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Judge Rules Travelers Subsidiary Doesn't Have to Cover Bank's Losses from Ponzi Scheme

Source: Hartford Courant

Posted on 20 May 2011

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A federal appeals court ruled that a Travelers subsidiary does not have to cover the losses of a Westport, Connecticut bank whose customers claim that the bank's investment in Bernard L. Madoff's Ponzi scheme cost them tens of millions of dollars in retirement savings.

Westport National Bank, part of a group of community banks in lower Fairfield County, Connecticut, went to court in an unsuccessful effort to force Travelers subsidiary St. Paul Mercury to cover losses that it and its customers experienced when Madoff's sham investment business imploded in 2008.

The bank and its owner, Associated Community Bancorp Inc., face claims by more than 200 customers who say the bank's placement of their money with Madoff breached its obligation to them as custodian of their retirement savings. Many have sued the banking company to recover funds.

Lawsuits by retirement customers place the losses — both actual and from lost investment opportunities — from $20 million to $60 million. The banking company already has begun to run up additional costs in defending itself from customer suits and fighting in court with its insurer.

Associated Community Bancorp claimed in a suit against Travelers that Madoff is a criminal and St. Paul Mercury is liable under its policy for both the cost of the bank's legal defense and any judgments won by customers trying to recover their retirement funds.

But U.S. District Judge Janet Hall wrote that exclusionary language written into the insurance contract — in particular language pertaining to bankruptcy-related claims — absolves the Travelers subsidiary of liability to the bank. Last week, the U.S. 2nd Circuit Court of Appeals in New York issued a summary order affirming Hall's conclusions.

Lawyers involved in the litigation either would not discuss it or could not be reached Wednesday.

Hall's decision a year ago against Associated Community Bancorp said that the bank's professional liability coverage contained an insolvency exclusion that exempts St. Paul from paying on any claim arising out of insolvency, receivership, bankruptcy, or financial inability to pay by any investment company, broker or securities dealer.

Madoff's so-called investment business — Bernard L. Madoff Investment Securities — not only became insolvent after his arrest in 2008, but a court-appointed trustee estimated that it created losses of $18 million. At the time Hall wrote the decision, Madoff's company was the subject of bankruptcy proceedings in New York.

Hall suggested that the mere existence of the bankruptcy was sufficient to trigger the policy's insolvency exclusion.

"Had Madoff not become insolvent and lost the investors' money, the investors would have had no damage and thus no reason to file suit against Westport," she wrote.

In response to arguments by bank lawyers that Madoff was a "criminal enterprise" rather than an investment company or securities dealer, Hall wrote that "the insolvency exclusion does cover 'sham investment companies,' because it covers claims arising out of the insolvency of 'any ... investment company.'"

Hall also said other policy exclusions, in addition to those related to insolvency, allow St. Paul Mercury to withhold liability coverage arising from the professional decisions of the bankers.

Bank customers investing in retirement plans did so through Westport National Bank. Some of those suing claim that the bank broke its custodial agreement with them by failing to obtain and hold securities in their names.