by Christopher Graham and Joseph Kelly

Ever see the movie Groundhog Day? Actor Bill Murray relives the same day repeatedly. Wake up. Same day. With twists. Wake up again. Same day. With twists. Strange way to start a blog about insurance? Not if you’re a regular reader. And you’ll soon see why.

Today’s story: So in this post we look at the world as if you’re a bank director. You of course have a D&O policy. And it has a so-called regulatory exclusion, for claims by the FDIC against you if the bank fails. The D&O insurer renews the policy. But the renewal policy doesn’t include a regulatory exclusion. “That’s good,” you say. “One less worry. I now have coverage for those claims if the bank were to fail.” But a California Federal magistrate in Hawker v. Bancinsure, Case No. 1:12-cv-01261 (E.D. Ca. Apr. 7, 2014), says you better think twice.

Why? Well, yes the insurer removed the regulatory exclusion. But the “insured v. insured” or IVI exclusion was unlike typical IVI exclusions. Like typical IVI exclusions, this exclusion applied to a Claim made by one Insured against another Insured, subject to exceptions. But unlike typical IVI exclusions and critical to this court, this IVI exclusion also explicitly applied to a Claim by a “receiver” against an Insured.

Why the groundhog? Recently, we did a post here, starting with two paragraphs nearly the same as the two above, except discussing Bancinsure v. McCaffree, et al, Case No. 12-2110-KHV (D. Kan. Feb. 27, 2014), recently appealed to the Tenth Circuit. Now we have a California decision about the same insurer’s policy with the same result, but like the repeating days in the Groundhog Day movie, with some twists.

Twist one: This was a renewal policy without a regulatory exclusion, but with an IVI exclusion for “a claim by, or on behalf of, or at the behest of, any other insured person, the company, or any successor, trustee, assignee or receiver of the company . . . .” The D&O policy in McCaffree had an endorsement deleting a regulatory exclusion, while separately keeping an IVI exclusion excluding loss from claims by a receiver.

Twist two: These directors and officers consented to entry of a default judgment against them for over $48.5 million! They also assigned all their claims against the D&O insurer to FDIC.

There was no assignment or default judgment in McCaffree. Instead, insurer advanced defense fees for the directors and officers, subject to a reservation of rights. It also sued for a declaration that the policy didn’t apply. Insurer, directors, officers, and FDIC then settled FDIC’s claims against the directors and officers, who confessed judgment for FDIC for the $5 million policy limit. The parties agreed $5 million was reasonable given the likelihood of a jury verdict substantially over policy limits. As of the court decision, $1 million was paid to FDIC on the judgment, $750,000 by the directors and officers and $250,000 by insurer.

Twist three: To determine if the IVI is ambiguous, Hawker “provisionally” addresses email communications about the policy, deposition testimony by the insurer’s corporate designee, an initial reinsurance report, and statements from insurer’s employees advertising the policy as having “broader coverage.” No extrinsic evidence was considered in McCaffree in deciding whether the IVI applied.

Argument one, IVI “receiver” doesn’t include FDIC: Citing dictionary definitions, FDIC argued “receiver” as used in this IVI exclusion “refers to a type of court appointed receiver, not to the FDIC” which wasn’t court-appointed. Citing Black’s law dictionary, this court disagreed, reasoning that “receiver” in its “ordinary and popular sense” wasn’t necessarily a court-appointed receiver. As the court explained:

The FDIC does not dispute that the FDIC, in its capacity as receiver for County Bank, performs the characteristic functions of a “receiver” as defined in Black’s Law Dictionary. The FDIC acts to protect or collect the assets of County Bank, which are subject to diverse claims from stockholders, creditors, depositors, etc. While the FDIC attempts to differentiate itself from other types of receivers, it fails to identify any significant distinction that would justify an interpretation of [IVI] Exclusion 21 that would treat the FDIC differently from any other type of receiver.

This wasn’t an argument addressed in McCaffree.

Argument two, the separate regulatory and IVI exclusions show the former was intended to exclude FDIC claims but the latter wasn’t: The regulatory exclusion would be superfluous if FDIC claims were already barred by the IVI, argued FDIC.

But says this court:

[T]he regulatory exclusion would bar suits brought by the FDIC in its capacity as federal insurer, also known as its “corporate capacity,” whereas the insured versus insured exclusion would only bar claims by the FDIC in its capacity as a receiver.

