I heard free-market economist Lawrence Reed speak today at a Foundation for Free Enterprise luncheon. Mr. Reed made the point that for free markets to function properly, citizens must assign top priority to raising the caliber of their character, and learning from those who display the highest ethics. His point was that society descends into barbarism when people abandon what’s right in favor of self-gratification at the expense of others; when lying, cheating, or stealing are “winked at” instead of shunned. We’ve seen a lot of lying and cheating in recent years, from Enron to Bernie Madoff. And, as a result, the current litigation climate isn’t so great for corporate officers and directors, the vast majority of whom are decent, hard-working people.
Not surprisingly, following the collapse of the financial markets in 2008, many coverage attorneys (including me) have been answering a lot of questions about the applicability of D&O coverage to lawsuits brought by unhappy investors and by regulators. Seemingly, not a day goes by without media coverage of a major settlement or lawsuit relating in some way to the Great Fiscal Meltdown. As I write this, J.P. Morgan, for example, has just paid $218 million to settle class-action litigation relating to the Madoff mess.
An interesting recent case out of Federal Court in Kansas dealt with the question of whether, when the FDIC brings a lawsuit, the “insured v. insured” exclusion negates specifically-purchased coverage for actions brought by regulatory agencies. The case involves the now-defunct Colombian Bank and Trust Company and its directors and officers. The Bank went belly-up in 2008, and the FDIC alleged that the bank’s directors and officers had breached their fiduciary duties by approving risky commercial real estate loans and failing to supervise bank lending functions properly. The FDIC eventually resolved its suit against the directors and officers for $5 million.
BancInsure, which had sold D&O coverage to the Bank’s directors and officers, disclaimed coverage for the FDIC suit, and filed a declaratory judgment action seeking to justify its “no pay” position.
The policy contained an “insured v. insured” exclusion with unique language, providing in part that BancInsure would not be liable for losses in connection with any claim against the directors or officers “based upon, arising out of, relating to, in consequence of, or in any way involving…a claim by, or on behalf of, or at the behest of…any… Receiver” of the Bank.
BancInsure cited the “insured v. insured” exclusion as part of the basis for its denial.
The Policy also contained a regulatory exclusion, which relieved BancInsure of liability for “any action…brought by or on behalf of any Federal or State regulatory or supervisory agency or deposit insurance organization…[including] any type of legal action which any Agency may bring as receiver.”
But: The policy contained an endorsement stating that the policy “is hereby amended by the deletion of the [Regulatory] Exclusion.”
The policyholders argued, quite logically, that by purchasing the endorsement, they had purchased protection for lawsuits brought by regulatory agencies, including the FDIC. Therefore, the policyholders contended, the specific coverage for suits brought by regulatory agencies trumped the “insured v. insured” exclusion.
Alas, the Court ruled in favor of the carrier. The Court noted a split of authority on the issue of whether “insured v. insured” exclusions in D & O policies can apply to claims by the FDIC. The majority view holds that coverage exists for FDIC claims, even though the FDIC steps into the shoes of a failed bank (in other words, the FDIC is considered to be an “insured” under certain D&O policies). The problem for the policyholders in this case, though, was that here (unlike in the cases making up the majority view), the policy specifically excluded coverage for claims by entities acting as successors, receivers, assignees and trustees. The Court noted: “Not only does the ‘insured v. insured’ provision exclude claims brought by or on behalf of the Bank against the individual defendants, but it also expressly excludes claims brought by or on behalf of receivers of the Bank.”
Citing a Federal Court decision from Georgia also involving BancInsure, the Court wrote: “The [Georgia] court noted that the ‘insured v. insured’ exclusion and the regulatory exclusion overlap when a regulatory agency brings an action as a receiver, but that removing the regulatory exclusion did not affect the application of the ‘insured v. insured’ exclusion. A reasonable person in the position of the insured would understand that the ‘insured v. insured’ exclusion means that claims by FDIC as receiver are excluded.”
It’s always interesting when Courts speak about the mythical “reasonable person in the position of the insured.” Here, we have policyholders who specifically purchased the deletion of the regulatory action exclusion – but the purchase of that deletion appears to have been meaningless based on the Court’s construction of the policy. Doesn’t the Court’s opinion here make the paid-for coverage for regulatory actions an illusion?
I think the important lesson is that, with regulatory enforcement on the rise, it’s very important for D&O policyholders to read all insurance policy provisions dealing with coverage for regulatory actions very carefully. If there appears to be any conflict in the policy language, don’t be shy about trying to negotiate with the carrier or through your broker.