When the FDIC Comes Calling: Protecting D&O Coverage for a Failed Bank's Directors and Officers

The Federal Deposit Insurance Corporation has begun the process of pursuing the directors and officers of failed FDIC-insured financial institutions by sending "claim letters" to former officials informing them of the FDIC’s intent to sue. As of December 1, 2009, 124 FDIC-insured banks have failed this year—over four times the number in 2008—and the FDIC most likely will allege that some former directors and officers are responsible for the failures, as it has done after roughly a quarter of all seizures since 1985. In addition to FDIC-related claims, ousted directors and officers may in the coming months face shareholder claims, securities and ERISA class action suits, and even criminal investigations and prosecutions.

Each area of potential liability implicates the insurance policies that financial institutions maintain as protection for such claims. In light of the upcoming wave of litigation, Directors and Officers (D&O) coverage, which often is described as “litigation insurance,” will be a significant asset to the failed financial institution’s officials.

This is not the first time we have witnessed claims and attendant insurance disputes arising from bank failures. The FDIC pursued similar lawsuits against banks and former officials during the savings and loan (S&L) crisis of the late 1980s and 1990s, and many of the same issues presented then are likely to arise now. Undoubtedly, insurance companies will attempt to deny D&O coverage arguing, for example, that the so-called “insured v. insured”and “regulatory” exclusions preclude claims and suits brought by regulatory agencies, such as the FDIC. In our experience, such assertions often have little basis in fact and are recited in an improper attempt to protect the financial self-interest of the insurance company. Policyholders should be prepared to resist such defenses.