In a January 23, 2018 unpublished decision (here), the Eleventh Circuit held that a D&O insurance policy’s prior acts exclusion does not preclude coverage where the subsequent claim against insured persons is “independent” from the alleged wrongful acts that occurred prior to the policy period. The appellate court’s opinion, in which it affirmed a district court’s ruling rejecting a D&O insurer’s argument that the exclusion precluded coverage for the FDIC’s claim against the former directors and officers of a failed bank, underscores the necessity for a link between the prior wrongful acts and the subsequent claim in order for the exclusion to preclude coverage for the claim. The Carlton Fields law firm’s February 26, 2018 memo about the decision can be found here.
During the period 2005 through 2007, Omni National Bank’s Community Development Lending Division (CDLD) engaged in unsound practices that subsequently triggered regulatory investigations. During the 2008 housing downturn, the bank foreclosed on many of the properties securing the CDLD loans. The foreclosed properties were held as Other Real Estate Owned (OREO) properties. The bank closed the CDLD in December 2007 and a short time later the bank’s board devised a plan to renovate the OREO properties rather than sell them “as is.” The regulators approved this plan in 2008, at a time when regulators had given the bank a “fundamentally sound” rating.
In September 2008, the regulators changed the bank’s CAMELS rating to 5, indicating that the bank was failing or would fail imminently. However, the bank continued to invest in the OREO from that time until the bank failed in March 2009.
After the closure, the FDIC sued certain of the bank’s directors and officer to try to recover the money spent rehabilitating the OREO properties. The directors sought coverage under their D&O insurance policy. The policy had been issued in June 2008 with a one-year policy period. The D&O insurer denied coverage for the OREO properties claim, contending that coverage for the claim was precluded based on the policy’s prior acts exclusion. The parties’ filed cross-motions for summary judgment. The district court denied the insurer’s motion for summary judgment and the insurer appealed.
The Relevant Policy Language
In arguing that coverage for the OREO properties claim was precluded under the policy, the insurer relied on a retroactive exclusion, which excluded coverage for:
Claims based upon, arising out of, directly or indirectly resulting from or in consequence of, or in any way involving:
- Any Wrongful Act actually or allegedly committed prior to 12:01 a.m. Local Standard Time on 9th June 2008, or
- Any Wrongful Act occurring on or subsequent to 12:01 a.m. Local Standard Time on 9th June 2008 which, together with a Wrongful Act occurring prior to such date would constitute Interrelated Wrongful Acts.
The policy further defined “Interrelated Wrongful Acts” as “Wrongful Acts which have as a common nexus any fact, circumstance, situation, event, transaction or series of facts, circumstances, situations, events or transactions.”
The January 23, 2018 Opinion
The Eleventh Circuit, in a January 23, 2018 per curiam opinion designated “Do Not Publish,” affirmed the district court, ruling that the policy’s prior acts exclusion did not preclude coverage for the FDIC’s OREO properties’ claim against the failed bank’s former directors and officers.
In seeking to have the district court’s summary judgment denial overturned, the D&O insurer had argued that the OREO properties claims against the director and officer defendants arose out of the CDLD’s improper lending practices, which took place prior to the policy period.
The appellate court rejected this argument based on its view that “the claim for the OREO Wrongful Acts is not inextricably linked to the Bank’s unsound lending practices in the CDLD.” Rather, the appellate court said, the “wrongful acts claimed are for the particular expenditures to rehabilitate the OREO properties that occurred after – and only after – the Bank received the downgrade to the CAMELS 5 rating in September 2008.”
The decision to continue these expenditures, “even when not necessary,” occurred “after the board knew of the Bank’s impending failure and thereby constitutes an independent business decision from the initial lending practices in the CDLD division.” Before the regulators downgraded the bank’s rating, the defendants’ investment in the OREO “was not a wrongful act.” The D&O insurer neither claimed nor proved that the ratings downgrade “’arose out of’ the wrongful acts of the CDLD division.” The continuing investments in the OREO after the ratings downgrade were not “interrelated wrongful acts” under the policy but “rather were independent wrongful acts that occurred during the policy period.
In reaching this conclusion, the appellate court and considered the D&O insurer’s attempt to rely on a 2017 Eleventh Circuit decision, Zucker v. U.S. Specialty Ins. Co. (here) , in which the court had concluded that a D&O policy’s prior acts exclusion precluded coverage for the FDIC’s claims against the former directors and officers of a different bank. The FDIC’s claim against the former directors and offices of the other bank involved its assertion that the individuals had wrongfully approved a prior dividend from the parent holding company to the subsidiary bank leading to the parent company’s subsequent insolvency. The FDIC contended that the transfer was wrongful at the time it was made because the company was insolvent at the time. The parent bank’s insolvency arose out of the transfer, and therefore the FDIC’s claim “arose out of” the prior wrongful act. The prior wrongful act in the Zucker case, the appellate court said here, was “an essential element” of the FDIC’s claim, and therefore had a “connection to” the subsequent claim, as a result of which the prior acts exclusion precluded coverage for the claim.
The appellate court distinguished Zucker from the current case, because in Zucker, the parent company’s insolvency was the result of wrongful acts that occurred before the policy period. Here, the subsequent claims (that the directors wrongfully decided to continue to fund the OREO expenditures after the bank was downgraded) were unrelated to the alleged wrongful prior acts (the CDLD’s allegedly wrongful lending practices).
Although I think the appellate court got this one right, I have to say I find the result a little bit surprising. The exclusion on which the insurer relied here is extraordinarily broad. The exclusion precluded coverage for subsequent claims if they were “in any way involving” a wrongful act that occurred prior to the policy inception. Although the court here concluded (correctly in my view) that the subsequent claims were based upon an “independent business decision” separate and apart from the initial improper lending practices in the CDLD, I can certainly envision that another court bent on precluding coverage might conclude that the OREO properties claims were “in any way involving” the improper CDLD practices.
The appellate court’s opinion itself may provide some explanation. Although I am not quite sure what the court meant, the court did say in its opinion that the insurer “did not argue that the ‘arising out of’ language in the policy here excluded the FDIC’s claim,” but rather that it “raised that contention for the first time at oral argument, and as a result , it is abandoned.” I find this comment puzzling. I can’t imagine that the insurer didn’t rely both at the district court level and at the appellate court level on the exclusion’s extraordinary breadth in trying to argue that exclusion precluded coverage.
In any event, the court’s holding here does underscore the point that it is not enough for an insurer to deny coverage based on a prior acts exclusion to show that there were prior wrongful acts. In order to rely on the exclusion, the insurer must also show, as the Carlton Fields law firm put it in its memo about the decision to which I linked above, “that the claims made during the policy period arose out of those prior acts.” The insurer must not only establish the wrongful prior act, but it “must also demonstrate the link between the prior wrongful act and the claim made during the policy period.”
I am still puzzled why the exclusion’s “in any way involving” language was not relevant in the analysis of whether or not there was a sufficient “link” between the prior acts and the subsequent claim. The appellate court’s comment about “abandoned” arguments might explain this anomaly. Or it may just be that the court took a coverage first approach to this decision, involving as it does claims brought by the FDIC.