Insured v. Insured Exclusion: Round II

November 5, 2013

Insurance LawThe metaphor of the Dutch Boy using his fingers to stem the flow of water from a dike is sometimes used to describe the evolution of insurance policy language. As courts interpret language in a manner inconsistent with the insurance industry’s intent, insurers adopt new language and then wait to see whether courts will give the language its intended effect. In the case of the insured v. insured exclusion, S&L era cases held that a suit by the FDIC as a failed bank’s receiver against the bank’s directors and officers is not a suit “by” the bank. Insurers responded to these decisions by revising the exclusion to apply to suits “on behalf of” an insured.

To date, only three reported decisions have examined the effect of this broader language on FDIC failed bank suits arising out of the subprime mortgage crisis. In late 2012 and early 2013, federal district courts in Georgia and Puerto Rico rejected the insurance industry’s argument that the broader “on behalf of” language renders inapplicable older S&L era cases interpreting an exclusion of coverage for claims “by” one insured against another. Like the courts in the earlier S&L cases, both courts pointed to the “multiple roles” the FDIC plays as a failed bank’s receiver and found ambiguity regarding whether the FDIC sued “on behalf” of the failed bank.

A Game Changer?

In St. Paul Mercury Ins. Co v. Miller, __ F.Supp.2d __, 2013 WL 4482520 (N.D. Ga. Aug. 19, 2013), another federal district court judge in Georgia considered and rejected the rationale traditionally employed in cases exempting the FDIC from the insured v. insured exclusion. In a sweeping opinion, Judge Richard Story distinguished S&L era cases interpreting the narrower form of the exclusion that applied only to claims “by” an insured, as opposed to “on behalf of” an insured. Using language quoted from the United States Supreme Court’s opinion in O’Melveny & Myers v. FDIC, 512 U.S. 79 (1994), he determined that the FDIC “steps into the shoes” of the failed bank. Thus, any defenses that could have been asserted against the bank had the bank brought the suit may be asserted against the FDIC.

The fact that the FDIC serves constituencies other than the bank when it acts as the bank’s receiver does not, in Judge Story’s view, render the exclusion ambiguous. He explained that “it is exceptionally rare for someone other than the FDIC … to raise a claim on behalf of a federally insured bank.” The fact that “the only party that could bring an action on a federally insured bank’s behalf is the FDIC” demonstrates that “the exclusion speaks specifically to this circumstance.”

Judge Story also rejected the FDIC’s argument that the exclusion should be limited to its underwriting purposes of precluding coverage for collusive suits. Judge Story said “this Court cannot refuse to give effect to an unambiguous term of the policy based on an assumption of why the language was put in the policy.”

Finally, Judge Story found no public policy reason for exempting the FDIC from the reach of the insured v. insured exclusion. He expressly “disagree[d] with the notion that it is appropriate to rewrite a contract between private parties in the name of saving the taxpaying public money. Again, there is no rule that the federal insurance fund should always win.”