FDIC Lawsuits Against Failed Banks' Law Firms g and Other Outside - - PowerPoint PPT Presentation

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FDIC Lawsuits Against Failed Banks' Law Firms g and Other Outside Professionals

Protecting Borrowers' and Lenders' Interests Under UCC Article 9

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific WEDNES DAY, MAY 18, 2011

Today’s faculty features: Dianne S . Wainwright, Partner, Margolis Edelstein, Pittsburgh Linda D. Kornfeld, Partner, Jenner & Block, Los Angeles Michael L. Zigelman, Partner, Kaufman Dolowich Voluck & Gonzo, Woodbury, N.Y .

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The FDIC and Current The FDIC and Current Banking Crisis: Banking Crisis: Anticipating Effects on Third Party Anticipating Effects on Third Party f Professionals Professionals

Michael L. Zigelman, Esq.

Partner

mzigelman@kdvglaw.com

135 Crossways Park Drive, Suite 201 y , Woodbury, New York 11797 www.kdvglaw.com

Introduction Introduction

FDIC Role

Introduction Introduction

FDIC Role Current Crisis S&L C t C i i S&L v. Current Crisis Claim Environment Professional Liability Exposures

6

FDIC’s Role in the FDIC’s Role in the U S B ki S t U S B ki S t

Currently Primary Regulator for 4,715 State Non-Member

U.S. Banking System U.S. Banking System

y y g Banks Dodd-Frank Act Also Establishes FDIC as Primary Regulator for All State-Chartered Thrifts Regulator for All State Chartered Thrifts Provides Deposit Insurance for 7,723 Banks (as of November 18, 2010) E h d it i i d f t l t $250 000 Each depositor is insured for at least $250,000 per insured bank Funded by its insured financial institutions y Backed by Full Faith & Credit of U.S. Acts as Receiver for Failed Banks and Thrifts to Liquidate Assets and Pay Claims Assets and Pay Claims

7

Failed Banks Failed Banks

2007 2007 T d T d 2007: 3 banks failed 2007 2007-Today Today 2007: 3 banks failed 2008: 25 banks failed 2009 140 b k f il d 2009: 140 banks failed 2010: 157 banks failed 2011: 25 banks have failed to date (as of March 18, 2011) , )

8

Top States for Bank and Thrift F il 2007 2010 Failures, 2007 – 2010

California 34 fail res assets totaling $102 5 B California: 34 failures, assets totaling $102.5 B Illinois: 38 failures, assets totaling $30.5 B

• s 38 a u es, assets tota

g $30 5 Florida: 45 failures, assets totaling $32.8 B Georgia: 52 failures, assets totaling $26.9 B

9

Current Crisis: Current Crisis:

N b f F il d B k N b f F il d B k

From 2007 through Sept. 10, 2010, 293 commercial banks with FDIC deposit insurance failed (only 18 bank failures from 2002-07)

Number of Failed Banks Number of Failed Banks

deposit insurance failed (only 18 bank failures from 2002 07). 10

FDIC Problem Institutions FDIC Problem Institutions FDIC Problem Institutions FDIC Problem Institutions

11

Savings & Loan Savings & Loan v. v. v. v. Current Crisis Current Crisis Refers to the crisis of the 1980s and 1990s during which hundreds of savings and loan associations in the U.S. failed Contributed to the large budget deficits of the early 1990s

12

Savings & Loan Savings & Loan v. v.

2 744 failed banks as result of S&L Crisis

Current Crisis Current Crisis

2,744 failed banks as result of S&L Crisis Annual Failures and Losses

Until 2009 not more than 50 bank failures in single year Until 2009, not more than 50 bank failures in single year since 1992. Current annual failures lower than each year of S&L Crisis but 2009 losses larger than most years of S&L Crisis, but 2009 losses larger than most years of S&L Crisis.

Aggregate Losses gg g

Aggregate nominal losses in S&L were $103 Billion, compared with $75 Billion from 2008 through June 2010. Recent per bank failures 3x larger than in S&L Crisis Recent per-bank failures 3x larger than in S&L Crisis.

