Robert Suomala examines litigation surrounding the insured versus insured
exclusion in D&O policies and claims by a trustee, receiver, or other
official of an insured corporation in bankruptcy.
Since at least the mid-1980s, almost all directors and officers (D&O)
liability policies have excluded from coverage suits brought by one insured
against another insured. A typical exclusion might bar coverage for "any
claim made against any Director or Officer by any other Director or Officer or
by the [insured] Institution ...." Other versions of the exclusion may bar
coverage "by or on behalf of" or "by, on behalf of, or in the
name or right of" any other insured.
The exclusion came into widespread use in the mid-1980s in response to
certain suits by corporations against their own directors and officers designed
to trigger D&O coverage for disastrous losses. In one of the most
well-known of these cases, for example, Bank of America blamed six officers for
certain disastrous mortgage-backed securities transactions, fired them, and
then sued them for $95 million in damages. The insurers were concerned that the
insured institutions were attempting to
unfairly render Directors and Officers coverage a form of "first
party" insurance which the insured corporation can trigger for any
losses it sustains by simply suing its own executives responsible for such
losses.… [Ichel, Directors and Officers Insurance Coverage: An Overview and
Current Problems in Officers and Directors Liability: A Review of the
Business Judgment Rule 673 (D. Goldwasser ed., PLI 1985).]
One of the most controversial and often litigated issues with respect to the
insured versus insured exclusion is whether the exclusion applies to claims by
a trustee, receiver, or other official of an insured corporation in bankruptcy.
In the last few months, several cases have shed light on this issue and have
highlighted the importance of the specific language used in the exclusions. To
put these cases in perspective, we first review some of the earlier case law on
this issue.
The Financial Institution Cases
In response to the financial institution crisis of the 1980s and early
1990s, the Federal Deposit Insurance Corporation (FDIC), Federal Savings and
Loan Insurance Corporation (FSLIC), and RTC made zealous efforts to hold former
management of hundreds of failed institutions financially responsible for those
failures. D&O insurers took the position that suits by regulators as
receivers, successors, or assigns of a failed financial institution against its
former directors or officers were barred from coverage by the insured versus
insured exclusion.
Several courts agreed with the insurers' position. These courts reasoned
that claims of an institution to which a regulator had succeeded, as receiver
or otherwise, fell squarely within the insured versus insured exclusion because
the regulator "stands in the shoes" of the institution with respect
to those claims: that is, the regulator has all the rights of, and is subject
to the same defenses as, the insured institution, had it brought the suit
before it failed.
The court in Gary v American Casualty Co.,
753 F Supp 1547, 1555 (WD Okla 1990), affirmed on other grounds, 975 F2d 677
(10th Cir 1992), rejected the FDIC's argument that the exclusion did not
apply to its claims because "the FDIC performs many functions and
represents not only a failed bank and its shareholders, but also its
depositors, creditors, the deposit insurance fund, and the public at
large," and criticized the judicial decisions that had accepted that
argument:
The problem with those courts' premise is that regardless of to whom
the benefits of any recovery on a D&O policy by the FDIC or FSLIC might
indirectly or immediately inure, their claims are claims of the financial
institution which they acquired after failure of such financial institution
by succession or purchase and are thus asserted in the capacity of assignee
of the failed financial institution. . . . In any event, regardless of whom
the FDIC may represent and to whom the benefits of any claim
asserted by it may inure, it is clear that in this case the FDIC is seeking a
determination of coverage for claims previously owned by the bank....
Other courts, however, held that the insured versus insured exclusion did
not unambiguously exclude regulators' suits, relying on two principal
arguments. First, these courts interpreted the language of the exclusion
narrowly, noting that the exclusion bars coverage for claims "by" an
insured, not "of" it, and contains no "language which would
indicate an intent to include insureds' successors...." Finci v American Casualty Co., 593 A2d 1069, 1082 (Md 1991).
But see Hyde v Fidelity & Deposit Co. of
Maryland, 23 F Supp 630, 634 (distinguishing Finci and holding
applicable to receiver's action an insured versus insured exclusion that
barred coverage for claims "by or on behalf of" an insured).
Second, courts found that a regulator did not merely "stand in the
shoes" of a failed institution because the regulator is authorized to sue
not only on behalf of the failed institution, but also on behalf of the
institution's shareholders and creditors, as subrogee to the rights of
depositors, and as a creditor itself on behalf of the deposit insurance funds.
For example, see Fidelity and Deposit Co. of Maryland v
Zandstra, 756 F Supp 429, 433 (ND Cal 1990). Some courts in accepting
this argument relied on the regulators' special governmental function and
indicated that they would not reach the same result with respect to an ordinary
trustee in bankruptcy. See FDIC v Zaborac, 773 F
Supp 137, 143 (CD Ill 1991).
The Purpose of the Exclusion
Several of the decisions holding that claims of a receiver are not the same
as claims by the failed institution were based on a mistaken understanding of
the purpose of the insured versus insured exclusion. For example, in
Zandstra the court found that a shareholder
derivative suit exception to an insured versus insured exclusion demonstrated
that the insurer intended to provide coverage for losses suffered by the
institution as a result of breaches of fiduciary duty by directors or officers.
