Ninth Circuit Correctly Recognizes that Insured-Versus-Insured Exclusion Does Not Bar FDIC From Pursuing Coverage Under Failed Bank’s D&O Policy

The Ninth Circuit recently held in St. Paul Mercury Insurance Co. v. Federal Deposit Insurance Corp. that a D&O policy’s insured-versus-insured exclusion does not prevent the Federal Deposit Insurance Corporation (“FDIC”), as receiver of an insured failed bank, from obtaining coverage under such policy. In so doing, the Court of Appeals follows the Eleventh Circuit and other courts that have addressed this issue and sided with the policyholder. This decision, while unpublished, is a timely one for policyholders, as regulators including the FDIC litigate these claims arising out of the financial crisis. Just this week, a Georgia jury returned a verdict in favor of the FDIC that awarded almost $5 million in damages for claims relating to a bank’s negligent management by its former officers and directors.

The FDIC brought claims against the former directors and officers of Pacific Coast National Bank for negligence, gross negligence, and breaches of fiduciary duty. The FDIC alleged that the former directors’ pursued an aggressive lending strategy, failed to ensure that loan practices complied with the bank’s policies, and inadequately supervised subordinate officers, which led the bank to suffer millions of dollars in losses. The insurer, The Travelers Companies, Inc., which comprises appellant Saint Paul Mercury Insurance Company, filed a declaratory judgment action to establish that the policy does not cover the FDIC’s claims. Considering the parties’ cross-motions for summary judgment on the action, the district court rejected Travelers’ contention that the exclusion barred coverage, holding that the exclusion did not expressly bar claims by the FDIC.

On appeal, the key issue was whether the language of the exclusion, which barred coverage for claims brought “by or on behalf of any Insured or Company,” was ambiguous. The FDIC argued that the phrase “on behalf of,” as applied to its action against the directors, was ambiguous, relying on the facts that it initiated the underlying case almost three years after the bank’s failure and that no person from the bank had any involvement in bringing its claims.

The insurer contended that the exclusion unambiguously barred the FDIC’s claim against the directors and officers because the receiver “steps into the shoes” of the failed bank, citing the Supreme Court’s decision in O’Melveny & Myers v. FDIC (1994).

The Ninth Circuit rejected the insurer’s argument. It concluded that the exclusion was ambiguous as applied to the FDIC in its capacity as receiver. The court reasoned that because the FDIC “represents a number of interests and does not operate as a normal successor,” it is ambiguous whether the receiver is pursuing its claims against the directors and officers “on behalf of” the failed bank, within the meaning of the exclusion. Applying California law, the court then construed that ambiguity against the insurer. The court noted the absences in the policy of any reference to claims brought by a receiver or an applicable regulatory exclusion. The court also highlighted that numerous interpretations of similar exclusions by other courts provided notice to the insurer of the exclusion’s ambiguity as applied to an insured’s receiver. Indeed, the court remarked that “the precise language of this precise insurance policy has been held to be ambiguous by the Eleventh Circuit.”

While unpublished, this decision by the Ninth Circuit further supports the proper interpretation of the insured v. insured exclusion in favor of receivers seeking coverage. As we have previously noted, this is the correct interpretation, because insuring claims a receiver brings against a failed bank’s directors does not implicate the anti-collusion rationale for the exclusion.