Avoid the “Insolvency Exclusion” Trap in E&O Policies: Tennessee Federal Court Confirms That Insolvency Exclusion Does Not Apply to E&O Claim Brought By Bankruptcy Trustee Against Financial Institution

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As the wave of litigation spawned by the 2008 financial crisis begins to ebb, insurance-coverage litigation arising out of the credit crisis continues unabated. Financial institutions have successfully pursued insurance coverage for many credit-crisis claims under directors and officers (D&O) and errors and omissions (E&O) policies that they purchased to protect themselves against wrongful-act claims brought by their customers, but in response, some insurers continue to raise inapplicable exclusions in an attempt to diminish or limit coverage for their policyholders.

One exclusion found in many E&O policies that some insurers increasingly cite to deny coverage for credit-crisis claims is the so-called “insolvency exclusion.” This exclusion, which originally appeared in E&O policies for insurance brokers but later made its way into bankers’ professional liability policies, typically bars coverage for a narrow class of claims arising out of the insolvency of certain enumerated third parties. By including this exclusion in their policies, insurers can limit their exposure to certain claims brought against financial institutions, by those financial institutions’ own customers, that are completely unrelated to the professional services the insurers agreed to underwrite. The insurers can thereby avoid the risk of becoming a backstop of last resort.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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