D&O 1st Cir.: Conflicting Authority Means Defense Must Be Provided Despite Insured v. Insured Exclusion

The First Circuit U.S. Court of Appeals held that AIG must advance defense costs to the directors and officers of Westernbank of Puerto Rico because it was unclear whether the insured-vs.-insured exclusion applied. The FDIC sent a written demand to the bank’s directors and officers for the defunct bank’s losses. The directors and officers notified AIG of the claim, and AIG denied coverage under the bank’s D&O policy based on the insured-vs.-insured exclusion, contending that the FDIC had stepped into the shoes of the bank, a named insured, when it brought claims against the executives, also named insureds. The directors and officers filed a declaratory action against AIG. The FDIC filed a complaint to intervene in that declaratory action, which stated that the FDIC had “succeeded to all of the rights and assets of Westernbank.” AIG later amended its complaint to state that it also sued the directors and officers on behalf of stockholders, members, account holders, depositors, and the FDIC insurance fund. The First Circuit explained that courts are divided on the insured-vs.-insured issue in similar situations, and therefore, because the case law is not settled, the court must resolve any doubts in favor of the insured. The court held that this lack of controlling authority allowed the directors and officers to meet the low bar of Puerto Rico’s standard of “a remote possibility of coverage” and, therefore, the duty to advance defense costs was triggered. The court did acknowledge that AIG may still challenge coverage and the applicability of the exclusion in a trial on the merits. W Holding Co. v. AIG Ins. Co. – Puerto Rico, No. 12-2008 (1st Cir. Mar. 31, 2014).

This case is noteworthy for its holding that the mere existence of conflicting authority on an issue itself is evidence of a possibility of coverage requiring a defense.  This approach has also been applied in determining whether or not a policy term is ambiguous.

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