A recent negotiated resolution of an FDIC failed bank
lawsuit suggests disputes over D&O insurance coverage may represent the
real frontline in the failed bank litigation wars. The compromise was reached
in the lawsuit the FDIC only recently filed in the District of Arizona
involving the failed First National Bank of Nevada. As discussed below, the
FDIC and the bank officer defendants have reached a settlement agreement that includes
a stipulated judgment, assignment of insurance rights, release of claims
against the individual defendants, and a covenant not to execute the judgment
against the individual defendants.
First National Bank of Nevada failed on July 25, 2008 (as
discussed here).
First National Bank of Arizona was one of FNB Nevada's sister banks until the
two banks merged less than 30 days prior to FNB Nevada's failure. As discussed here
(scroll down), on August 23, 2011, the FDIC filed an action in the District of
Arizona against Gary Dorris, who was CEO and Vice Chairman of the banks'
holding company as well as of both FNB Nevada and FNB Arizona, and Phillip
Lamb, who was EVP of the banks' holding company as well as of both FNB Nevada
and FNB Arizona. The FDIC's complaint alleged mismanagement and gross
negligence at FNB Arizona that allegedly left FNB Arizona holding millions of
dollars of bad loans.
On September 2, 2011, just days after the FDIC filed its
complaint against the two individuals, the FDIC and the two defendants filed a
joint motion for entry of judgment. A copy of the joint motion for entry
of judgment can be found here.
Though they had filed an answer denying liability, the defendants nevertheless
consented to the entry of judgments "for purposes of compromising disputed
claims." Pursuant to the parties' settlement agreement, the two individuals
each consented to the entry against each of them of separate judgments in the
amount of $20 million (plus post-judgment interest).
As part of the parties' settlement agreement, upon the
entry of the judgment the defendants will assign to the FDIC all of their
rights and claims against the D&O insurer. The FDIC for its part agreed not
to take any action to enforce the judgment against the individuals, except with
respect to the individuals' rights under the D&O policy. The joint motion
alleged that the bank's D&O insurer has "denied coverage, refused to
defend, to advance defense costs, to indemnify, or to consider settlement of
the claims brought against the defendants."
Assuming for the sake of discussion that the court enters
the consent judgment in the form the parties have requested, the FDIC's obvious
next move is to file a lawsuit against the bank's D&O insurer, seeking to
recover the amount of the judgments from the D&O insurer. The joint motion
does identify the D&O insurer, but it does not specify the face amount of
the D&O insurance policy, nor does it specify the basis on which the
D&O insurer has denied coverage.
The fact that the consent judgment was submitted within
days after the initial complaint was filed does seem to suggest that the
lawsuit filing was itself part of a coordinated plan anticipating the consent
judgments, as a way to shift the FDIC's focus from the individuals themselves
to the D&O insurer, the recovery of whose policy proceeds appears to have
been the FDIC's objective all along.
The problem with this approach is that it has not been
established that the individuals in fact breached any duties or that they
should be or could be held liable on the merits. Of course, the individuals
would contend that when the D&O insurer failed to provide them with a
defense, they were left on their own to take whatever steps they could to
protect themselves from liability and to avert the accumulation of further
defense expense. The FDIC, as the individuals' successor in interest under the
policy, now undoubtedly will argue that having disclaimed coverage and having
declined to participate in the individuals' defense, the carrier should not be
heard to object to the basis on which the individuals compromised the lawsuit.
But merely because the FDIC will succeed to the
individuals' rights under the policy does not establish that there is coverage
under the policy or that the D&O insurer has any liability for the amounts
of the consent judgment. If it comes to that, the D&O insurer will
undoubtedly attack the judgment on many bases. The D&O insurer will also
likely maintain its assertion that there is no coverage under the policy for
the claims against the individuals as well as for the judgment.
Given that this bank closed in mid-2008, which was very
early in the current wave of bank failures, it is relatively unlikely that the
operative policy had a regulatory exclusion (as those had only just started
making their return to the D&O insurance marketplace at or about that
time). The likelier possibility is that the coverage denial is based on some
policy process issue, such as timely notice, claims made date, or the like.
As I previously noted, it could be argued that the
D&O insurer, having denied coverage, should not be heard to object to the
fact that the individuals have taken steps to protect themselves. However, the
problem with these type of consent judgment/covenant not to execute type deals
is that this approach can run the risk of slipping into a collusive
arrangement, with the insured individual willingly agreeing to a settlement
amount that has no relation to the his or her true liability exposure. In my
prior life as an insurance company coverage attorney, I saw more than one deal
that could only be described as abusive, and I have one particular deal in
mind that qualified as grotesque bad faith (it was so awful no court would
touch it and it died a very ignominious death).