13

Savings & Loan Savings & Loan v. v.

Comparing Assets of Failed Banks

Current Crisis Current Crisis

Comparing Assets of Failed Banks

79% of recent failed banks had less than $1 Billion, but accounted for 20% of Deposit Insurance Fund losses. 91% of S&L failed banks had less than $1 Billion (in 2010 dollars) and accounted for 37% of losses 2010 dollars) and accounted for 37% of losses.

Striking Similarities in Practices

High-risk business strategies, concentrations in high- g g g risk sectors, overreliance on “hot money” funding sources, weakness in staffing, and poor oversight. Poor underwriting policies credit administration risk Poor underwriting policies, credit administration, risk management, and monitoring.

14

Claim Environment Claim Environment

Bank failures concentrated in Georgia and Florida g Due to depressed commercial values from

• verbuilding and weak economic

g fundamentals. Most matters are potential claims FDIC retaining private counsel to pursue claims E-Discovery E Discovery More evidence than during S&L Crisis.

15

Claim Environment: Claim Environment:

FDIC I it FDIC I it

FDIC protected from its own post-closing

FDIC Immunity FDIC Immunity

p p g negligence and/or failure to mitigate. Many courts deemed FDIC immune or Many courts deemed FDIC immune or subject to no duty of care (although courts not uniform on issue). Potential sovereign immunity under Federal Tort Claims Act for FDIC’s own ti i actions as receiver.

16

Claim Environment: Claim Environment:

FDIC’ Liti ti T ti FDIC’ Liti ti T ti

As receiver, FDIC has access to bank’s internal

FDIC’s Litigation Tactics FDIC’s Litigation Tactics

, documents. FDIC can also subpoena individuals from banks FDIC can also subpoena individuals from banks for evidence. FDIC may collaborate w/ DOJ to develop criminal FDIC may collaborate w/ DOJ to develop criminal charges against D&O’s.

E g Two Integrity Bank officers sued by FDIC also E.g., Two Integrity Bank officers sued by FDIC also

• indicted. FDIC, as Receiver of Integrity Bank of

Alpharetta, Georgia v. Steven M. Skow et al., U.S. District Court N D Ga Case No 1:2011 cv 00111 District Court, N.D. Ga., Case No. 1:2011-cv-00111.

17

FDIC’s Claims Against D&O’s FDIC’s Claims Against D&O’s

FDIC authorized suits against 130 D&O’s with claimed damages of $2.6 Billion.

During S&L Crisis, FDIC recovered $1.3 Billion from banks’ D&O’ D&O’s.

Most FDIC investigations completed within 18 months of bank closure. T d t FDIC fil d it i t 4 b k ’ D&O’ ( i To date, FDIC filed suits against 4 banks’ D&O’s (naming 35 individuals).

• IndyMac. FDIC v. Van Dellen, et al., U.S. District Court, C.D. Cal.,

Case No SA cv 10 004915 Case No. SA-cv 10-004915. Heritage Community Bank. FDIC, as receiver of Heritage Community Bank, v. John M. Saphir et al., U.S. District Court, N.D. Ill., Case No. 1:10-cv-07009. Integrity Bank. FDIC, as Receiver of Integrity Bank of Alpharetta, Georgia v. Steven M. Skow et al., U.S. District Court, N.D. Ga., Case No. 1:2011-cv-00111. 1st Centennial Bank FDIC as receiver of 1st Centennial Bank v 1st Centennial Bank. FDIC, as receiver of 1s Centennial Bank, v. James R. Appleton et al., U.S. District Court, C.D. Cal., Case

• No. cv-11-00476.