And in addition, per this court: “Overlap” in the exclusions didn’t mean the IVI is “superfluous”; they’re not “identical.” The court explained:

Since the regulatory exclusion has some effect beyond that which is provided by the insured versus insured exclusion, namely, the exclusion of claims by the FDIC in its corporate capacity, the regulatory exclusion is not superfluous and the Court does give some meaning to all the [Executive protection] Policy’s terms under [insurer’s] proposed interpretation

Argument three, IVI prevents collusive suits by one insured against another: This was the “reasonable expectation,” this suit wasn’t collusive, and so IVI didn’t apply, argued FDIC. This Circuit’s appeals court explained the IVI’s genesis and how it shows the parties’ reasonable expectations about coverage:

Such exclusions “arose . . . as a reaction to several lawsuits in the mid-1980s in which insured corporations sued their own directors to recoup operational losses caused by improvident or unauthorized actions. [Footnote omitted.] Such lawsuits created problems of moral hazard, collusion, and unintended expansion of coverage. The reasonable expectations of the parties were that they were protecting against claims by outsiders, not intracompany claims.” Biltmore Associates, LLC v. Twin City Fire Ins. Co., 572 F.3d 663, 668 (9th Cir. 2009)

But, according to the court, limiting the IVI to claims by one insured against another, would mean the term “receiver” in the IVI would have no meaning; the exclusion would never apply to a claim by any receiver, whether the FDIC or any other receiver; and that would be contrary to a rule for reading contracts, namely, that all contract terms are to be given meaning.

This court went even further though, stating that FDIC receivership claims “have the potential of sharing some of the characteristics of the typical insured versus insured claim”:

Much like a corporation suing its own directors and officers for operational losses caused by improvident actions, the FDIC in its capacity as a receiver steps into the shoes of a failed bank and, in this case, seeks to recoup operational losses caused by improvident actions.

Further, per this court: “[A] suit by the FDIC against a failed bank’s directors and officers has potential for collusion just as a suit by a corporation against its own directors and officers.”

The court explained:

While the Court is not accusing the FDIC of collusion in this instance, hypothetically speaking, the interests of the FDIC-as-receiver could be aligned with the interests of the directors and officers of a failed bank when an insurer is involved. Insurance proceeds paid out on a claim brought by the FDIC would be used to pay off the failed bank’s creditors, which may include the same directors and officers that were defending the lawsuit. Accordingly, it is not difficult to imagine a scenario involving collusion between the FDIC and the directors and officers whereby the directors and officers allow judgment to be entered against them so that the insurer is forced to pay the judgment. In such a scenario, the directors and officers benefit by having their uninsured investment and loans paid from the insurance proceeds.

While suggesting that “scenario” to justify its decision, this court cited no evidence that collusion would occur if insurer’s policy applied to FDIC’s suit. Although these directors and officers consented to a $45.5 million default judgment and assigned their claims against the insurer to FDIC, this court didn’t characterize those circumstances as “collusive” and explicitly stated it was “not accusing the FDIC of collusion . . . .”

The McCaffree court also concluded the IVI wasn’t limited to collusive suits; what mattered, per that court, was that the exclusion expressly applied to a “receiver.” Collusion wasn’t raised as a “reasonable expectations” argument, although “reasonable expectations” applies under Kansas law when there’s ambiguity; instead it was raised as “industry custom and practice,” but the McCaffree court didn’t see any need to consider the evidence as it believed there was no ambiguity about whether the IVI applied to the FDIC claims in that case.

Argument four, prior cases holding IVI inapplicable to FDIC receiver claims: Those cases were inapplicable, said the court; the IVI exclusions didn’t apply to claims by a receiver as this IVI. The McCaffree court reached the same conclusion.

Argument five, emails, reinsurance reports, insurer corporate designee testimony, and other insurer statements show IVI doesn’t apply: If contract wording is unambiguous, other “extrinsic” evidence about what the wording may mean–such as emails, reinsurance reports, and testimony about intent–ordinarily is inadmissible. But in some states, courts may consider not just the contract wording, but extrinsic evidence to determine if wording is ambiguous. This court by-passed determining whether under California law extrinsic evidence is admissible to determine ambiguity. Instead it “provisionally considered” FDIC’s extrinsic evidence and determined: “Even if all the evidence was properly authenticated and admissible, the [Executive protection] Policy is not ‘reasonably susceptible’ to the interpretation urged by the FDIC.”

FDIC-cited email exchanges cited supported insurer rather than FDIC’s position, said this court.