Whatever the merits or demerits of these types of deals,
we undoubtedly will see many more of them before the current round of failed
bank litigation finally plays itself out. FNB Nevada failed in the earliest
days of this wave of failed banks, and the FDIC is just now getting around to
pursuing claims and insurance coverage related to its closure. Many hundreds of
banks have failed in the interim and over the coming months and years, the FDIC
will be pursuing claims and insurance coverage in connection with many of those
subsequent bank failures. In many of these cases, as apparently was the case
here, the FDIC's ultimate objective will be the recovery of D&O insurance
proceeds.
As a result, there may well be many more occasions where,
as here, individuals, in order to extricate from an FDIC lawsuit, similarly
agree to a consent judgment and an assignment their rights to their D&O
insurance policy in exchange for a covenant not to execute the judgment against
them and their assets.
The larger message here is that as the FDIC ramps up its
claims and lawsuits against the former directors and officers of failed banks,
one of the consequences will be a rash of coverage lawsuits involving the
failed institutions' D&O insurance policies. All I can say is that it seems
like old times to me. I expect that all across the country there are coverage
attorneys getting their files from 20 years ago out of storage.
As I said at the outset, D&O insurance coverage suits
may represent the real frontlines of the failed bank litigation wars. (It is no
coincidence that the lawsuit filed at the same time as the suit against the FNB
Arizona defendants, the one filed against former directors and officers of
Silverton bank, described here,
apparently also is really a dispute about D&O insurance coverage; indeed in
that case, the FDIC took the extraordinary step of naming the D&O insurers
as defendants in the liability lawsuit.)
In any event, it is clear that coverage lawsuits
involving failed bank D&O policies will be one of predominant features of
the D&O insurance scene for the next several years to come.
News coverage regarding the bank executives' settlement
with the FDIC can be found here.
Special thanks to a loyal reader for sending me a copy of the parties' joint
motion for entry of judgment.
Court Rejects Failed Bank Directors and
Officers Bid to Dismiss Claims Against Them: Meanwhile, in a case
in the Northern District of Illinois involving the former directors and
officers of the failed Heritage Community bank, the court has rejected the
individual defendants' motions to have the claims for negligence and breach of
fiduciary duty against them dismissed, except to the extend the negligence
claims are duplicative of the fiduciary duty claims.
As discussed here,
in November 2010, the FDIC filed a lawsuit against certain former directors and
officers of Heritage. The defendants moved to dismiss the FDIC's negligence and
breach of fiduciary duty allegations, arguing that the alleged misconduct that
on which the negligence and breach of fiduciary duty claims are based are
protected by the business judgment rule; that the FDIC had failed to
sufficiently state claims for gross negligence, negligence or breach of
fiduciary duty; and that the negligence and breach of fiduciary duty claims
were duplicative.
In a September 1, 2011 order (here), Northern
District of Illinois Judge Rebecca Pallmeyer
denied the defendants' motions, except that she granted the motions to the
extent the negligence claims were duplicative of the fiduciary duty claims. In
rejecting the defendants' attempt to rely on the business judgment rule, she
found that because these arguments represented affirmative defenses
and held that the "appropriate mechanism for consideration" of the
affirmative defenses is "a motion for judgment on the pleadings or for summary
judgment."
Judge Pallmeyer also found that the FDIC's allegations
"are sufficient to meet the liberal notice pleading requirements and to set for
the duty, breach, causation and damage elements of claims for gross negligence,
negligence and breach of fiduciary duty."
For those involved in defending former directors and
officers in FDIC litigation (and these individuals' D&O insurers), Judge
Pallmeyer's ruling may be concerning. One of their principal defenses for
individuals caught up in FDIC failed bank litigation will be that under FIRREA,
they can only be held liable for gross negligence (refer here
for an excellent discussion of these issues). This argument is most compelling
with respect to outside directors, as a judge in the Central District of
California recently recognized in dismissing NCUA claims that had been brought
against outside directors of the failed WesCorp credit union (as discussed at
greater length here).
Although Judge Pallmeyer did dismiss the negligence claims to the extent they
were duplicative of the fiduciary duty claims, she did not reach the question
whether or not under FIRREA the individuals can be held liable only for gross
negligence.
Special thanks to a loyal reader for forwarding the
Heritage bank ruling to me.
Annual Law Firm Survey of D&O Insurance
Coverage Issues: On September 7, 2011, my good friends at the
Troutman Sanders law firm issued
their annual survey of coverage decisions involving D&O and professional
liability insurance policies, which can be found here.
The survey is very comprehensive and has the added virtue of being indexed by
topic, which makes the survey a particularly useful resource for those involved
with D&O insurance claims to keep at hand.
Read
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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