With bank stability and the related stock market rout now dominating the headlines for the first time since the 2008 financial crisis, are financial institutions’ D&O and bankers’ professional liability / E&O (“BPL”) liability policies ready to help backstop coverage, or potentially full of holes? Coming out of a hard market where insurers carefully and quietly pulled back some policy enhancements over the course of several years, now is the time for financial institutions to review their insurance policies to identify and fill any significant gaps and holes in their executive risk coverages. The last two weeks demonstrate that financial institutions, as well as their directors and officers, face the risks of receivership, government investigations, securities lawsuits, and personal liability following a bank failure or stock rout in the face of financial stability concerns.
Memories of 2008 may be hazy for some in-house counsel and risk managers, but the financial crisis and the earlier savings and loan crisis of the 1980s and 1990s each led to a wave of lawsuits and regulatory actions against financial institutions and billions of dollars in losses. Despite these massive losses, financial institutions and their directors and officers in turn recovered billions of dollars of those losses under their BPL and D&O insurance policies. While it remains unclear whether recent bank failures and the new interest rate environment will translate into a 2008 sized credit crisis or mini-crisis, now is the time for all financial institutions to dust off their BPL and D&O policies to make sure they are ready to respond to and backstop losses, if needed.
BPL policies are often a bank’s first line of defense in the event of claims alleging that a bank committed professional services wrongful acts, and D&O policies are designed first and foremost to provide valuable “lockbox” coverage to directors and officers to avoid having their personal assets on the line when they are faced with derivative and other lawsuits and government investigations. Important issues to review in these executive risk policies include:
- “Claim” definition: BPL policies are usually written on a “claims made” basis, meaning that coverage is triggered when a “Claim” (as that term is defined in the policy) is made against the insured. The typical BPL policy defines a Claim to include a lawsuit or a demand letter, and BPL policies also often extend coverage to include government investigations, regulatory inquiries or proceedings, and other matters concerning alleged wrongful acts by the bank and/or its directors and officers. In the wake of the 2008 financial crisis, many BPL insurers sought to avoid liability for billions of dollars in settlements with state and federal regulators based on a narrow view of the definition of Claim. In many cases, these coverage-defeating arguments did not hold up in court. Therefore, it is important to both ensure the definition of “Claim” is broadly defined in the policy and also to push back against an insurer’s narrow view of the definition of Claim in the event an investigation triggers potential coverage.
- Scope of Regulatory Coverage: While many D&O and BPL policies will afford some coverage for SEC or DOJ investigations, financial institutions also should ensure their policies are broad enough to provide coverage for investigations or proceedings brought by the Office of the Comptroller of the Currency (“OCC”), the Consumer Financial Protection Bureau (“CFPB”), the Federal Trade Commission (“FTC”), state attorneys general, and other regulators that have been more active since the last financial crisis. Further, even if a policy does not specifically include the word regulatory “investigation” in the definition of “Claim,” contrary to what insurers will argue, the policy may still provide coverage for regulatory investigations depending on the type of document that initiated the investigation. It is important to consult with experienced insurance recovery counsel to both review and seek any enhancements now to these policies and then ensure the financial institution and its directors and officers are not leaving insurance dollars on the table or putting personal assets at risk when defense costs and settlements need to be funded.