The court concluded that the "obvious intent behind the insured versus
insured exclusion is to protect the insurer against collusive suits among the
institution and its directors and officers," and that it was "clear
beyond doubt" that the FDIC was genuinely adverse to the directors and
officers and that its suit was not collusive. [756 F Supp at 431-32.]
However, that reasoning does not appear sound. The presence of a specific
exception for shareholder derivative actions from a broad insured versus
insured exclusion indicates both (1) that, in the absence of such a specific
exception, derivative suits would fall within the scope of the exclusion; and
(2) that claims of the institution asserted derivatively by a successor to the
institution, other than a shareholder derivative claim, fall within the scope
of the exclusion.
Moreover, Zandstra was mistaken in its
assumption that the sole purpose of the insured versus insured exclusion is to
prevent "collusive" suits. Suits such as
the Bank of America case, however, certainly
did not involve any "collusion" between the plaintiffs and
defendants. The true purpose of the insured versus insured exclusion was
to
prevent [insurers] being put in the position of underwriting the daily
business risks of the insured companies… J. Olson & J. Hatch, Director
and Officer Liability: Indemnification and Insurance § 10.06 [6] [b] [iii],
at 10-33 (1990), precisely the risk presented by suits by receivers or
trustees in bankruptcy.
Recent Cases
The smaller body of case law involving application of the insured versus
insured exclusion to suits by nongovernmental trustees or receivers in
bankruptcy, like the financial institutions case law, has been split. Compare
In re Buckeye Counrymark, 251 B.R. 835 (SD Ohio
2000) (exclusion held inapplicable), with Reliance
Insurance Co. v Weis, 148 B.R. 575 (ED Mo 1992), aff'd, 5 F3d 532
(8th Cir 1993) (table) (exclusion held applicable).
A number of cases decided in the last year, however, indicate that the trend
may be against application of the exclusion, at least based on the language
involved in those cases. See Alstrin v St. Paul Mercury
Insurance Co., 179 F Supp 2d 376 (D Del 2002); In re Molten Metal Technology, 271 B.R. 711 (Bankr. D Mass
2002); Zurich American Insurance Co. v Boyes,
2001 U.S. Dist. LEXIS 15123 (ND Tex 2001).
The courts in each of these three recent cases held that the plain language
of the insured versus insured exclusion did not apply to claims by a trustee in
bankruptcy or estate representative, emphasizing that such claims "are not
the same as claims brought 'by' the Debtor under the exclusionary
provision." [Alstrin, 179 F Supp 2d at
404.]
The courts emphasized that a bankruptcy estate is a separate entity created
by federal bankruptcy law, and that the estate has different functions from and
serves different constituencies than the corporation prior to bankruptcy. In
Molten Metal (as well as in Alstrin) the insured
versus insured exclusion barred coverage for claims "brought by any
Insured or by the Company." The court noted that "Company" was
"expressly defined to mean MMT [the insured corporation] and its
subsidiaries. The definition includes no reference to successors or assigns of
any nature." [271 B.R. at 725.]
The court also found support for its holding in the term "brought
by." The court stated that:
in order [for the exclusion] to encompass the Trustee's claims it
would not be enough for "claim brought by" to include "claim
belonging to" or "claim brought on behalf of." In order to
encompass the Trustee's claims, "claim brought by" would have
to include "claim that originated in favor of but that no longer belongs
to and that is brought neither by nor on behalf of." No objectively
reasonable insured could construe "claim brought by" to have that
reach. [Id. at 726.]
The courts in Alstrin and Molten Metal also noted that their holdings were consistent
with the purpose of the insured versus insured exclusion to prevent collusive
suits, although they found it unnecessary to examine intent in light of their
finding that the language of the exclusion was plain and unambiguous. [179 F
Supp 2d at 404; 271 B.R. at 728.]
All three courts also stated that, if the language of the exclusion had been
found to be ambiguous, they would have construed it against the insurer and
reached the same result. See Alstrin, 179 F Supp
2d at 404; Molten Metal, 271 B.R. at 725, 726.
In Boyes—where the exclusion barred coverage not only for claims "by"
but also "on behalf of" an insured—the court stated:
The ambiguity appears when the court applies the clause to a suit by a
Trustee in bankruptcy, who has responsibilities and obligations defined by
the bankruptcy code that do not fit squarely with the phrase "on behalf
of." . . . The Trustee's and [insureds'] interpretation of that
phrase, read in light of the policies of the bankruptcy code and job of the
Trustee, is a reasonable one and supplies an alternate basis for the
declaratory judgment. [2001 U.S. Dist. LEXIS 15123, at *6.]
Conclusion
In light of these recent cases, both insurers and insured corporations and
directors and officers will wish to consider precisely what risks they wish to
insure, particularly in times of financial uncertainty. New policy language
likely will be introduced defining in greater detail the scope of coverage for
claims by bankruptcy trustees or receivers or by other successors or assigns of
the corporation.