Suppose a troubled bank went to renew its D&O insurance in the throes of the financial crisis. Suppose further that the bank’s D&O insurer refused to renew its primary policy without a regulatory exclusion. Suppose that the primary insurer’s renewal binder specified that the renewal was subject to a regulatory exclusion. However, suppose further that when the insurer issued the policy, the insurer omitted the regulatory exclusion. Suppose the insurer noticed the omission of the exclusion a month later – coincidentally, the same day regulators closed the bank and the FDIC was appointed the bank’s receiver – and sent the bank’s insurance agency an endorsement intended to add the omitted exclusion to the policy.

As you might well imagine given these circumstances, when the D&O insurer later denied coverage for the FDIC’s claims against the failed bank’s former directors and officers based on the regulatory exclusion, coverage litigation ensued.

On March 18, 2016, in an interesting opinion that is both very fact-intense and highly dependent on a federal statute specifying what kinds of agreements can be enforced against the FDIC as receiver of a failed bank, Northern District of Georgia Judge Thomas W. Thrash, Jr. denied the insurers’ motions for summary judgment and granted the summary judgment motions of the FDIC, holding that the regulatory exclusion could not be enforced. A copy of Judge Thrash’s March 18, 2016 opinion and order granting the FDIC’s motion can be found here. His separate March 18, 2016 opinion and order granting the individual directors’ and officers’ motion for partial summary judgment can be found here.

Background

Silverton Bank of Atlanta, Georgia failed on May 1, 2009. As discussed here, in August 2011, when the FDIC filed a lawsuit alleging claims of breach of fiduciary duties and negligence against Silverton’s former directors and officers, the FDIC also named as defendants Silverton’s primary and excess D&O insurers.

At the time the bank failed, it carried a total of $10 million of D&O insurance, arranged in two layers consisting of a primary layer of $5 million and an additional $5 million layer excess of the primary. When the primary insurer issued its renewal binder on March 3, 2009, the binder listed ten endorsements, including an endorsement containing the so-called regulatory exclusion (for background about the regulatory exclusion, refer here). However, when the primary carrier issued the actual policy on April 1, 2009, only seven of the ten endorsements that had been listed on the binder were included on the policy. Among the endorsements listed on the binder but not included on the issued policy was the regulatory exclusion endorsement.

On the afternoon of May 1, 2009 (that is, the day regulators closed Silverton), a representative of the primary carrier sent Silverton’s agent an email message that he “had noticed that the Regulatory Endorsement was on the Binder but left off the policy in error,” and attached to the email an endorsement with the regulatory exclusion dated May 1, 2009 but with an effective date of March 9, 2009.

In March 2010, the FDIC sent demand letters to former Silverton directors and officers, which the directors and officers tendered to the insurers. The carriers denied coverage for the FDIC’s claims, in reliance on the regulatory exclusion. The lawsuit that the FDIC subsequently filed both against the directors and officers and against the D&O insurers among other things sought a judicial declaration that the agency’s claims against the failed bank’s former directors and officers were covered under the policies. The individual defendants separately filed claims against the insurers for breach of contract. The parties filed motions for summary judgment.

In support of its motion, the primary D&O insurer contended that the undisputed facts showed that insurer and the bank had agreed that the insurer’s renewal policy would contain the regulatory exclusion. The excess insurer, whose policy provided excess coverage on a follow-form basis, also contended that the regulatory exclusion precluded coverage, and argued further that if the regulatory exclusion was not included in the policies, the policies should be reformed to include the exclusion. Finally, the excess insurer contended that if the regulatory exclusion was not a part of the primary policy, then it had issued its policy pursuant to a material misrepresentation, and therefore it should be rescinded.

In support of its summary judgment motion, the FDIC relied in part upon 12 U.S.C. Section 1823(e), which provided in pertinent part that:

No agreement that tends to diminish or defeat the interest of the [FDIC] in any asset acquired by it under this section … shall be valid against the [FDIC] unless such agreement – (A) is in writing, (B) was executed by the depositary institution and any person claiming an adverse interest thereunder, including the obligor, contemporaneously with the acquisition of the asset by the depositary institution, (C) was approved by the board of directors of the depositary institution or its loan committee, which approval shall be reflected in the minutes of said board or committee, and (D) has been, continuously, from the time of its execution, an official record of the depositary institution.

The FDIC argued in reliance on this statutory provision that a private party may not enforce against the FDIC any obligation not specifically memorialized in a written document such that the agency would be aware of the obligation when conducting an examination of the institution’s assets. Section 1823(e) prevents parties from diminishing the FDIC’s interest in an asset by relying on an agreement that was not contained in the bank’s records. The FDIC argued that the D&O insurance policies were assets of the bank. The FDIC argued further that the alleged agreements concerning the regulatory exclusion diminished the FDIC’s interest in its claims against the directors and officers because the exclusion would diminish any potential recovery by the FDIC.

