November 6, 2013
Although less common than the insured v. insured exclusion, the regulatory exclusion was specifically designed to preclude coverage for enforcement actions brought by regulatory agencies such as the FDIC. The regulatory exclusion typically applies specifically to claims against directors and officers “based upon or attributable to any action or proceeding brought by or on behalf of the Federal Deposit Insurance Corporation, the Federal Savings and Loan Insurance Corporation, any other depository insurance organization, the Comptroller of the Currency, the Federal Home Loan Bank Board, or any other national or state regulatory agency.”
Faced with the regulatory exclusion’s unambiguous language, insureds usually mount a public policy challenge to its applicability, arguing that it interferes with the regulator’s statutory authority to resolve the claims of insured institutions. With the exception of the Colorado Supreme Court, state and federal appellate courts have uniformly rejected public policy challenges to the regulatory exclusion. Most courts reason that the freedom to contract does not yield to general considerations of the public interest. Courts have required bank regulators and insureds to point to an express public policy embodied in specific statutes, which they have not been able to do. One court pointed out that since banks are not required to purchase D&O coverage, public policy should not circumscribe their freedom to limit the scope of coverage when they do buy it.
Attempts to characterize the regulatory exclusion as ambiguous have been similarly unavailing. For example, in American Casualty Co. of Reading, PA v. Baker, 758 F.Supp. 1340, 1348 (C.D.Cal. 1991), aff’d, 22 F.3d 880 (9th Cir. 1994), the court rejected the Resolution Trust Corporation’s argument that the regulatory exclusion applies only to secondary suits “attributable” to the actions of a regulatory agency. Similarly, in FDIC v. Zaborac, 773 F.Supp. 137, 141 (C.D. Ill. 1991), the court rejected the contention that the FDIC did not “bring” the action, but was merely maintaining it on behalf of a third party.
Given the willingness of courts to enforce the regulatory exclusion, the best news for policyholders is that due to market competition among insurers the exclusion no longer commonly appears in D&O policies. The regulatory exclusion may, however, make a comeback as D&O insurers attempt to add the regulatory exclusion back into their policies when financially troubled banks seek to renew their coverage—a possibility that recently caused the FDIC to take the unusual step of warning banks about new exclusions in D&O policies.