18

FDIC’s Causes of Actions Against D&O’s Negligence and/or Gross Negligence Negligence and/or Gross Negligence

Gross Negligence under Financial I tit ti R f R d Institutions Reform, Recovery and Enforcement Act

Breach of Fiduciary Duty Breach of Duty to Supervise Breach of Duty to Supervise

19

Defenses of Bank D&O’s Defenses of Bank D&O’s Defenses of Bank D&O s Defenses of Bank D&O s

B i J d t R l Business Judgment Rule Statute of Limitations Statute of Limitations

From bank closure, FDIC has 3 yrs for torts and 6 yrs for contract claims and 6 yrs for contract claims

Loss Causation

Unforeseeability of industry-wide crisis

FDIC’ O C l bilit FDIC’s Own Culpability

20

Professional Liability Professional Liability E

Other policies exposed

Exposures Exposures

BPL, Fiduciary, Lawyers E&O, Accountants E&O

As receiver FDIC will sue other professionals As receiver, FDIC will sue other professionals.

Historically, FDIC filed suits against D&O’s of ¼ of failed banks—same number of additional suits brought g against lawyers, accountants, and insurers. During S&L Crisis, FDIC filed 205 legal malpractice and 139 acco nting malpractice s its and 139 accounting malpractice suits. During S&L, FDIC recovered $1.6 Billion for legal and accounting malpractice claims compared to $1 3 accounting malpractice claims, compared to $1.3 Billion in D&O claims.

21

Theories for Professional Theories for Professional Li bilit Cl i Li bilit Cl i

Tort claims for breach of fiduciary duties and/or

Liability Claims Liability Claims

Tort claims for breach of fiduciary duties and/or negligence against officers and directors Malpractice claims against accountants, p g , attorneys, appraisers, brokers or other professionals Breach of Contract claims

Fidelity Bonds Mortgage Fraud – Cost Per Loan Mortgages, Closing Instructions, Indemnification

22

Professional Liability Exposures: Professional Liability Exposures: R i R i Recoveries Recoveries

Total professional liability collections from January Total professional liability collections from January 1986 to December 1996 exceeded $5 Billion.

$4.5 Billion of the $5 Billion was collected from 1990 th h 1995 through 1995 Of the $4.5 Billion, the FDIC and RTC collected more than $1.2 Billion on accounting liability claims

During the six years after the enactment of the Financial Institutions Reform, Recovery, and E f t A t f 1989 (“FIRREA”) 1989 t 1995 Enforcement Act of 1989 (“FIRREA”), 1989 to 1995, the FDIC and RTC collected $500 Million on attorney malpractice claims. malpractice claims.

23

Professional Liability Exposures Professional Liability Exposures Professional Liability Exposures Professional Liability Exposures

As of April 12, 2011, the FDIC authorized 11 fidelity p , , y bond, attorney malpractice, and appraiser malpractice lawsuits.

Also 142 residential malpractice and mortgage fraud suits pending (some inherited). Additional lawsuits likely in Georgia and Florida.

24

Professional Liability Exposures: Professional Liability Exposures: Ti i d I t A l i Ti i d I t A l i Timing and Impact Analysis Timing and Impact Analysis

It is too earl to determine the potential impact of It is too early to determine the potential impact of the FDIC’s focus on professional liability claims. As the receiver for failed banks and thrifts the As the receiver for failed banks and thrifts, the FDIC has three years to file tort claims, and six years for breach-of-contract claims unless the years for breach of contract claims unless the institution's home state has a longer statute of limitations. Most of the concerned failures occurred in 2008 and after, during the height of the crisis, and have either not yet met or are approaching the three-year mark.

25

Conclusion Conclusion

FDIC aggressively pursuing former D&O’s More litigation is anticipated More litigation is anticipated Impact of Dodd-Frank Financial Reform A t Act FDIC also pursuing third-party professionals involved with failed banks Too early to gauge the impact on certain y g g p third-party professionals - i.e. lawyers and law firms, associated with failed institutions

26

FDIC LAWSUITS AGAINST THE FDIC LAWSUITS AGAINST THE FAILED FINANCIAL INSTITUTION’S OUTSIDE AUDITORS

Dianne S. Wainwright, Esquire Margolis Edelstein 525 William Penn Place Suite 3300 Suite 3300 Pittsburgh, PA 15219 412.355.4951 DWainwright@margolisedelstein.com g @ g www.margolisedelstein.com

27

Outside Auditors have been involved with Financial Institutions for many Years

The Independent Auditor is engaged generally: 1 T d t l dit f th fi i l t t t

y

• 1. To conduct annual audits of the financial statements

and to verify the financial statements.