Explaining why one of the emails supported insurer, the court stated:

[Insurer’s representative] takes the position that the insured versus insured exclusion would not bar claims by the FDIC in its corporate capacity, but that “case decision trends” would interpret Exclusion 21 as barring claims brought by the FDIC in its capacity as a receiver

Explaining why other emails supported insurer, the court stated:

[T]he e-mail from Ms. Wohlford demonstrates that [the insured] County Bank interpreted [the IVI] as excluding claims brought by the FDIC in its receiver role and asked [insurer] to include an endorsement “to cover these sorts of claims.” [citation omitted] Thus, the e-mail exchange . . . shows that, at that time, County Bank believed that [IVI] would operate to bar claims by the FDIC in its capacity as a receiver and sought an “endorsement to the policy to cover these sorts of claims.”

An FDIC-cited internal email exchange by insurer employees while not supporting insurer, didn’t support FDIC either, according to this court: “[T]his response does not appear to speak at all about the implication of claims brought by the FDIC in its capacity as a receiver for County Bank.”

The insurer’s corporate designee’s testimony cited by FDIC, per this court, was based on “an incomplete hypothetical” and “is consistent with the interpretation that the regulatory exclusion barred FDIC claims in all capacities and the insured versus insured exclusion only barred FDIC claims in its capacity as a receiver: an insured may have thought some regulatory claims (e.g., regulatory claims by the FDIC in its corporate capacity) would be covered if the regulatory exclusion were removed from the insurance policy.”

And also per this court, that the insurer’s reinsurance report mention the regulatory exclusion, but not the IVI doesn’t prove the IVI is inapplicable.

This court also found no support in FDIC’s position based on cited “statements from [insurer] employees advertising the . . . Policy as having ‘broader coverage.'” Per the court:

FDIC presented no foundation or context for these statements and it is unclear what is being compared to the new EPL Policy. To the extent that the policy is being compared to the prior D&O policy that included the regulatory exclusion, the EPL Policy would be considered broader since it allowed claims by the FDIC in its corporate capacity.

The McCaffree court didn’t consider any such extrinsic evidence.

Regarding insurer’s discovery responses in Columbian Bank Financial Corp. v. Bancinsure, Case No. 08-cv-2642 (D. Kan. Nov. 30. 2009), this court couldn’t tell whether the policy in that case included an identical IVI and concluded the “discovery responses merely state that claims by the FDIC as a receiver would be barred by the regulatory exclusion and do not speak to whether those same claims would be barred by an insured versus insured exclusion.”

The McCaffree court rejected FDIC’s argument that based on interrogatory answers in Columbia Bank, insurer was judicially estopped from arguing the IVI exclusion applied to FDIC claims as receiver.

Argument six, excluding coverage for FDIC claims would mean inserting additional terms omitted by the parties:Rejecting this argument, this court explained:

While the regulatory exclusion was omitted from the [Executive protection] Policy, the insured versus insured exclusion is in the policy. The exclusion of claims by “receivers” is not a term being inserted into the policy by the Court.

FDIC relied on American Alternative Insurance Corp. v. Superior Court, 135 Cal. App. 4th 1239 (2006). There the insured purchased an endorsement eliminating an exclusion for physical damage to an aircraft cause by government seizure. “The court reasoned that, taking into consideration the availability and elimination of this exclusion, the policy without the exclusion would be interpreted to cover physical damage from governmental seizures.”

This court distinguished American Alternative. First:

[T]his is not a scenario where the regulatory exclusion existed in the EPL Policy and County Bank purchased an endorsement to remove the exclusion. Instead, the regulatory exclusion was removed as a matter of course by [insurer] in order to remain competitive in the insurance market.

Second:

[T]he rationale in American Alternative appears to be premised on the fact that the governmental seizure exclusion would have been mere surplussage if the underlying policy did not cover damage from governmental seizures in the first place. As discussed above, this is not the case with the regulatory exclusion, because even if the insured versus insured exclusion is interpreted to exclude claims by the FDIC in its capacity as a receiver, the regulatory exclusion would still have significance because it would further exclude claims by the FDIC in its corporate capacity.

Limited application: Unlike typical IVI exclusions, the IVI in Hawker and McCaffree explicitly applied to a “receiver” and, for that reason alone, these case could have only limited application as Kevin LaCroix’s states in his D&O Diary post about the case here. There will be more to come on McCafree, now on appeal to the Tenth Circuit. Keep your eyes open for an appeal in Hawker.

Tags: California, Kansas, D&O, executive liability policy, management liability policy, failed bank, insured versus insured exclusion, IVI exclusion, regulatory exclusion, collusion, reasonable expectations, surplussage, FDIC, receiver