D&O Insurance: Later Securities Suit and Prior FDIC Failed Bank Claim Held Unrelated, Securities Suit Not Covered

D&O Insurance: Later Securities Suit and Prior FDIC Failed Bank Claim Held Unrelated, Securities Suit Not Covered

 On May 8, 2014, Southern District of New York Judge Deborah Batts, applying New York law, held that a there was not a sufficient “factual nexus” between a securities suit filed after the expiration of a failed bank’s D&O insurance policy and an FDIC claim that had been first made during the policy period and therefore — because the subsequent claim did not relate back to the prior claim — it is not covered under the policy. The decision raises interesting questions about degree of overlap required to make different claims interrelated.

A copy of the opinion can be found here [an enhanced version of this opinion is available to lexis.com subscribers]. This decision is discussed in a June 5, 2014 post on theSedgwick Insurance Law Blog (here). A May 19, 2014 post on the Wiley Rein law firm’s Executive Summary blog can be found here.

Background

State banking authorities closed the Park Avenue Bank on March 12, 2010. Three days after the bank close, Charles Antonucci, the bank’s President and CEO, was arrested and charged with attempting to defraud the Troubled Asset Relief Program and for self-dealing with bank funds, which included several “round trip transactions” that he claimed were personal investments in the bank.

On September 1, 2010, the FDIC sent certain former directors of the bank a demand letter in which the FDIC asserted claims against the individuals for alleged breaches of fiduciary duty, negligence and gross negligence. The demand letter asserted that the individuals’ acts and omissions caused the bank a loss of approximately $50.7 million. The FDIC’s claim, as Judge Batts later summarized it, “primarily focused on [the individuals’] deficient policies, internal controls, and practices, which ultimately led to PAB’s failure,” such as having inadequate collection procedures and failing to properly supervise employee compensation. However, as Judge Batts also noted, the FDIC demand letter also alleged that the individuals “failed to act on allegations of improper conduct made against [Antonucci], ultimately causing significant financial harm to the bank.”

The individuals notified the bank’s D&O insurer of the FDIC claim. The D&O policy in force at the time had a policy period from September 9, 2008 to September 9, 2009, but the period had been extended to November 8, 2010. The D&O insurer accepted the FDIC demand letter as a claim under the policy.

On February 12, 2012, well after the expiration of the D&O policy, Bruce Kingsley filed a lawsuit against the bank’s former directors under Arizona securities laws. The Kingsley complaint alleges that Antonucci had made material misrepresentations and omissions in order to induce the Kingsley plaintiffs to make investments in two customers of the bank. The investments were actually used to fund Antonucci’s round-trip transactions. The Kingsley plaintiffs contended that the bank’s former directors should be liable for their “lax oversight” of Antonucci and for the bank’s lack of “sound corporate governance.” The Kinglsey complaint alleged that the directors “did not act in good faith with respect to their control or lack of control of Antonucci” and “did not take reasonable steps to maintain and enforce a reasonable and proper system of appropriate supervision and internal controls.”

The directors submitted the Kingsley lawsuit to the bank’s D&O insurer asserting that the FDIC demand letter and the Kingsley lawsuit involved interrelated wrongful acts. The D&O insurer denied coverage for the Kingsley lawsuit contending that the lawsuit had been filed after the policy had expired and that the two claims did not involve interrelated wrongful acts.

The directors filed an action in the Southern District of New York seeking a judicial declaration that the two claims involved interrelated wrongful acts and that the D&O insurer had breached the policy when it denied coverage for the Kingsley lawsuit. The D&O insurer filed a motion to for judgment on the pleadings.

In the policy, Interrelated Wrongful Acts are defined as “Wrongful Acts which have as a common nexus any fact, circumstance, situation, event, transaction or series of related facts, circumstances, situations events or transactions.”  Under the policy all claims based on Interrelated Wrongful Acts “shall be considered a single Claim” that is “deemed to be first made on the date the earliest of such Claim was first made.”

The May 8 Ruling 

In her May 8, 2014 memorandum and order, Judge Batts granted the D&O insurer’s motion for judgment on the pleadings, ruling that the two claims do not present Interrelated Wrongful Acts “because they do not share a sufficient factual nexus.” Because the two claims are not related, the D&O insurer did not breach the policy by declining coverage for the Kingsley Claim.

In reaching this conclusion, Judge Batts considered several cases under New York law in which courts had interpreted interrelated wrongful acts provisions and in which the courts had held that for two claims to be related they must “share a sufficient factual nexus.” She observed, based on her review of the cases that “where courts have found a sufficient factual nexus, the two claims had specific overlapping facts.”