• 2. To review the bank managements’ internal control
• 2. To review the bank managements internal control

mechanisms. Conceptually, accountants agree to utilize Generally A t d A ti P i i l (“GAAP”) d G ll Accepted Accounting Principles (“GAAP”) and Generally Accepted Audit Standards (“GAAS”) in completing audits and reviewing internal controls. However, both GAAP g , and GAAS are subject to multiple interpretations.

28

The FDIC as Receiver

• The FDIC as Receiver for a failed financial institution acquires the

rights of the financial institution to assert claims for losses caused by professionals hired by the failed financial institution: including A t t d A dit Accountants and Auditors. – When asserting claims as Receiver, the FDIC can utilize the accountant’s annual engagement letters to demonstrate privity d i t i tli i th d ti d and assist in outlining the duties owed. – “The FDIC,” as the failed bank’s “receiver, can only bring claims that would be available to the thrift.” FDIC v. Deloitte & Touche 834 F S 1129 (E D A k 1992) 834 F. Supp.1129 (E.D Ark. 1992) – Note: The FDIC can also file claims on behalf of depositors or creditors in its “corporate” capacity. These claims are asserted by th FDIC t di i “Thi d P t B fi i i ” d th the FDIC standing in as “Third Party Beneficiaries” and they are different claims than those brought as Receiver.

29

The FDIC Acquires/Inherits the Rights of the Failed Financial Institution

• Contract rights and/or applicable insurance

policies/fidelity bonds.

• Contract rights owed from third party professionals to the

failed financial institution. Professional Malpractice Claims

• Professional Malpractice Claims

Negligence Negligent Misrepresentation Negligent Misrepresentation

• Other Tort Claims

30

The FDIC as Receiver (cont.)

• The FDIC, as Receiver, attempts to recover assets from
• thers who may be liable for the failed institution losses.

This process begins with the investigation. – Investigation The Professional Liability Operation

• The Professional Liability Operation

– When a financial institution fails the Professional Liability Operation unit conducts an investigation. y p g – Part of the investigation involves identifying potential areas of recovery for the failed i tit ti Cl i i t di t ffi

• institution. Claims against directors, officers,

lawyers, accountants, brokers and/or appraisers will be examined.

31

Th P f i l Li bilit O ti

The Investigation

• The Professional Liability Operation

– Generally, 18 months to investigate (from the time the financial institution is closed).

• Complex and detailed in nature
• Multi-layer review by the FDIC attorneys and investigators
• Subpoena power: the FDIC has authority to serve subpoenas

p p y p to the failed Financial Institution’s former auditors. See 12 U.S.C. 1821(d)(2)(I), Claims will be pursued only if they pass a two-part test: p y y p p

• (1) Meritorious and
• (2) Cost-effective

32

The Two-Part Test

(1) The claim must be legitimate on the merits:

• If the FDIC’s lawyers and investigators believe the claim is

more likely than not to succeed in the litigation, then the FDIC will evaluate the second prong of the two part test will evaluate the second prong of the two part test.

• The Professional Liability Operation unit will carefully examine

the causes of action and evidence available to support the various claims. (2) The litigation must be cost-effective.

• Considering the available personal or corporate assets of the

defendant target and the available insurance coverage does it defendant target and the available insurance coverage, does it appear that there are assets available to recover?

• Numerous meritorious lawsuits have not been pursued because
• f insufficient sources of recovery to justify the loss.

33

The FDIC’s Recovery History The FDIC s Recovery History

• During the 1980s and 90s the FDIC pursued claims

i t dit d it th f t th t h liti ti against auditors despite the fact that such litigation was complex and expensive.

