Failed Bank Battles: Is D&O Insurance Coverage the Real Frontline?

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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