Banking Law

FinCri Advisor (free registration required) continues its exploration of D&O policies for bank officers and directors and the defenses that carriers are raising to avoid having to actually defend the directors and officers. As my Contracts professor told his class during my first semester of law school, insurance companies exist by collecting premiums and denying liability.

Among the defenses raised by insurance companies are the following:

• Requiring "warranty letters" at the time of, and as a condition to issuing, the policy, then raising "breach of warranty" defenses when a claim is made. As Jenner & Block partner Matt Jacobs advises, when it comes to a request for a warranty letter, banks should just say "No."
• The regulatory exclusion (which we recently earlier this year).
• "Insured-vs.inured" exclusions, which insurance companies are attempting to use to deny claims filed by the FDIC against officers and directors it has removed. Jacobs advises that banks should negotiate as many carve-outs as possible at the time the policy is issued.

Jacobs discusses the landmine presented by the "warranty letter."

Most D&O policies, he adds, include two severability provisions that limits application of exclusions due to prior knowledge and also apply to representations in the application. A warranty letter might override these severability provisions.

"The bank, when it is out buying the coverage, needs to obtain full severability on the application," Jacobs urges. "That means that the white hat director who does not have the knowledge will not lose coverage. The contract is a separate contract for each director."

Jacobs also suggests that banks include a clause that says the policy cannot be rescinded as to independent directors, important given that rescissions could be asserted even for small omissions. "That's a big issue, and it became a bigger issue with all these financial fraud claims" during the crisis, he adds.

If your carrier is adamant about including a warranty letter, and your broker says no other insurer is available, revise and narrow the language, Jacobs says. For instance, make it clear that the only applicable knowledge is something material that would trigger only a catastrophic claim at the top layer. "There are ways to limit their draconian effect," he says.

This is an issue that is critical, especially to banks in troubled condition. However, reviewing your policy after your bank is already on the brink (or over the brink) of serious difficulties can be like checking the lifeboats for leaks after you've hit the iceberg. The time to deal with these issues is at the time the bank is shopping for a policy. It's also critical at that time to (1) get expert advice before you apply, and certainly before you accept the policy, and (2) explore as many options as you can with your broker if the first carrier you contact proposes these potentially disastrous provisions and won't back off.

NOTE: Posting will be unpredictable for the rest of the month. That should be a relief to the reader who e-mailed to tell me that I was posting too much. Apparently, terrorists were torturing him by forcing him to read every single one.