When Choosing a Policy with a “Prior Acts” Exclusion, Buyer Beware

Bank directors ended up with no insurance coverage in Zucker v. U.S. Specialty Insurance Co., 2017 WL 2115414 (11th Cir. May 16, 2017).  The Eleventh Circuit, applying Florida law, applied a “prior acts” exclusion from D&O coverage to allegedly fraudulent transfers which were made after the policy’s inception date but which arose out of bank officers’ alleged misconduct before the policy inception date.

The transfers in question were made in January 2009, when BankUnited, a holding company, transferred two tax refunds, totaling $46 million, to its wholly-owned subsidiary. A year earlier, in January 2008, the Office of Thrift Supervision had begun investigating the subsidiary.  Also in 2008, the parent contributed $80 million to the subsidiary, leaving the parent with only $40 million to service $125 million in debt.  And in September 2008, the parent’s investors filed a class action alleging that the parent’s officers had violated federal securities laws.  At about the same time, both banks entered into agreements with the OTS in which they stipulated that “they had engaged in unsafe and unsound lending practices that . . . resulted in [the subsidiary] being in an unsatisfactory condition.”

At that point, the parent’s insurer declined to renew its D&O coverage. U.S. Specialty was willing to provide coverage, and offered the bank a choice:  the bank could buy a policy with a “prior acts” exclusion, or spend more for a policy without the exclusion.  The bank chose the cheaper option, which excluded coverage for any claim “arising out of, based upon or attributable to any Wrongful Act committed or allegedly committed, in whole or in part,” before the first day of coverage under the new policy, which was November 10, 2008.

Several months later, in early 2009, the parent transferred the $46 million in tax refunds to its subsidiary. Shortly after that, the regulator closed the subsidiary and the parent filed for bankruptcy.  The bankruptcy plan administrator filed an adversary proceeding against three of the bank’s former officers, alleging that they had breached their fiduciary duty by failing to maintain adequate internal controls; by providing incomplete and inaccurate information to the bank’s board of directors; by approving the $80 million infusion without sufficient investigation; and by transferring the $46 million to the subsidiary in 2009.  U.S. Specialty denied coverage for all the claims, based on the “prior acts” exclusion.   After a settlement and assignment to the plaintiff of the officers’ claims against the insurer, the plaintiff filed a claim against the insurer for breach of contract and bad faith.

The district court granted the insurer’s motion for summary judgment, finding that the prior acts exclusion barred coverage for the 2009 transfers. The plaintiff appealed.

The Eleventh Circuit, applying Florida law, affirmed the district court. Chief Judge Ed Carnes, writing for a panel also including Judge Fay and Judge Barrington Parker visiting from the Second Circuit, cited a Supreme Court of Florida decision finding that the phrase “arising out of” is not ambiguous, and has a broad meaning.  The standard “requires more than a mere coincidence between the conduct . . . and the injury,” according to Florida’s highest court, but “does not require proximate caus[ation].”  And Florida courts have construed the phrase broadly, the court noted, even when it is used in insurance policy exclusions.

Against that backdrop, the Eleventh Circuit concluded that the 2009 transfers “arose out of” wrongful conduct preceding the policy inception date. The court noted that the plaintiff had alleged in the bankruptcy court that the bank’s officers had committed wrongful acts, some before November 2008, that harmed the bank financially, and so “has admitted that the wrongful conduct of the corporate officers contributed to the insolvency that made the 2009 tax refund transfers fraudulent under Florida law.”  (The fact that the plaintiff didn’t expressly incorporate the allegations about 2008 into his count about the 2009 transfers, the court said, didn’t matter.)  “It is no coincidence that insolvency and misconduct converged on the Parent Bank,” the court concluded.  “Instead, the misconduct was a significant contributing cause of the Parent Bank’s vulnerability to the 2008 financial crisis.  For that reason, it is plain that [the plaintiff’s] fraudulent conveyance claims ‘arose from’ wrongful acts that predate November 10, 2008 and therefore fell within the scope of the Prior Acts Exclusion.”

The Eleventh Circuit also rejected the plaintiff’s argument that applying the exclusion to the 2009 transfers rendered the policy’s coverage illusory: “The Prior Acts Exclusion excludes a lot of coverage, but not all coverage.”  But the court noted that the result could be different in a case involving an individual insured:  “[R]egardless of what the result might have been had this exclusion been included in an adhesion policy issued to a layperson, it was not.  The Parent Bank entered into this insurance contract with its eyes wide open and with its wallet on its mind.”

Posted by Valerie Sanders.

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