First Circuit Holds That AIG Must Defend Directors and Officers in FDIC Litigation

What you need to know:

The United States First Circuit Court of Appeals recently held that an insured versus insured exclusion did not exempt AIG from advancing defense costs under a D&O policy in a suit brought against the directors and officers of Westernbank by the bank’s FDIC receiver.

What you need to do:

D&O insurers should be aware of the split of authority regarding the applicability of insured versus insured exclusions relative to entities in government receivership, and should make coverage decisions accordingly. 

Background

Westernbank, once one of Puerto Rico’s leading banks, entered Federal Deposit Insurance Corporation receivership as a result of an agency investigation.  Investigators concluded that certain bank officers and directors had breached their fiduciary duty to Westernbank, resulting in more than $367 million in losses and jeopardizing the bank’s financial soundness.  The FDIC demanded reimbursement from the directors and officers who, in turn, notified Chartis Insurance Company (now AIG Insurance Company) asking Chartis to confirm coverage under a directors and officers liability insurance policy issued to Westernbank’s owner, W Holding Company, Inc.

Though the D&O policy provides that Chartis will “advance defense costs” for covered actions, Chartis disclaimed coverage, citing an insured versus insured exclusion.  This exclusion states that Chartis is not liable for claims “brought on behalf of or in the right of” the insured organization.  Chartis reasoned that, as receiver, the FDIC had stepped into Westernbank’s shoes, and that its claims were on behalf of Westernbank and thus excluded from coverage.  The directors and officers, together with W Holding, sued Chartis in Puerto Rico superior court seeking a judgment declaring coverage, including all expenses incurred in defending against the FDIC.  The FDIC intervened in the suit and removed the case to federal court. 

In the US district court, the directors and officers moved for an order directing Chartis to advance their defense costs.  Chartis opposed the motion, again reasoning that the insured versus insured exclusion nullifies any coverage duty.  In response, the FDIC claimed that under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, it sought recovery not only on behalf of the bank, but on behalf of the bank’s account holders, depositors, and the drawn-down FDIC insurance fund, none of which qualified as insureds under the D&O policy.  The district court held that the FDIC’s claims on behalf of those third-party constituencies fell outside the insured versus insured exclusion.  Chartis then appealed the ruling to the First Circuit.   

The Court’s Ruling

The First Circuit held, among its other conclusions, that:

  • The First Circuit had the authority to hear an appeal on the cost-advancement motion, because the district court ruling was, in substance though not in title, a preliminary injunction order.
  • Puerto Rico law dictates that an insurance company must advance defense costs if a complaint against its insured alleges claims that create even a “remote possibility of coverage.” 
  • Puerto Rico’s insured-friendly rules reflect an underlying principle that it “is the purpose of insurance policies to provide protection for the insured.” 
  • Chartis’s arguments did not address, and could not overcome, this strong presumption in favor of the insured under Puerto Rico law.  
  • The FDIC’s Second Amended Complaint, which alleges that the FDIC has succeeded to the rights of Westernbank’s depositors, creditors and account holders – including the right to “bring this action” – creates at least the possibility that the FDIC is suing on behalf of these non-insureds.
  • Conflicting case law, none of it binding in this instance, exists as to whether insured versus insured exclusions apply in cases in which FDIC receivers seek recovery from bank directors and officers.
  • Because the court must resolve doubts in favor of the insured, the First Circuit affirmed the district court’s decision granting defense costs to the plaintiffs.
  • However, the ruling only upholds a preliminary injunction;  if Chartis succeeds on the merits in the district court, the insurer may be able to recoup defense costs.  

Conclusion

The First Circuit held that because federal law allowed the FDIC receiver to assume the rights of the bank’s depositors, creditors and account holders, the insured versus insured exclusion in the bank’s D&O policy did not necessarily preclude coverage.  Because the law on this issue varies by jurisdiction, insurers may wish to contact counsel before making coverage decisions involving similar issues.  Insurers may also consider rewriting the language of their standard insured versus insured exclusions to bar coverage related to suits instituted by FDIC-type regulators. 

 

Topics:  AIG, D&O Insurance, FDIC, Financial Institution Liability, Policy Exclusions

Published In: Business Organization Updates, Civil Procedure Updates, Civil Remedies Updates, General Business Updates, Insurance Updates

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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