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Insight FDIC Insured vs. Insured Exclusion

Recent decisions from the federal district court in Puerto Rico and the First Circuit Court of Appeals add to the confusion over whether bank directors and officers will receive insurance coverage when they are sued by the FDIC.

Most directors and officers insurance policies cover directors, officers, and the company itself. These so-called A/B/C policies typically include a coverage exclusion for lawsuits between insured parties. For example, the D&O policy will not cover a director, who is insured by the policy, who is sued by the company, which is also insured by the policy. This coverage exclusion is commonly called the “insured vs. insured exclusion.”

We’ve previously blogged about the effect of the insured vs. insured exclusion when the FDIC takes over a bank and subsequently sues the banks former directors or officers. In short, decades of litigation has not answered the question of whether the insured vs. insured exclusion eliminates coverage for directors and officers of a failed financial institution that are subsequently sued by the FDIC. Each case has been decided based on particular facts and policy language, and no general rule or consensus has emerged.

In the latest case, the federal district court for the district of Puerto Rico held that an insurer was required to advance defense costs to former bank directors and officers who were sued by the FDIC. In this case, the FDIC asserted claims on behalf of the failed bank. The FDIC also asserted claims on behalf of the bank’s shareholders and depositors. The directors and officers sought advancement of defense costs from their D&O insurer based on a provision in the policy that required the insurer to advance covered defense costs. In response, the insurer refused to advance the defense costs based on the insured vs. insured exclusion, and the directors and officers sued to compel coverage.

The trial court and the First Circuit Court of Appeals both ruled against the insurer. An insurer can avoid a duty defend only if no possibility exists that the claims would result in coverage under the policy. In this case, however, the insurer could not make this showing for two reasons. First, given the unsettled law in this area, the possibility existed that the trial court could rule that the insured vs. insured exclusion did not bar coverage for the FDIC’s suit. Second, the insured vs. insured exclusion only operates, if at all, to bar coverage for claims made by one insured, such as the bank or the FDIC as its receiver, against another insured, such as a former director or officer of the bank. But in this case, the FDIC also asserted claims on behalf of shareholders and depositors who were not insured by the bank’s D&O policy, and these claims would be covered by the D&O policy. Accordingly, the possibility existed that the FDIC’s claims on behalf of the shareholders and depositors could trigger coverage under the D&O policy even if the insured vs. insured exclusion barred coverage for the claims the FDIC brought on the bank’s behalf. For these two reasons, the First Circuit ruled that the directors and officers had established a remote possibility that the claims would be covered by the banks D&O policy—and that this remote possibility was sufficient to trigger the insurer’s duty to defend.

Like previous rulings in this area, this ruling is fact specific, but it offers some comfort to directors and officers of FDIC insured financial institutions. The practical reality is that most directors and officers do not have sufficient personal means to fund protracted and expensive litigation against a government agency such as the FDIC. Although this case does not settle the larger matter of whether the insured vs. insured exclusion applies to actions brought by the FDIC as the receiver of a failed bank, the case does create helpful precedent for future insureds who seek to have their D&O carrier advance their defense costs.

As we have noted before, the best practice is for banks to negotiate D&O coverage that expressly provides coverage for claims brought by the FDIC as the receiver for the bank.

For more information contact our Banking group or call 208.344.6000

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