Here, Judge Batts said, “the factual overlap between the two Claims is tenuous at best; Plaintiffs allegedly failed to act properly with respect to Antonucci, whether it be their control and oversight of him, as alleged in the Kinglsey Complaint, or their failure to investigate allegations of his misconduct, as alleged by the FDIC.”

Judge Batts said with respect to these allegations about Antonucci, “if painted in broad strokes, the two Claims may arise out of the same deficient corporate structure or Plaintiff’s lack of oversight.” However, she said, the directors “merely plead in a conclusory manner that the two Claims share common facts and circumstances, yet, as previously explained, the FDIC Claim merely references Antonucci’s general misconduct whereas the Kingsley Claim makes specific allegations of his fraud on the Kingsley plaintiffs.” The directors “bald allegation” that the two Claims arise out of a common set of circumstances “are insufficient to demonstrate a common factual nexus.”

Without more, Judge Batts said, “there simply is not a sufficient factual nexus between the FDIC Claim and the Kingsley Claim.” To interpret the two as interrelated “would be to grant the insured more coverage than he bargained for and paid for.”

Discussion

In considering Judge Batts’s decision, I will begin where she ends, with her saying that if these two claims were considered to be interrelated, the insureds would be getting more coverage than they bargained and paid for. I find this a curious statement, since the bank had bargained and paid for a policy providing that coverage extended not only to claims made during the policy period but also to claims made subsequent to the policy period if the subsequent claims were related to a claim made during the policy period. The problem is not that the bank did not bargain and pay for the kind of coverage the directors are seeking here; the problem is, as I have frequently noted on this blog, that relatedness issues are notoriously elusive.

The difficulty here, as in all coverage cases involving relatedness issues, is determining what degree or quantum of relatedness is sufficient to make alleged wrongful acts interrelated. It is not as if the FDIC Claim and the Kingsley claim were entirely unrelated – there is at least one important area of overlap:  both involve allegations that the board had breached its duties to supervise and control Antonucci. Judge Batts in fact acknowledged the overlap is evident when the picture here  is “painted in broad strokes.”

Indeed, I think a reasonable person might easily conclude that the two claims, involving as they do allegations of lack of proper oversight of Antonucci, have “as a common nexus” a “circumstance” or “situation.” In that regard, I note that the policy’s definition of Interrelated Wrongful Acts is written very broadly; it provides that Wrongful Acts are Interrelated if they have as a common nexus “any fact, circumstance, situation, event or transaction.”

The word “any” is very comprehensive – if there is any fact circumstance or situation having a common nexus, then the Wrongful Acts are interrelated. Judge Batts faulted the directors’ argument because the overlap on which the directors relied was “painted in broad strokes” – that is, it only appeared at a high level of generalization. However nothing about the policy says that this level of generalization is insufficient. To the contrary, and to reiterate, the policy itself refers to any fact, circumstance, situation, event or transaction

The comprehensiveness of this definition communicates that it was intended to be interpreted and applied very broadly. In fact, insurers often are arguing that it should be interpreted very broadly, as for example when arguing that a subsequent claim is related to a prior claim made during a prior policy period in which the insurer did not provide coverage (refer for example here), or when the insurer is arguing that multiple claims made over multiple policy periods triggers only a single policy of insurance, not multiple policies (here).

Even recognizing all of the points Judge Batts made in her ruling, I still think it could reasonably be argued that the definition is amply expansive to include both of the claims involved here. And – to turn Judge Batts’s valedictory declamation on its head – since the policyholder expressly bargained and paid for a policy that provided coverage for subsequent claims that are interrelated with claims that are made during the policy period, the insurer here ought to provide coverage for the Kingsley claim, particularly given the breadth of the scope of the definition of Interrelated Wrongful Acts.

As I have said previously about cases interpreting and applying interrelated wrongful act provisions, the cases taken collectively illustrate nothing so much as how elusive these issues can be. This case is a good example of this principle. The problem of course is that this is not some theoretical exercise. The individuals seeking coverage here now have no insurance to rely on to defend themselves against the allegations in the Kingsley complaint.

All of that said, I understand the Insurer’s position here as well. The Kingsley complaint was a securities fraud lawsuit relating to the bank CEO’s involvement in a third party (or self-interested) transaction. The FDIC demand letter related to the alleged mismanagement of the bank. I can see why the insurer felt that the two claims were unrelated. That is the problem with interrelatedness disputes. There are no clear answers and the outcomes wind up being a matter of perspective. 

 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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