By Joseph P. Monteleone
There are a number of key issues that might influence the effectiveness of a directors’ and officers’ (D&O) liability insurance policy when a bank fails and the Federal Deposit Insurance Corporation (FDIC) steps in.
The standard for D&O liability in claims brought against them by the FDIC in its capacity as a receiver of a failed bank is either negligence or gross negligence, depending on applicable state law. Although it might be more difficult to establish gross negligence, neither standard presents any insurance implications, as the policies will typically cover any wrongdoing short of willful or knowing misconduct. The FDIC, however, may sometimes elect to seek civil penalties against these individuals, and fines and penalties are almost always excluded from D&O coverage.
Perhaps the two most important policy provisions to consider are the regulatory and insured-versus-insured exclusions. The regulatory exclusion is typically added to a policy by way of an endorsement, but it is not necessarily commonplace. On the other hand, the insured-versus-insured exclusion is found in most policy forms, but may be substantially modified by way of endorsements.
Both of these exclusions were actively litigated during the savings and loan crisis in the 1980s and 1990s in actions brought by the FDIC and other regulators directly against D&O insurers. After an initial round of somewhat mixed results, the courts ultimately upheld the regulatory exclusion on a widespread basis.
The language of the exclusion varies from insurer to insurer, but a well-crafted exclusion will preclude coverage for any claim brought by the FDIC or similar federal or state banking regulator. Simply put, one essentially need only consider who is the claimant to determine the applicability of the exclusion.
The problem for insurers, however, is that many of them were caught flat-footed at the advent of the current wave of bank failures and did not have these exclusions in place as the claims began to be asserted.
Insurers have experienced somewhat more mixed results with the insured-versus-insured exclusion. Although present in most policy forms, there are often many “carveouts” to the exclusion that reduce its efficacy. One such carveout, for example, is that the exclusion may not apply to any claim brought by a receiver. Although the intent of the exclusion was not limited to precluding coverage for collusive suits (and suits by the FDIC against bank officers and directors are rarely, if ever, collusive), many courts have considered this factor in deciding not to uphold the exclusion.
Personal Assets Targeted
Most D&O policies on the market provide coverage for directors and officers and, to a more limited extent, the corporate entity and its non-officer employees. In a failed bank situation, the entity coverage, which would extend to the bank itself and any corporate parent holding company, is not a consideration, as both are typically insolvent and not the subject of any claims.
Employee coverage is a bit more tricky, and may be limited to situations where securities claims are brought and where the employee is a co-defendant with an otherwise covered director or officer. In many failed bank situations, key wrongdoers and targets of the FDIC are non-officer employees. Policy wordings vary and must be carefully analyzed to determine if these employees are afforded coverage.
Finally, and although the FDIC is frequently the most aggressive plaintiff in pursuit of bank directors and officers, failed bank situations typically result in a number of claims from different constituencies. As a real-life example, in a current failed bank case, claims have been brought by:
- the FDIC
- a class action by shareholders of the bank’s parent company
- an Employee Retirement Income Security Act action brought by participants in and beneficiaries of the bank’s pension and welfare plans
- a Department of Labor investigation in connection with alleged ERISA violations
- a Securities Exchange Commission investigation involving alleged securities law violations
- a Department of Justice investigation concerning potential criminal conduct of one or more bank officers
All of the claims are subject to coverage under the same limited pool of insurance proceeds.
What happens if the insurance is not sufficient to satisfy all of those feeding at the trough? The unfortunate answer for bank directors and officers is that many of these claimants, in particular the FDIC, will pursue the directors’ and officers’ personal assets in addition to the available insurance.