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April 11, 2016

Texas Court Slams Insurer Mantra of No Coverage for Restitution and Disgorgement

The Flood Gates are Open; Restitution and Disgorgement are No Longer Valid Defenses to Coverage.

The Flood Gates are Open; Restitution and Disgorgement are No Longer Valid Defenses to Coverage.

Insurance companies, like politicians, repeat the same mantra in the hopes that if enough people buy it, it will become conventional wisdom.  Once upon a time, insurers denied environmental cleanup claims on the grounds that such costs were not “damages” within the meaning of general liability insurance policies.  Years ago, they started denying coverage on this basis, and began a massive, well-coordinated campaign to change conventional legal wisdom.  At the height of the movement, they actually convinced some judges to buy the argument.  Although the insurers pushed this “as damages” argument hard for many years, eventually, enough companies with effective coverage counsel fought the issue, the tide turned and the dam broke.  Now, we are back where we started, with an overwhelming number of courts rejecting the insurers’ “damages” mantra.

Are “Restitution and Disgorgement” the New “As Damages”?

More recently, insurers have been campaigning that “loss” under D&O and other policies is not covered if such loss can be characterized as “restitution” or “disgorgement.” A number of courts have been convinced by the argument, and insurers have been working overtime to try and make this the new contention conventional wisdom.   But, in the last few years, major cracks have appeared in this supposed defense as well, and the restitution and discouragement defense now looks to be heading for the same fate as the “as damages” defense.

Texas Sets the Stage

Texas affords a great example of how this transition is taking place.  Despite no state law to support their rationale, two federal courts adopted the insurer’s restitution and disgorgement position. See In re Trans Texas Gas Corp., 597 F.3d 298 (5th Cir. 2010); John M. O’Quinn P.C. v. National Union Fire Ins. Co. of Pittsburgh, PA, 33 F. Supp.2d 756 (S.D. Texas 2014).  The first Texas appellate court to address the issue, however, recognized that the federal courts were wrong, and soundly rejected the argument. See Burks v. XL Specialty Ins. Co., 2015 WL 6969610 (Tex. Ct. App. Nov. 10, 2015) (“Burks”).

Payment of Restitution or Disgorgement Losses Is Not Against Public Policy

The linchpin for the insurer’s argument against paying so-called restitution or disgorgement losses is that doing so is against public policy.   Insurers consistently make this public policy argument, even when there is no statute declaring restitution or disgorgement payments uninsurable.  Further, the insurers’ argument ignores the public interest in the enforcement of insurance policies protecting directors and officers from unforeseen losses, as well as the public interest in freedom of contract. See Cohen v. Lovitt & Touche, Inc., 308 P.3d 1196 (Ariz. Ct. App. 2013).

Burks exposed the fallacy of the insurers’ argument. In Burks, the CFO for a company in bankruptcy sued the company’s D&O insurer for breach of contract for refusing to advance defense costs and pay for his settlement with the bankruptcy plan agent.  Like most D&O and other claims-made policies, the policy at issue did not cover “matters which are uninsurable under the law”:

The policy defined “loss” as “damages, judgments, settlements or other amounts . . . and Defense Expenses that the Insured Persons are obligated to pay,” but “Loss will not include: . . . matters which are uninsurable under the law pursuant to which this Policy is construed.”

2015 WL 6949610 at *6. The insurer claimed that it had no duty to indemnify the CFO for the settlement because it was “uninsurable disgorgement or restitution.” Id. at *8.

The appellate court rejected the insurer’s contention because a claim seeking coverage for restitution or disgorgement losses is not against public policy or uninsurable under the law of Texas. Id. at 8-9.  The insurer relied on a federal court decision by the Fifth Circuit, In re Trans Texas, as well as a Texas case often and erroneously relied on by insurers, Nortex Oil & Gas Corp. v. Harbor Insurance Co., 456 S.W.2d 489 (Tex. Civ. App. 1970) (“Nortex”).  The Burks court properly distinguished Nortex, because Nortex concerned whether conversion claims were claims for “property damage” under a general liability policy, not whether a “loss” is “uninsurable” under a D&O policy:  “Unlike in Nortex, ‘settlements’ [in the Burks D&O policy] is not modified by a particular type of claim, such as ‘property damage,’ which can be ascertained by reference to the claims asserted in plaintiff’s petition or complaint.” Id. at *9.

The critically important holding in Burks was that “no Texas court has held that insuring a settlement of a claim seeking restitution or disgorgement is against public policy or otherwise generally ‘uninsurable under the law’ of Texas; nor has the Legislature enacted any legislation on point.” Id. Therefore, “[u]nder these circumstances, we cannot hold as a matter of law that the parties intended for a settlement such as this one to be excluded from coverage.” Id. Finally, the court disapproved of the Fifth Circuit’s ruling to the contrary:  “To the extent the Fifth Circuit in In re Trans Texas understood Nortex as establishing a public policy in Texas against insuring settlements made in satisfaction of claims alleging ill-gotten gains, we disagree with that reading.” Id.

With this holding in Burks, Texas has now joined courts in New York, Arizona, Minnesota, and Michigan that have rejected the insurers’ restitution and disgorgement defense. See Cohen v. Lovitt & Touche, Inc., 308 P.3d 1196 (Ariz. Ct. App. 2013); J.P. Morgan v. Vigilant Ins. Co., 992 N.E.2d 1076 (N.Y. 2013); U.S. Bank v. Indian Harbor Ins. Co., 2014 WL 3102969 (D. Minn. July 3, 2014) (applying Delaware law); William Beaumont Hosp. v. Federal Ins. Co., 2014 WL 185388 (6th Cir. Jan. 16, 2014).  To the extent that there ever was a dam, it is now breaking.

Conclusion

On the restitution and disgorgement issue, insurers have tried to have it both ways for way too long. When selling policies, insurers claim they provide the broadest coverage possible and that they cover all losses that are insurable under the law of the applicable state.  But, when a claim is made, they argue strongly that the public policy of every state prohibits coverage for restitution and disgorgement.

The time has come for policyholders to reject the insurers’ mantra that there is no coverage for restitution and disgorgement losses. Insuring restitution and disgorgement losses is not against public policy.  If insurers want to exclude that coverage, perhaps they could do so with a clear exclusion instead of trying to argue one thing when selling policies, and another when denying claims.

Prevailing as policyholders on this issue may not be easy. Despite these losses, insurers are still pushing the argument.  More courts need to be persuaded that the “public policy” rationale is simply wrong, and the well-reasoned rationale of Burks provides some of that support.

Miller Friel, PLLC is a specialized insurance recovery law firm whose sole purpose is to help corporate clients maximize their insurance coverage. For additional information about this post, please call 202-760-3160.

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