choice, even at considerably greater cost.
There is one more thing to think about with respect to the wording of the past acts exclusion. Clearly it was critically important, perhaps outcome determinative, that the exclusion here used the “arising out of” language. The causal connection between the bank officers’ wrongful misconduct (causing the bank’s insolvency) and the subsequent fraudulent transfer provided the basis on which the court held that the exclusion applies. The outcome might well have been different if instead of using the “arising out of” language, the exclusion had used a “for” wording. The claim against the individual defendants was not “for” wrongful acts that occurred prior to the past acts date. The policy’s use of the “for” wording would have narrowed the exclusion’s preclusive effect and reduced the chance of a subsequent claim falling into a gap.
Of course, under the circumstances here, the carrier involved was very focused on making sure that at the lower priced option without past acts coverage that the past acts exclusion would have a broad preclusive effect. The carrier almost certainly would be unwilling to offer the exclusion using the “for” wording. For that matter, most carriers seeking to preclude past acts coverage will seek to word the exclusion as broadly as possible. It may be that an exclusion using the “for” wording simply is not and will not be available in most circumstances. It is still worth thinking about though, given the broad preclusive effect that courts give for exclusions with the broader wording.