• As a result of their efforts, the FDIC and RTC ultimately

ti t d th $1 15 billi d i thi ti i d negotiated more than $1.15 billion during this time period as a result of the auditing malpractice claims. – Four global settlements involving KPMG, Deloitte & Touche Arthur Anderson and Ernst & Young Touche, Arthur Anderson and Ernst & Young accounted for over $1 billion of the $1.15 billion recovered.

34

Assuming Cost Effective, Litigation may be Pursued where the Following Elements are Met:

– (1) Strong liability claim

• A clear showing that there was a deviation from the

accounting/auditing standards. – (2) Damages that are discernable/quantifiable. – (3) Causation: Assuming the FDIC can show that the auditor ( ) g deviated from the accepted auditing standards, the FDIC must be prepared to show that the breach of the duty or breach of contract caused the harm to the failed financial institution; (reliance on the audit report may be required).

35

Theories of Liability Against the External Auditors

• Professional Negligence

– The breach of, or deviation from, the applicable professional t d d f hi h d h standard of care, which caused harm.

• Negligent Misrepresentation

– The breach of, or deviation from, the applicable professional standard resulting in the auditor misrepresenting a material fact upon which the Financial Institution relied.

• Breach of Contract

– The failure to adhere to or follow the provisions of the Engagement Contract; the engagement letter generally includes language indicating that the audit will be conducted in accordance with generally accepted audit standards.

36

Theories of Liability Against the External A dit ’ (C ’t) Auditor’s (Con’t)

• Fraud
• Fraudulent Misrepresentation

p

• Aiding and Abetting management’s breach of its

fiduciary duties B h f Fid i D

• Breach of Fiduciary Duty

37

Professional Negligence and Negligent Misrepresentation

• Professional Negligence

– Exercising reasonable care what should the “auditor have discovered” in the course of the audit.

• Negligent Misrepresentation

Exercising reasonable care in the course of the audit – Exercising reasonable care in the course of the audit, what should the auditor have revealed to management?

• Audited financial statements
• Audit opinion report
• Management letter
• Meeting with management and/or the

audit committee audit committee

38

Negligent Misrepresentation (cont.)

• The FDIC has the benefit of hindsight.
• By the time the financial institution fails, the FDIC knows

th t th dit d fi i l t t t t i ll that the audited financial statements are materially misstated; i.e. the audited financial statements support negligent misrepresentation claims.

• Audit opinion report = often unqualified.
• Management letter = the auditor’s additional report to the

Fi i l I tit ti ’ t di th t Financial Institution’s management regarding areas that “need attention.”

39

Third Party Claims against the Auditors

• Potential claims arising out of the FDIC actions

against others against others. – It is possible, if not likely, that if the FDIC pursues claims against Directors and Officers pursues claims against Directors and Officers, that these Directors and Officers will file Third Party Complaints against the Auditors, seeking to join the Auditors as parties to the lawsuit. – See FDIC v. Loube (v. KPMG Peat Marwick), 134 F.R.D. 270 (N.D. Ca. 1991).

40

What Damages Will the FDIC Assert?

• Generally the FDIC will assert that the Financial

Institution continued to fund loans and incurred b t ti l l lt f thi ti d substantial losses as a result of this continued funding. If the auditor would only have discovered the – If the auditor would only have discovered the problem (underwriting procedures, loan loss reserves, collateral etc…), the losses would reserves, collateral etc…), the losses would have been drastically reduced.

• Loss in shareholder value
• Lost opportunities

41

The Auditor’s Defenses

• No duty breached – GAAP and GAAS involves professional

judgment. – Where there is an interpretation over an audit standard, experts p , p will often disagree about whether the auditor actually deviated from the accepted standard of care.

• Comparative or Contributory Negligence

p y g g – The Auditors argue that the actions, (misfeasance/malfeasance)

• f the Financial Institution’s management caused the losses, and

therefore management’s negligence either bars the claims or in g g g the alternative reduces the amount of the recovery.

• The auditors may be able to raise serious questions about what

the Board of Directors knew and how the Board failed to act.

