In the wake of the savings and loan crisis of the 1980s, insurers and bankers feuded over directors and officers' liability policies. At issue: whether D&O policies covered claims brought by the Federal Deposit Insurance Corporation against a failed bank's officers. Years of messy litigation failed to settle the question conclusively, and insurers responded by tightening their policies with ironclad exclusions of future FDIC claims.
But with few bank failures in the decade and a half that followed, insurers began loosening their terms in an effort to attract new business.
Now, with hundreds of banks having been seized, bankers, insurers, and the FDIC are on the verge of picking up coverage disputes where they left off. Only a few examples of such disputes have landed in court so far, but there are potentially billions of dollars of insurance claims are on the line.
"The FDIC has been proceeding so gradually with filing [director and officer liability] suits that the truth-telling about this problem has been kicked down the road," says Kevin LaCroix of Oakbridge Insurance Services, which acts as an intermediary between specialty insurers and purchasers. "There's going to be a point when there are enough of these cases to have an impact."
The parties involved are already seeking to test the limits of the policies' coverage. Directors of Puerto Rico's WesternBank are seeking a determination in Puerto Rican court that would require Chartis Insurance, a subsidiary of AIG, to indemnify them against at least $50 million in yet un-filed FDIC claims.
In the case of Michigan's Heritage Bank, Progressive Casualty Insurance Company is asking for a declaratory judgment absolving it from responsibility for the FDIC's claim against a loan officer who allegedly "routinely ignored the Bank's Lending Policy and prudent lending practices." With the failed Silverton Bank, the FDIC itself is seeking a court's blessing to tap two Chubb insurance policies in a $71 million suit alleging that Silverton's leadership behaved recklessly and plowed the struggling bank's money into private jets.
In all of these filed cases, the debate boils down to whether the policies protect bank directors from suits brought by a bank's receiver or another regulator. In most cases, such insurance relieves an insurer of having to pay claims brought by one insured party against another. A bank could not, for example, seek to recoup losses due to mistakes made by its own management. Many policies also include some level of "regulatory exclusion," protecting the insurer from government claims.
Whether the FDIC counts as an outside party has been a thorny question. Because the FDIC is the receiver of a bank at the time of its failure, some courts have found that the agency becomes the bank and is thus ineligible to make an insurance claim. Others have ruled that this "insured versus insured" exclusion doesn't apply to the FDIC, as long as the agency can prove it is acting on a third-party's behalf.
The basis for determining whether an insurer is responsible can get even more muddled still. Some policies contain "carve outs" and "carve backs" in their exclusions of regulatory claims. According to LaCroix and others, some polices even make exclusions to the exclusions. The FDIC might not be allowed to file a claim as an agency, for example, but might have the right to do so under a provision that allows a bankruptcy trustee or a liquidator to bring a similar action.
The insurance industry played a part in bringing about this situation, said LaCroix. If it had left a simple regulatory exclusion in the contracts, the FDIC and bank directors would have no case at all in such cases. But the wording of the insurers' policies became more generous-or at more least vague-as time went on.
"Underwriting discipline is an oxymoron," LaCroix says. "The industry is very competitive."
The case of WesternBank's directors illustrates how much is now up in the air. The Mayaguez, Puerto Rico bank was seized in April, 2010 by the FDIC, which seized its assets and transferred them to Banco Popular. Following the failure, the FDIC notified WesternBank's management and directors that it was considering a $367 million suit against them.
The directors hired Miami law firm Rivero Mestre to defend them and notified its D&O insurer, AIG subsidiary Chartis, that it wished to tap its $50 million policy to cover legal fees. Chartis told the law firm that it did not intend to pay for the board's defense or subsequent judgments, according to a complaint filed by the directors.
"We're the first group of directors and officers that said, 'We're going to sue,'" says Andrés Rivero, a partner at Rivero Mestre.
The firm filed its suit in Mayaguez, Puerto Rico, WesternBank's home town, which Rivero describes as a "favorable" location. The FDIC has not yet intervened in the case, though it has the legal right do so.
WesternBank's D&O policy does not include regulatory exclusion provisions, meaning that "the battle's going to be on the insured versus insured issue," Rivero says.
On the issue of D&O coverage, the interests of the FDIC and the directors are closely aligned. If directors are able to tap insurance coverage, Rivero says, he'll likely try to hand over the policy proceeds to the FDIC in exchange for the agency's agreement to drop claims against the personal assets of the bank's former officials.
Rivero argues that the insurer rejected his client's claim because it wants to hold the line against future litigation. If Chartis pays out on one claim, he says, the insurer would likely face a flood of similar claims.
"As soon as they pay somebody it's going to break the dam," he says. "We have another bank that we have done work for, and they're insured by Chartis," Rivero says. "We're expecting a similar situation there, unless we set a precedent."
Neither Chartis nor its lead lawyer in the case returned calls seeking comment. But LaCroix argues that the results of such suits are unlikely to settle the issue of liability in cases involving the FDIC. The policy language included in insurance contracts has changed a great deal since S&L bankruptcy wave. What's more, D&O policiy terms are sometimes negotiated, meaning that judicial rulings could produce a series of case-by-case decisions.
At the very least, insurers look likely to face a costly legal battle.
"Because there have been so few settlements, any number is going to be pretty speculative," says LaCroix of the costs to insurers. "But the aggregate number is going to be large."