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Counter-Cyclical Thoughts About D&O Insurance

It can be a challenge, when economic times are relatively good, to take time away from thinking about new opportunities to discuss topics like D&O insurance.  Even though I am biased, I’ll admit that, in those times, discussing the risks of potential liability and how to insure those risks can feel both a pretty unpleasant and a pretty remote thing to be discussing.  However, like all risk-related issues, it is precisely in those times when business is going well that a little bit of counter-cyclical thinking and attention can do the most good over the long haul.

As you approach your next D&O policy renewal – and particularly in the 30-60 days prior to the expiration of your current policy, there are a few things that you may want to consider.

Multi-year endorsements – what’s the catch? 

In good times, many insurers will offer packages styled as multi-year policies, usually touted as an option that allows for some premium savings and perhaps a reduced administrative burden.  However, as with all things, these advantages may come with a catch.

Many multi-year endorsements will reserve to the insurer the discretion to assess additional premium on an annual basis within the multi-year period if the risk profile of the bank changes in a material way.  So premium savings may not ultimately be realized, depending on the facts.

Beyond this, some multi-year endorsements will actually impose additional requirements on the insured to provide notice of events that could trigger the carrier’s repricing rights or other conditions.  Those obligations may be triggered when those events occur on an intra-period basis, which can set up a potential foot-fault for an organization that does not keep those requirements front of mind (which can be a practical challenge, as if those events are happening, it is likely that there are a number of issues competing for management and the board’s attention).

Companies looking at multi-year endorsements should make sure they understand fully the terms on which the multi-year option is being provided and should have counsel or an independent broker review the specific language of the proposed multi-year endorsement itself on their behalf.  In addition, while it may be tempting to use a multi-year endorsement to try to extend the renewal horizon and to try to reduce the administrative burden that comes with the renewal process, doing so may also reduce your ability to negotiate appropriate enhancements to your policy terms over the multi-year period.

Multi-year policies may be the right fit for your institution, but they should not be viewed as a one size fits all solution.  Before heading down that road, ask yourself how much is being saved and how real those savings actually are and, perhaps just as importantly, whether avoiding a broader discussion of your coverage strategy on at least an annual basis is a good thing or not.

What about the bank has changed? 

Times of economic expansion often bring with them opportunities to explore new lines of business.  In addition, substantial recent technological innovations in the financial services industries and increasing consumer demands for technological solutions have meant that not only are new market opportunities being explored but that they are being explored in new ways.  And if that isn’t enough, there is always the ever-changing regulatory and compliance landscape to contend with.

All of these trends – as well as your decisions of where and how your institution will choose to participate (or not to participate) in them – bring with them new and different risks.  To the extent that your bank has expanded its offerings, changed its footprint or portfolio mix, or otherwise changed its policies or ways of doing business, you should think about how those changes may impact your insurance needs.  It can be easy, particularly when you have a long relationship with an incumbent carrier, for the renewal process to become somewhat rote.

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Forming a Game Plan for TruPS

Forming a Game Plan for TruPS

November 14, 2014

Authored by: Ken Achenbach and Michael Shumaker

For the past 15 years, trust preferred securities (TruPS) have constituted a significant percentage of the capital of many financial institutions, mostly bank holding companies.Their ubiquity, both as a source of capital and as a common investment for banks, made them a quiet constant for many financial institutions. Even in the chaos of the Great Recession, standard TruPS terms allowed for the deferral of interest payments for up to five years, easing institutions’ cash-flow burdens during those volatile times. However, with industry observers estimating that approximately $2.6 billion in deferred TruPS obligations will come due in the coming years, many institutions are now considering alternatives to avoid a potential default.

Unfortunately, many of the obstacles that caused institutions to commence the deferral period have not gone away, such as an enforcement action with the Federal Reserve that limits the ability to pay dividends or interest. It is unclear if regulators will relax these restrictions for companies facing a default.