- Coverage for “Restitution” and Civil Monetary Penalties: Another coverage issue that insurers frequently raised in prior financial crises was whether coverage exists for settlements / judgments that could be characterized as “restitutionary” or as a civil monetary penalty. Some executive risk policies specifically exclude civil monetary penalties or restitution, but most have a boilerplate exclusion for losses that are “uninsurable as a matter of law.” However, virtually all executive risk policies provide “coverage for “settlements,” and most do not exclude coverage for disgorgement / restitutionary or fraud damages absent a final adjudication of the excluded conduct in the underlying matter. This is true particularly if the matter is resolved by a settlement instead of a judgment or consent decree that allocates a specific amount to a civil monetary penalty or “restitution.” For example, in coverage litigation arising from the Bear Stearns collapse, the New York Court of Appeals held that a $140 million disgorgement payment to the Securities and Exchange Commission (“SEC”) was covered “loss” rather than an uninsurable “penalt[y]” under the BPL policies at issue. J.P. Morgan Sec. Inc. v. Vigilant Ins. Co., 183 N.E.3d 443, 445 (N.Y. 2021). Critically, most states do not have statutes or common law making disgorgement / restitution uninsurable, and it is only the specific state law that applies to the policy at issue that matters. Therefore, do not be lulled when an insurer cites to cases from other jurisdictions as a basis to deny or limit coverage when your state either does not bar restitutionary type losses as uninsurable or is silent on the issue.
- Related Claims / Prior Acts Exclusions: Most executive risk policies contain exclusions that attempt to limit coverage for wrongful acts arising from conduct that occurred in prior policy periods, or that may be related to conduct giving rise to earlier litigation. Insurers often try to invoke these “interrelated wrongful acts” provisions to argue that coverage is only available in a prior coverage period (where coverage may be exhausted or where notice was not given), or alternatively, that claims are unrelated such that a policyholder should be forced to incur multiple self-insured retentions / deductibles in several policy periods. These insurer defenses—which are inconsistently raised depending on which position inures to the insurer’s financial benefit in that particular case—should never be accepted at face value. The wording of these provisions varies considerably from policy to policy, and most courts agree that the question of whether claims are “interrelated” or “related back” to “prior acts” are fact intensive questions.
- Timely notice: Most claims made policies require that notice of any Claim(s) be given “as soon as practicable” or within a prescribed time period. In many jurisdictions, these time limitations are strictly enforced. However, policies are sometimes less clear on whether pre-suit circumstances or investigations that could give rise to a “Claim” should be noticed. Moreover, many states have developed common law that requires insurers to prove actual prejudice before they can rely on late notice to bar or limit coverage. Financial institutions should consult with coverage counsel and their broker when evaluating whether to provide notice, or when considering how to respond to an insurer’s attempt to bar or limit coverage based on allegedly late notice.
- Insured vs. Insured and Entity vs. Insured Exclusions in D&O Policies: Most D&O policies contain restrictions on coverage for certain types of lawsuits between insureds—i.e., where an insured is on both sides of the “vs.” Financial institutions should carefully review their D&O policies and ask for “Entity vs. Insured” exclusions, which are increasingly common, to ensure coverage for intra-insured person disputes. Moreover, to protect against the risk of claims brought in a financial institution’s name, whether in receivership or under laws like Dodd-Frank, financial institutions should ensure their policies have exceptions to “Insured vs. Insured” and “Entity vs Insured” exclusions that became increasingly standard after the 2008 financial crisis, including for claims brought by bankruptcy trustees.
- Bankruptcy protection for Directors and Officers: Directors and officers can rest assured that in the instance of an FDIC stay, D&O policies should remain in place to provide first dollar coverage for non-indemnifiable losses, including defense costs. However, to protect the personal assets of Ds&Os in the event of an financial institution’s bankruptcy or receivership, where a trustee may argue that insurance policies are the property of the estate, financial institutions should make sure their policies contain language providing that directors and officers have priority of coverage in the event of losses, and that insurers agree that, notwithstanding the filing of bankruptcy, coverage will be paid to individual insureds if a bankrupt financial institution is unable to indemnify its directors and officers against the massive legal expenses that may follow a bank failure.
Many financial institutions have not reviewed their policies in recent years due to concerns about a hard market or because of other distractions during the COVID-19 pandemic. But all financial institutions should take a closer look, sooner rather than later, at their coverages with their brokers and policyholder coverage counsel to ensure they are ready for the unexpected in today’s rapidly changing environment and unstable financial market.