42

The Auditor’s Defenses (Con’t) ( )

• No Reliance or lack of causation:

– Discovery may reveal that no one from within management “relied” upon Discovery may reveal that no one from within management relied upon the audited financial statements, management letters and or other statements made by the auditors. See FDIC v. Ernst & Young, 967 F.2d 166 (5th Cir. 1992) where the Court stated, “If nobody relied upon the audit, then the audit could not have been a substantial factor in b i i b t th i j ” bringing about the injury.” – Timing may preclude a showing of causation; losses occurring well before the release of the audited financial statements could not have been caused by the opinion of the auditor.

• Statute of Limitations

– The audited financial statements at issue may have been published several years before the failed Financial Institution’s demise. See FDIC R i C & M 996 F 2d 222 (10th Ci 1993 )

• v. Regier Carr & Monroe, 996 F.2d. 222, (10th Cir. 1993.)

–

43

The Auditor’s Defenses (Con’t) The Auditor s Defenses (Con t)

• As an “independent auditor” there was no

As an independent auditor there was no Fiduciary Duty to the failed Financial Institution. See RTC v. KPMG Peat Marwick, 844 F. Supp 431, (N.D. Ill. 1994). – In an auditor malpractice case where a failed bank is alleging an improper or negligently performed “independent audit”, the auditor cannot be held to owe a fiduciary duty toward cannot be held to owe a fiduciary duty toward the client.

44

Auditor’s Defenses (Con’t) Auditor s Defenses (Con t)

“In pari delicto potio est conditio defendantis”, In pari delicto potio est conditio defendantis , meaning, in a case of equal or mutual fault the position of the defending party is the stronger

• ne.

The defense is similar to the comparative or contributory negligence defense, however it is stronger because it can operate to bar tort, contract and equity claims contract and equity claims.

45

In Pari Delicto (Con’t)

• Rooted in agency law principles, the defense provides

that the fraudulent conduct of a corporate officer is i t d t th ti if itt d i th f imputed to the corporation if committed in the course of the officer’s employment and for the benefit of the corporation. – The defendant bears the burden to prove that the corporate officer undertook the fraudulent conduct in connection with his/her employment and further that connection with his/her employment and further that he/she did so “for the benefit” of the corporation. – See: The Official Committee of Unsecured Creditors

• f Allegheny Health Education and Research

Foundation (“AHERF”) v. Pricewaterhouse Coopers LLP 989 A 2d 313 (Pa 2010) LLP, 989 A.2d 313 (Pa. 2010)

46

Imputation Imputation

• The AHERF Court reasoned that the imputation of

management’s fraudulent conduct can be imputed where g p management was an active, voluntary participant in the wrongful conduct for which it seeks redress, and further that it bears “substantially equal” [or greater] y q [ g ] responsibility for the underlying illegality as compared to the Defendant auditor.

• With respect to using “imputation” as a defense the

applicable state law will apply. See O’Melveny & Meyers v FDIC 512 U S 79 114 S Ct 2048 (1994) [FDIC

• v. FDIC 512 U. S. 79, 114 S. Ct. 2048 (1994) [FDIC

pursued claims against a failed savings and loan’s attorneys.]

47

Adverse Interest Exception Adverse Interest Exception

• If the officer or management acted solely for his/her own

g y personal benefit, and to the detriment of the corporation

• r company, imputation will not apply.

H C t h d t i d th t h – However some Courts have determined that where the agent and the corporation both benefit, that the wrongful conduct of the agent can nevertheless be imputed to the corporate entity.

• See AHERF opinion for detailed discussion

concerning how various jurisdictions have concerning how various jurisdictions have interpreted this defense.

48

Conclusions Conclusions

• Over 330 Financial Institutions have failed since January 1, 2009.

Wi h hi b i i lik l h h P f i l Li bili – With this number it is likely that the Professional Liability Operation is conducting multiple and complex investigations at this time. – We are beginning to see some lawsuits against g g g Directors/Officers and Lawyers; accordingly, it is possible that actions against Auditors will be filed. Although it is impossible to know what will happen next, it appears that numerous theories of liability and likewise numerous that numerous theories of liability and likewise numerous corresponding defenses will, once again, be at the core of any FDIC litigation involving claims against the failed bank’s auditors.