The March 18 Rulings

In his March 18 Opinion and Order, Judge Thrash granted the FDIC’s motion for summary judgment and denied the motions of the insurers. In a separate order, he granted the individuals’ motion for partial summary judgment, holding that the insurers were obligated to pay the individuals’ defense expenses.

In granting the FDIC’s motion, Judge Thrash agreed that the insurance policies were assets of the bank and that any efforts to diminish the value of the asset to the FDIC were subject to the requirements of the statute. Judge Thrash rejected the insurers’ arguments that the regulatory exclusion was part of the policy based on the reference in the primary insurer’s renewal binder to the regulatory exclusion, noting that the binder by its own terms terminated upon issuance of the policy. After the primary insurer issued its policy, there was nothing in the bank’s records to show that the insurance had been issued subject to the regulatory exclusion; to the contrary, the only relevant document in the bank’s records after that was the primary policy, which had been issued without a regulatory exclusion.

Judge Thrash also concluded that the primary insurer’s belated effort to amend the policy by sending the endorsement with the exclusion to the bank’s agent did not satisfy the requirements of Section 1823(e). Under the statute, in order for the amendment to be effective, the bank would have to have an agreed to the amendment and the amendment would have to complied with all of the other requirements of Section 1823(e).

Judge Thrash rejected the excess insurer’s argument seeking reformation of the primary policy, because any alleged intent to include the regulatory exclusion on which a reformation would be based was not documented to the bank’s record as the statute required. Judge Thrash also rejected the excess insurer’s argument that it was entitled to rescission based on a misrepresentation about the inclusion of a regulatory exclusion, finding that fraudulent inducement or reliance on a misrepresentation is barred by Section 1823(e).

Judge Thrash’s separate order granting the individuals’ motion is terse. In the order, Judge Thrash characterized the primary insurer’s argument against coverage for the individuals’ defense costs as made in reliance on a “presently non-existent exclusion.” After reciting the allegations the FDIC has raised against the individuals, Judge Thrash noted that the primary insurer’s policy “as written, covers such allegations,” and therefore, under Georgia law, that the primary insurer has a duty to advance the individuals’ defense costs. He added, without elaboration or explanation, that the insurer’s “efforts to reform the policy to include a regulatory exclusion has been defeated.”

Discussion

In a recent post, I noted that it is important for D&O insurance professionals to keep up with court decisions in coverage cases not only to understand how courts are interpreting and applying policy provisions, but also for the practical lessons that the cases often present. This case certainly underscores this point. The facts involved in this case provide a veritable parable about the importance of making sure that the issued policy matches the terms of the binder.

In the end, Judge Thrash’s contention that the insurers could not enforce the regulatory exclusion against the FDIC was heavily dependent on the fact that the insurers were seeking to enforce the exclusion against the FDIC and the fact that the FDIC had a potent statutory weapon to use in defeating the insurer’s attempts to deny coverage.

I will leave it to others to analyze whether or not the statute appropriately should be interpreted or applied as Judge Thrash did here. What is much more interesting to me is Judge Thrash’s ruling with respect to the individuals. Although his ruling with regard to the individuals is very brief, it appears that because, by operation of the statute, the regulatory exclusion could not be enforced with regard to the FDIC, the exclusion could not be enforced or applied as to the individuals either, full stop.

It seems clear from the factual recitation in Judge Thrash’s opinion that while the bank had not wanted to renew its D&O insurance with a regulatory exclusion added, the bank had accepted the primary insurer’s renewal offer on the terms proposed, including with respect to the inclusion of the regulatory exclusion. The binder memorialized the parties’ agreement and understanding with respect to the inclusion of the regulatory exclusion; the binder reflected the terms to which the parties had agreed, the policy that was subsequently issued did not. I wonder, in the absence of the kind of statutory provisions on which the FDIC was able to rely here, would a party seeking to enforce coverage have been able to avoid the application of the regulatory exclusion?

Whatever else you might want to say, it seems likely that if the policy had been issued consistently with the binder, the claims against the former bank’s directors and officers likely would have been subject to the preclusive effect of the regulatory exclusion. That is, there likely would not have been coverage under the primary policy for the claims. For that matter, there likely would not have been coverage under the excess policy either.

There might be those who think that this outcome is particularly unfair to the excess carrier, since it was not one that committed the policy issuance error. However, as I understand the facts, the excess carrier did have a copy of the primary policy (from which the regulatory exclusion had been omitted) when the excess carrier issued its policy, yet issued its policy anyway. The dynamic between the excess insurer and the primary insurer are certainly further complicated by the fact that the excess insurer recently purchased the primary insurer.

Special thanks to a loyal reader for sending me a copy of Judge Thrash’s opinion.