Bank Failures, Liquidity, and Your Insurance Program

The federal government has moved swiftly to stabilize the United States banking systems. The news that depositors with Silicon Valley Bank will have access to their funds means that innumerable companies are no longer scrambling to address their liquidity needs.

Many boards and management teams will, no doubt, review their approach to banking in the next several weeks. One question that may arise is what role a company’s insurance risk management program may play when it comes to a potential future bank crisis.

At a high level, a typical corporate insurance program is not designed to facilitate immediate cash needs caused by a bank failure. However, the right insurance program can help with certain possible consequences of a bank failure.

Below are some frequently asked questions—and answers—that may be of use to directors and officers thinking about risk management when it comes to bank failures.

If my bank fails and I have immediate cash needs, such as the need to make payroll, is there a way for my insurance program to help?  

No. The failure of your bank is a counter-party business risk. This is not something that a typical insurance program would cover.

Would my business interruption insurance respond to this situation? 

No. Business interruption insurance is triggered by a loss to physical property. The failure of a bank is not a loss to physical property. As a result, business interruption insurance included within your property policy will not respond.

Could my D&O insurance policy be a source of funds in a bank failure situation?

Your D&O insurance policy only responds if a third party makes a claim against you. You cannot proactively tap into the policy as a source of funds.

Suppose my company had most or all of our corporate funds at a bank that failed. Would my D&O insurance policy respond if my shareholders file suit alleging that this decision was a breach of my fiduciary duties?

If shareholders bring a fiduciary duty suit against directors and officers, the D&O insurance policy will respond. If your company is solvent, the policy will respond after you first pay the self-insured retention (which is similar to a deductible, but must be paid before the policy starts to respond). If your company is insolvent, the policy typically provides first-dollar coverage.

Are such suits likely? Shareholders and others may be disappointed upon learning that a company had most or all of its funds on deposit at a bank that failed. But these circumstances alone are unlikely to be the basis for a successful breach of fiduciary duty suit.

The decision of where to place a corporation’s monies falls clearly within the business judgment rule, absent self-dealing or other independence issues. For example, until the week of the bank’s failure, SVB was regarded as a large and stable bank. The rapidity and surprising nature of its decline only underscores that a decision to place funds with the bank was a reasonable decision that a court would not second guess. But should such a suit be filed, D&O policies would typically respond to defend against the claim.

Most boards or audit committees regularly review things like where cash deposits are being held, how cash is being invested, whether cash is being swept off book into instruments that are held at other institutions, and the like. In the case that you are, in fact, sued over these decisions, you will be glad if your board minutes reflect these normal discussions in reasonable detail.

What if a bank failure leads to the bankruptcy of my company? Would my D&O insurance policy provide any protection?

Bankruptcy may be a possibility for some companies impacted by a bank failure. To the extent that creditors were to sue directors and officers for breaching their fiduciary duties, the Side A portion of the D&O insurance policy should respond to advance legal defense costs on a first dollar, no deductible basis. Just as with shareholders, however, a creditor suit for a fiduciary duty breach premised on the idea that it was somehow unreasonable to put corporate funds in a bank that unexpectedly failed is unlikely to be successful.

I have heard that as a director or officer, I could be criminally liable for failure to pay my employees their wages. Will my insurance policies respond if the state or my employees sue me because I can’t make payroll due to an unexpected bank failure?

First, contrary to what some have suggested, it is unlikely that the state attorney general would immediately pursue officers and directors of companies that are unable to make payroll due to the unexpected failure of a bank.

Having said that, directors and officers finding themselves in this type of difficult situation must produce a responsible plan that may include furloughs and the like to avoid having employees work without being able to pay them. You will want to speak with your lawyers about executing such a plan as expeditiously as possible. This is the best way to address director and officer liability issues that can arise in the context of the wind-down of a company.

Let's say employees do bring suit. The first insurance policy in line to respond if your employees sue you for something related to their employment (think “workplace tort”) would be an Employment Practices Liability insurance or EPL policy. However, failure to pay wages is not a named peril under an EPL policy, so the policy is unlikely to respond. EPL policies are certainly not designed to pay for wages themselves. For clarity, the EPL policy will respond to things like claims of discrimination, wrongful termination, and the like.

For public companies and in some private company D&O policies, there may also be some coverage for directors and officers (but not the corporate entity) for employment claims. Whether or not these policies will provide any defense or settlement for claims related to unpaid wages will depend on the terms of the policy in question.

My company has sufficient sources of liquidity to weather the failure of one of our banks where we keep cash. But my customers may not. Can insurance be helpful for customer non-payment?

Potentially yes, if you have trade credit risk insurance already in place. Trade credit risk insurance typically insures against your customers' late payments, failure to pay invoices, or insolvency. This type of policy is not a quick way to get cash given that the policy usually will not recognize a claim until at least 60 days after your company’s normal payment terms have elapsed. Trade credit risk policies can, however, be a valuable part of a company’s overall risk management strategy. 

Are there other creative solutions that insurance can offer as we assess our liquidity options?

In some cases, absolutely. For example, consider a company that wants to take a loan but whose only real collateral is its intellectual property. Banks have traditionally struggled to make loans against intellectual property. There is a type of insurance that companies can buy to facilitate this type of loan. Contact your Woodruff Sawyer account executive for more information about this insurance product.

Are there other ways insurance may respond that are not discussed in this FAQ?

No doubt the answer may be yes. Most crises include unexpected effects in the mid and longer term, not just the immediate short term. Talk to your insurance broker both before events unfold as well as during the events themselves. A knowledgeable broker can be a trusted business advisor both before and during a crisis—including by helping you discern during a crisis where to spend your limited time when there are so many demands on it.

The information in this article is general in nature and is not legal advice. Talk to your trusted insurance broker and outside counsel for information specific to your situation.