49

Lawyers’ E&O Lawyers’ E&O Exposures Exposures

Historically – Claims against attorneys were brought in less than 10% of failed banks

Exposures Exposures

less than 10% of failed banks

205 attorney malpractice suits filed by FDIC/RTC during prior crisis Over $500 Million recovered from suits and pre litigation Over $500 Million recovered from suits and pre-litigation settlements

Same Legal Standards Apply to Attorneys in Failed Bank Context Context Good Legal Counsel Requires Compliance with Contractual, Fiduciary and Ethical Duties Areas of Focus

Lawyer as Gatekeeper (e.g., Closing Attorney) Failure to Disclose Facts Proper Advice Given to “Client” Conflicts of Interest

50

Lawyers’ E&O Exposures: Lawyers’ E&O Exposures: Th i f Li bilit Th i f Li bilit

Negligence in performing the basics

Theories of Liability Theories of Liability

Common in “Make Money Fast” cases against loan closing attorneys F il f li f ll l i i i Failure to perfect liens or follow closing instructions

Failure to disclose material facts Failure to counsel/Inaccurate opinions Conflicts of interest

Switching clients Joint representations Post-failure, Bank’s counsel becomes FDIC’s counsel and privileges pass to the FDIC

51

Lawyers’ E&O Lawyers’ E&O Exposures Exposures

FDIC so far filed 3 suits in Georgia against failed banks’ outside law firms

Exposures Exposures

banks outside law firms.

After S&L Crisis, FDIC recovered $500 Million from legal malpractice claims. Most recent filing: February 7 2011 against a Georgia law Most recent filing: February 7, 2011 against a Georgia law firm, Smith Welch & Brittain, and J. Mark Brittain. FDIC v. Smith, Welch, & Brittain, LLP and Joseph Mark Brittain, U.S. District Court, N.D. Ga., Case No. 1:2011-cv-00372. A reflection of fact that Georgia has had more bank failures than any other state

Allegations: g

Loans handled by firms were rendered defective or invalid because property descriptions did not match title records, thereby preventing banks from foreclosing. Handled loans where borrower was also a client and

• btained loans based on inflated property values.

52

Lawyers’ E&O Exposures: Lawyers’ E&O Exposures: Aidi d Ab tti B h f Aidi d Ab tti B h f Aiding and Abetting Breaches of Aiding and Abetting Breaches of Fiduciary Duty Claims Fiduciary Duty Claims

Premise: the financial institution’s management breached its fiduciary duty, the lawyers aided and y y y abetted the management in their breach, and therefore, the lawyers are also liable for the damages that flowed from management’s breach damages that flowed from management s breach Circumvents defenses such as contributory negligence that would otherwise be available in a negligence that would otherwise be available in a straight legal malpractice suit This claim type is as yet largely untested by the This claim type is as yet largely untested by the courts.

53

Lawyers’ E&O Exposures: Lawyers’ E&O Exposures: P ibl D f P ibl D f Possible Defenses Possible Defenses Lawyers are not the “last to review” Lawyers are not the last to review

Accountants, auditors, in-house counsel, management management

Lawyers may be working under a limited scope, not all legal work is comprehensive in nature

54

Q ti & A Questions & Answers

Mi h l L Zi l E Michael L. Zigelman, Esq.

Partner

i l @kd l

135 Crossways Park Drive Suite 201

mzigelman@kdvglaw.com

516.681.1100 135 Crossways Park Drive, Suite 201 Woodbury, New York 11797 www.kdvglaw.com

New York | Pennsylvania | New Jersey San Francisco | Los Angeles | Florida

55

FDIC L it A i t B k ’ O t id FDIC Lawsuits Against Banks’ Outside Professionals: Insurance Considerations

May 18, 2011 Linda Kornfeld Jenner & Block lkornfeld@jenner.com (213) 239-5176

WHICH POLICIES MAY APPLY?

