Directors and officers (D&Os) of troubled companies should be highly sensitive to D&O insurance policies with Prior Act Exclusion.  While policies with such exclusion may be cheaper, a recent decision by the U.S. Court of Appeal for the Eleventh Circuit raises the spectre that a court may hold a loss to have more than a coincidental causal connection with the officer’s conduct pre-policy period and make the (cheaper) coverage worthless.

As the financial condition of Bank United Financial Corp. (the “Parent”) and its subsidiary Bank United FSB (the “Bank”) was deteriorating, in September 2008 the Parent was seeking to renew its D&O insurance policy. The insurer refused to renew. A new insurer agreed to provide coverage. The annual premium for a policy with Prior Act Exclusion was US$350,000 and without the exclusion, US$650,000. The Parent elected for the policy containing the Prior Act Exclusion. In September 2008, prior to the binding of the new policy (November 10, 2008), investors filed a class action against certain officers of the Parent and Bank for violation of securities laws. Also in September, the Parent and Bank entered into agreements with the Office of Thrift Supervision (“OTS”) acknowledging that they engaged in unsafe and unsound practices that resulted in the Bank’s unsatisfactory financial condition.

In early 2009 the Parent transferred to the Bank US$46 million in tax refunds it received.  Subsequently, in May 2009, the OTS closed the Bank and appointed the FDIC receiver and a day later the Bank filed for Chapter 11. In the Chapter 11 case, the unsecured creditor committee (later substituted by the Chapter 11 Plan Administrator) commenced an action against the Parent’s former executives for:

(a) breaches of fiduciary duties, which resulted in the company’s insolvency;

(b) the infusion of US$80 million into the Bank to avoid its seizure by regulators; and

(c) the approval of the tax refunds transfers. 

The litigation was submitted to the insurer who denied coverage based on the Prior Act Exclusion. The District Court agreed and the Chapter 11 Plan Administrator appealed. The Eleventh Circuit U.S. Courts of Appeal affirmed.

The Prior Act Exclusion provided that the insurer is not liable for any loss “in connection with a Claim arising out of, based upon or attributable to any Wrongful Act committed or allegedly committed … prior to [November 10.2008].” Wrongful Act was defined as any “act, error, misstatement, misleading statement, omission or breach of duty” by an insured person with respect of Securities Claims, or claims against insured person for acts in his capacity as an insured person.  The Plan Administrator argued that the tax refunds transfers were made in 2009, after the effective date of the policy and that insolvency is not a wrongful act. But the Court of Appeals agreed with the insurer that the insolvency, although not a wrongful act, resulted from the officers’ pre-November 2008 alleged conduct, and thus is captured by the Prior Act Exclusion:  “[W]e conclude that the Parent Bank’s insolvency ‘arose out of’ wrongful acts that occurred before November 10, 2008….[T]he Parent Bank’s insolvency has a connection to some prior wrongful acts of Parent Bank’s officers and directors that occurred before the policy’s effective date.”

The opinion: Zucker v. U.S. Specialty Ins. Co.