So what happens if a financial institution defaults on its TruPS obligations? It is early in the cycle, but some data points are emerging. In two cases, TruPS interests have exercised the so-called nuclear option, and have moved to push the bank holding company into involuntary bankruptcy. While these cases have not yet been resolved, the bankruptcy process could result in the liquidation or sale of the companies’ subsidiary banks. Should these potential sales result in the realization of substantial value for creditors, it is likely that we will see more bankruptcy filings in the future.

Considering the high stakes of managing a potential TruPS default, directors must be fully engaged in charting a path for their financial institutions. While there may not be any silver bullets, a sound board process incorporates many of these components:

Consider potential conflicts of interest.
In a potential TruPS default scenario, the interests of a bank holding company and its subsidiary bank may diverge, particularly if a holding company bankruptcy looms. Allegations of conflict can undercut a board’s ability to rely on the business judgment rule in the event that decisions are later challenged. Boards should be sensitive to potential conflicts, and may want to consider using committees or other structures to ensure proper independence in decision-making.

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A Rundown on Georgia’s FDIC Failed Bank Litigation

As we have reported before, Georgia has the unfortunate distinction of leading the nation in bank failures since the onset of the late-2000s financial crisis.  Georgia has also seen far more FDIC bank failure lawsuits than any other state:  15 of the 63 bank failure cases brought by the FDIC since 2010 involve Georgia banks and are currently pending in Georgia federal courts.  While some allegations vary from case to case, the general thrust of all of these lawsuits is that the former directors and/or officers of the banks were negligent or grossly negligent in pursuing aggressive growth strategies, with these strategies usually involving a high concentration of risky and speculative speculative real estate and acquisition, construction and development loans.  Here is a rundown of the most interesting and significant developments to date:

The most heavily litigated issue has been whether the business judgment rule insulates bank directors and officers from liability for ordinary negligence.  Beginning with Judge Steve C. Jones’ decision in FDIC v. Skow, concerning the failure of Integrity Bank, the district courts have consistently dismissed ordinary negligence claims, citing the business judgment rule.  As we previously reported in November, the Eleventh Circuit has agreed to hear an interlocutory appeal in the Skow case.  That appeal has now been fully briefed by the parties.  The FDIC’s briefs can be found here and here, while the Defendants/Appellees’ brief can be found here.  The parties’ briefs all focus on the interplay between the business judgment rule and Georgia’s statutory standard of care, with the FDIC arguing that the statute’s expression of an ordinary care standard precludes the application of any more lenient standard, and the Defendants/Appellees arguing that Judge Jones correctly followed the Georgia appellate courts’ interpretation of the business judgment rule.  Note:  This firm represents the Georgia Bankers Association and Community Bankers Association of Georgia, who have been granted leave to appear as amici curiae in support of the Defendants/Appellees.  The amicus brief can be found here.

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FDIC Sues Former Bank Officer for Fraud

On May 23, 2012, the FDIC filed an action against the former directors and select former officers of Innovative Bank (“Innovative” or the “Bank”).  Innovative was based in Oakland, California, and it had four other branches in the state when it was closed by the FDIC in April 2010.  For a copy of the FDIC’s lawsuit, click here.

The FDIC’s complaint in this case contains the same hallmark claims for negligence, gross negligence and fiduciary breach that we have come to expect from its D&O suits.  But this case is unique in that the FDIC also asserts a direct claim for fraud.

The alleged fraud was rooted in the Bank’s high-volume SBA lending program.  According to the complaint, the senior vice president in charge of SBA lending, Jimmy Kim, had free rein to originate, recommend and approve SBA loans, all with virtually no supervision by senior management or the board of directors.  The SBA loans generated huge commissions for Mr. Kim, and he reportedly received monthly commissions in excess of $100,000.  In order to continue the flow of high commissions, the FDIC alleges, Mr. Kim colluded with borrowers and loan brokers to cause the Bank to extend millions of dollars of loans that absent fraud would not have qualified for the SBA lending program.

