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One of the many distinctive traits of the litigation that
surrounded the S&L crisis in the late 80s and early 90s was the plethora of
lawsuits between the FDIC (and other federal banking regulators), on the
one hand, and the failed banks' insurers, on the other hand, over
the interpretation of the banks' management liability insurance policies. Among
the questions surrounding the current bank failure wave has been whether or not
we will see a similar round of insurance coverage litigation. If a lawsuit
filed last week in the Middle District of Alabama is any indication, the
anticipated insurance coverage litigation may be on its way.
The coverage lawsuit arises out of the massive failure of
Colonial Bancorp, which closed its
doors on August 14, 2009. The bank's holding company filed for bankruptcy
on August 25, 2009. Among the factors contributing to Colonial's failure was
the criminal conspiracy relating to the failed mortgage lender, Taylor Bean
& Whitaker. In April 2011, Lee Farkas, Taylor Bean's ex-Chairman, was
convicted of wire fraud and securities fraud.
Prior to Farkas's conviction, two Colonial Bank employees
pled guilty in connection with the Taylor Bean scheme. As reflected here, on
March 2, 2011, Catherine Kissick, a former senior vice president of Colonial
Bank and head of its Mortgage Warehouse Lending Division, pleaded guilty to
conspiracy to commit bank, wire and securities fraud for participating in the
Taylor Bean scheme. As reflected here, on
March 16, 2011, Teresa Kelly, the bank's Operations Supervisor and Collateral
Analyst, pled guilty on similar charges.
The two bank employees allegedly caused the bank to
purchase from Taylor Bean and hold $400 million in mortgage assets that had no
value. The employees also allegedly engaged in fraudulent actions to cover up
overdrafts of Taylor Bean at the bank. The employees are also alleged to have
had the bank engage in the fictitious trades with Taylor Bean that had no
At the time of the bank's failure, the bank carried three
financial institution bonds. At or about the time that Colonial failed, the
bank submitted notices of claim under the financial institutions bonds in
connection with the activities and actions that ultimately were the topic of
the criminal guilty pleas of the bank employees.
In a complaint filed on July 29 in the Southern District
of Alabama (a copy of which can be found here), the FDIC
as receiver for Colonial Bank, as well as the bankrupt bank holding company on
its own behalf, filed an action against the bank's bond insurer. Among other
things, the complaint alleges that the losses caused by the misconduct
"constitute recoverable losses under the Bonds up to the full aggregate limits
of liability of the Bonds."
The complaint states that the bond insurer "has neither
accepted nor denied the Plaintiffs' claims under the Bonds." The complaint
alleges that the insurer "has failed to investigate the claims and losses
in a reasonable and appropriate manner." After cataloging the back and
forth between the FDIC and the insurer on their respective efforts to enter a
confidentiality agreement, the complaint alleges that the insurer "has declined
to enter into any of the proposed confidentiality agreements or offer
appropriate confidentiality agreements of its own," and "hence" the FDIC is
unable to produce the confidential information that the insurer has requested.
The complaint asserts a single claim for breach of contract.
Interestingly, the complaint does not specify whether or
not the FDIC or the bankrupt holding company is entitled to recover under the
bonds, but rather says that the amount of any recovery under the bonds is to be
deposited in a bankruptcy court escrow account, where the issue of entitlement
to the proceeds will be determined.
There are a number of arguably unusual features of this dispute.
First, it is filed in connection with the failed bank's financial institutions
bonds, rather than in connection with the failed bank's D&O insurance
policy. To be sure, given the circumstances surrounding the bank employees'
guilty pleas, the implication of the bonds is hardly surprising. But the
typical bank closure during the current round of bank failures will not
implicate the failed bank's financial institution bonds. The relevant insurance
issues will more likely arise, if at all, under the failed bank's D&O
Another interesting thing about this dispute is that the
parties are in coverage litigation even though the carrier has not even denied
coverage. It looks as if the parties' so-far unsuccessful attempts to hammer
out a confidentiality agreement have gotten a little bit out of hand. It is
mercifully uncommon for parties in similar circumstances to be unable to come
up with a mutually acceptable confidentiality agreement. It may be that once
the parties in this circumstance can finally manage to come up with a
confidentiality agreement that this whole dispute will resolve itself without
the need for further litigation (whether or not there was ever really any need
for litigation in the first place.)
But the fact that the FDIC has not hesitated to file this
suit in the first place certainly does evince a willingness to use the court to
pursue its claims, as receiver, in connection with failed banks' insurance
policies. And while this case may not on its face present any significant coverage
issues of more general significance, the likelihood is that as the FDIC presses
claims for insurance recovery, that some of these claims will find their way
into court with significant implications for questions of coverage under the
As I have said
before, so many aspects of the current bank failure wave provide a feeling
of déjà vu for those of us who lived through the S&L crisis. If the feeling
is not necessarily one of nostalgia, it at least has a certain familiarity. Of
course, it remains to be seen whether or not there will be any where near the
amount of coverage litigation this time around. It just looks to me from this
recent lawsuit that just like last time, the FDIC is not messing around, and it
is not going to hesitate to use the courts to pursue claims against failed
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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