When the FDIC takes over a failed bank as receiver and then sues the bank’s former directors and officers, does that inevitably preclude coverage under an insured vs insured exclusion? In a folksy and clearly written decision, with relevance even to banks and other firms that may never be taken over by the FDIC, the First Circuit decided that such a claim is not inevitably excluded, and affirmed an injunction ordering AIG to pay defense costs on behalf of the former directors and officers, even though the FDIC “stepped into the shoes” of the bank when it became receiver.
W Holding Co., Inc. v. AIG Insurance Co., decided very recently on March 31, arose from the demise of Westernbank of Puerto Rico. Westernbank had been one of Puerto Rico’s leading banks, but that status ended in the late 2000s when local regulators ordered the bank closed and appointed a federal regulator – the FDIC – as receiver. The FDIC investigated and concluded that certain bank officers and directors had violated their fiduciary duties to the bank. Further, the FDIC found that these violations caused more than $367 million in losses to the bank, and so the FDIC demanded that those officers and directors pay that amount.
AIG (at the time known as Chartis) denied coverage based primarily upon the “insured vs insured” exclusion, which provides that AIG:
shall not be liable to make any payment for Loss in connection with any Claim made against an Insured . . . which is brought by, on behalf of or in the right of, an Organization or any Insured Person other than an Employee of an Organization, in any respect and whether or not collusive.
In response, the directors and officers sued AIG, the FDIC intervened and added more directors and officers, as well as their spouses and conjugal partners, reduced the damage claim to $176 million, but also estimated that the federal deposit insurance fund could lose as much as $4 billion. After some involved procedural wrangling, AIG moved to dismiss all claims against it, and the directors, officers and other affected individuals counter-moved for an injunction ordering AIG to advance defense costs.
AIG argued that because the FDIC brought its claim “on behalf of or in the right of Westernbank,” and because Westernbank was a named insured, then there could be no coverage. Both the FDIC and the individuals argued that the insured vs insured exclusion should not include the FDIC, regardless of whose shoes it was wearing. In addition, they argued that the FDIC also brought claims on behalf of third-party creditors and depositors.
Insured vs Insured Exclusion Does Not Apply – AIG Must Defend Failed Bank D&Os
In the end, the directors and officers prevailed – both in the trial court and in the First Circuit – on the second argument, and also because of the traditionally broad application of the duty to defend or to pay defense costs. In affirming the District Court’s injunction that ordered AIG to advance defense costs, the First Circuit noted Puerto Rico’s rule that an insurance company must advance those costs if there is a “remote possibility” of coverage, which it described as “A pretty low standard, indeed.”
Further, because the court treated the cost-advancement order as a preliminary injunction, it determined that the individuals needed only to demonstrate a mere “likelihood” of a “remote possibility” of coverage in order to prevail at this stage. Under that standard, the court upheld the cost-advancement order, on the substantive grounds that the FDIC has sued not only as receiver for Westernbank, but as successor to the depositors and creditors of the bank, and also alleged that it was suing to recover money that the FDIC spent after the bank shut down. The court also rejected AIG’s novel argument that the application of the insured vs insured exclusion was determined solely on the initial demand letter, and because the FDIC did not mention the alternative theories for recovery until later, both coverage and the defense obligation were precluded.
Lessons for Policyholders and Counsel
There are three primary lessons for policyholders and counsel in this case:
- the duty to defend or to advance defense costs can be won based upon what seem to be minor, alternative, claims in the underlying suit;
- if you can meet the irreparable harm element of a preliminary injunction (here the policyholders argued they could not afford a defense on their own), the “likelihood of success” element can then provide an easier path to defense costs than summary judgment; and
- when analyzing the insured vs insured exclusion, one party can be both an insured, and not-an-insured, at the same time.