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D&O Carrier Seeks Denial of Coverage Against Former Directors of Failed Bank

On March 30, 2012, Progressive Casualty Insurance Company filed an action naming as defendants the FDIC as Receiver of Omni National Bank, as well as the former officers and directors of Omni whom the FDIC had previously sued.  The Complaint asserts a claim for declaratory judgment that Progressive is not obligated to cover any of the claims asserted by the FDIC against the former directors and officers in the Omni litigation.  This action is significant in that it raises a number of coverage issues which former directors and officers of failed banks may see raised by their own D&O insurance carriers, and the presence or absence of D&O coverage is a critical factor considered by the FDIC in determining whether to bring an action seeking any kind of recovery.

Progressive had underwritten a director and officer liability policy for the directors and officers of Omni with a total policy limit of $10 million.  The policy did not contain any exclusion which would directly exclude coverage for any action brought by a governmental or regulatory agency such as the FDIC (a so called “regulatory exclusion”).  Nonetheless, apparently after having received notice of the claim by the FDIC, Progressive denied coverage on a number of separate bases, which now form the basis of the declaratory judgment lawsuit.

First, Progressive alleged that coverage for the former directors and officers of Omni was barred by the insured v. insured exclusion contained in the policy.  An insured v. insured exclusion is a common feature of a directors and officers liability policy, and essentially provides that any claim brought by, on behalf of, or at the behest of any insured company or insured person under the policy against insured persons under that same policy are not covered.  Progressive alleges that, because the FDIC steps into the shoes and succeeds to all the rights and privileges of the Bank, and brought the action against the directors and officers in its capacity as Receiver for the Bank, the insured v. insured exclusion is triggered and therefore no coverage is available.  Whether a standard insured v. insured exclusion in fact bars coverage for an action by the FDIC against former officers and directors is an important question, and is certainly debatable.

Next, Progressive alleges that, because unpaid unrecoverable loan losses are carved out from the definition of “loss” under the policy, there is no coverage for the losses alleged in the FDIC’s complaint against the former Omni directors and officers.  Progressive alleges that the FDIC’s complaint is specifically based on $24.5 million in losses that the bank suffered on over 200 loans.

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FDIC Criticizes Civil Money Penalty Insurance

In recent exam cycles, bankers have generally been no strangers to heightened scrutiny by FDIC examiners on a variety of topics.  In the past several months, the insurance policies carried by banks have been added to the list of potential hot-button items.

Specifically, FDIC examiners have begun to scrutinize bank insurance policies to determine whether the policies provide coverage for civil money penalties (“CMPs”) that may be assessed against bank officers or directors. If any bank insurance policies are found on examination to contain an endorsement extending coverage for CMPs to officers or directors, the FDIC is citing such policies as being in violation of Part 359 of the FDIC’s Rules and Regulations.

Part 359, among other things, prohibits banks and affiliated holding companies from making certain “prohibited indemnification payments.” These prohibited payments include any payment or agreement to pay or reimburse bank officers or directors for any CMP or judgment resulting from any administrative or civil action which results in a final order or settlement in which that officer or director is assessed a CMP, removed from office or ordered to cease and desist from certain activities. As a matter of public policy, this provision is designed to prevent banks from bearing the costs of penalties assessed against individuals for actions that could result in harm or potential harm to a bank or to the safety and soundness or integrity of the banking system more generally.

Part 359 explicitly permits reasonable payments by banks to purchase commercial insurance policies, provided that the policy not be used to pay or reimburse an officer or director the cost of any judgment or CMP assessed against him or her. However, Part 359 does permit the insurance paid for by the bank to cover (1) legal or professional expenses incurred in connection with such a proceeding and (2) the amount of any restitution to the bank, its holding company, or its receiver.