• Errors & Omissions Coverage—the critical focal

g point

– Covers “claims” for allegations of “professional” misconduct – Must act within “professional” capacity as defined by policy p y

57

58

58

What constitutes a “claim”? What constitutes a claim ?

• Demand letters?

Subpoenas?

• Subpoenas?
• “Informal investigations”?

g

59

Duty to “advance” defense fees Duty to advance defense fees

• “Potentiality” standard

“Prior to final adjudication” the “timing” question

• Prior to final adjudication —the timing question

60

Amounts spent for “excluded” claims Amounts spent for excluded claims

• Could be covered if “benefits” covered claims

Parties shall use “best efforts” to allocate between

• Parties shall use best efforts to allocate between

covered and uncovered claims

61

Panel counsel and insurer “consent” Panel counsel and insurer consent

• Before choosing counsel not on “panel counsel” list,

should obtain consent

• Impact of failure to obtain consent

62

“Intentional conduct claims” Intentional conduct claims

• Should not impact payment of defense fees

e g Cal Ins Code section 533

• e.g., Cal Ins Code section 533

63

ALLOCATION OF LIMITED RESOURCES BETWEEN COVERED INSUREDS BETWEEN COVERED INSUREDS

• Early notice •
• Timely submissions of legal bills •
• Stipulations amongst insureds •
• Stipulations amongst insureds •

64

POLICY EXCLUSIONS POLICY EXCLUSIONS INSURERS MAY RAISE

Fraud Exclusion Fraud Exclusion

• Does not impact defense duty

“Final adjudication”/“fraud in fact” language

• Final adjudication / fraud in fact language
• “Final” means “final” after all appeals

pp

• “Severability” of insureds

66

“Personal Profit” Exclusion Personal Profit Exclusion

• Final adjudication/in fact language

Did the executive reap an “illegal” profit or gain?

• Did the executive reap an illegal profit or gain?
• Did the executive commit “insider trading” or some

g

• ther form of “theft”?
• Wrongful “bonus” not enough
• Wrongful bonus not enough

67

“Insolvency” Exclusion Insolvency Exclusion

• Some policies exclude coverage for claims: “arising out of

… the insolvency or bankruptcy of the Insured or any other fi i ti ” person, firm or organization”

• Do FDIC claims related to failed banks “arise out of” the

“insolvency” of an “organization”?

• Zurich Specialties London Limited v. Bickerstaff (9th Cir.

p (

• Mar. 28, 2011)

68

“Regulatory” Exclusion Regulatory Exclusion

• Created by S&L crisis
• 1/2-3/4 of D&O policies contain, not as common in E&O,

but still may be relevant

• Soft market lessened the use of such exclusions
• Are such exclusions ambiguous or create “illusory”

coverage?

• Some favorable decisions in D&O context

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“Penalty” Exclusions Penalty Exclusions

• What is the true nature of the claimed “fine” or “penalty”?

p y

• Many policies cover “the multiplied portion of any multiplied

damages ” damages . . .

• If the “penalty” can be characterized as “multiplied

damages ” then applying the exclusion could render the damages,” then applying the exclusion could render the “multiplied damages” coverage mere surplusage

• At the very least, the competing provisions arguably may

create ambiguity

70

Prior or Pending Acts Exclusions Prior or Pending Acts Exclusions

• Purport to bar coverage for claims arising out of

insured’s allegedly wrongful conduct prior to specified date

• Date may coincide with termination of coverage
• Date may coincide with termination of coverage

under a previous policy

• Disputes exist regarding whether “acts” are

sufficiently “related” to trigger the exclusion

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• Notice of potential claims under

prior policies with less prior policies with less restrictive exclusions?

• Notice today of possible future

claims?

72

Issues to Consider When Purchasing Future Coverage

• Professionals that provide services in significant

part to banks may face increased scrutiny in the underwriting process

• Carefully consider the breadth of proposed
• Carefully consider the breadth of proposed

regulatory exclusions and attempt to negotiate to increase protection p

• Evaluate all potential claims and do not let “prior

acts” exclusions create challenges down the road acts” exclusions create challenges down the road

73