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Recent Settlement Indicates FDIC’s Focus on D&O Insurance

A recent negotiated settlement in an FDIC failed bank lawsuit, which has as its sole focus potentially available funds under a D&O policy, and in fact assigns claims under that policy to the FDIC, further suggests that the FDIC’s real focus in failed bank litigation is on proceeds that may be available under D&O policies, as opposed to the personal assets of former directors and former officers.

The First National Bank of Nevada (“FNB Nevada”) failed on July 25, 2008, less than thirty days after First National Bank of Arizona (“FNB Arizona”) was merged with an into FNB Nevada.  On August 23, 2011, the FDIC filed an action in the District of Arizona against the former CEO and Vice Chairman of the Bank’s holding company as well as of both FNB Nevada and FNB Arizona and additionally against the holding company’s Executive Vice President (“EVP”), who was also the EVP of FNB Nevada and FNB Arizona.  There was nothing remarkable about the FDIC’s complaint, which basically alleged negligence and gross negligence in lending, primarily at FNB Arizona, which allegedly resulted in millions of dollars of bad loans that ultimately contributed to the Bank’s failure.

What is remarkable about the FNB Nevada case is that shortly after the complaint was filed, on September 2, 2011, the FDIC and the two named defendants jointly filed a Motion for Entry of Judgment which would in effect settle all of the FDIC’s claims against the two named defendants.  In the proposed settlement contemplated by the Motion for Entry of Judgment, each of the individuals consented to the entry against them of separate judgments in the amount of $20 million.  Notably, however, those amounts were to be paid only through what the FDIC is able to recover from the D&O carrier, Catlin, which had denied coverage and refused to defend the FDIC’s claims on behalf of the named defendants.  The settlement specifically provides that the FDIC will not pursue any aspect of the judgment against the named defendants individually, and will limit its efforts at recovery to its claims for wrongful denial of coverage against the D&O carrier.

This settlement no doubt had some appeal to the two named defendants, in that it, if approved, it will result in a full release of any and all claims against them individually, as well as an agreement not to pursue any aspect of the agreed upon judgment from them individually.  However, the insurance company is likely to take the position that the settlement, which was entered into without development of any actual evidence or proof that either of the named defendants engaged in any kind of actionable wrong-doing, was collusive and was entered into without any rational analysis, and solely at the expense of the carrier.  The response to that, however, is likely to be that the D&O carrier should not now be heard to criticize the manner and extent to which the FDIC’s claims were analyzed or defended, after it refused to provide any coverage under the policy or to provide any defense to the named defendants.

In any event, it is yet another indication that the FDIC’s primary focus in the failed bank litigation is the proceeds of directors and officer liability policies, not the personal assets of former officers and directors of failed institutions.

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Can You Improve Your D&O Insurance Coverage?

There is a common presumption among community banks, and their directors, that D&O insurance coverage is a commodity.  That presumption is inaccurate; there can be significant differences in the scope and quality of D&O coverage between policies and among carriers.  D&O insurance policies can, and should, be negotiated to improve the coverage for directors and officers.

On March 24, 2011, the ABA’s Banking Journal published an article by Bryan Cave attorney Jim McAlpin, “How good is your bank’s D&O policy?

In the article, Jim highlights ten possible enhancements that you may be able to obtain in your D&O coverage, including:

  • limiting the definition of “Application” in the policy to public filings for the past 12 months;
  • expanding the definition of “Claim” in the policy;
  • obtaining non-rescindable Side A coverage;
  • limiting insured vs. insured carve-backs for derivative suits and bankruptcy;
  • carving back defense costs from regulatory exclusions; and
  • including coverage for punitive damages.

Read the complete article on the ABA’s website for all ten possible enhancements, as well as additional information regarding potential improvements to your bank’s D&O insurance coverage.

If you’d like to discuss further, please consider reaching out to Jim McAlpin or any other member of Bryan Cave’s Financial Institutions practice.

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