Ever since the Seventh Circuit’s 2001 decision in Level 3 Communications, Inc. v. Federal Insurance Co., 272 F.3d 908 (7th Cir. 2001), insurance companies have argued that settlements constituting restitution or disgorgement are uninsurable on grounds of public policy. While numerous decisions since 2001 have undercut this defense, two recent decisions out of the New York Court of Appeals and the Northern District of Illinois further confirm that coverage does not depend on how the damages paid are characterized. In both J.P. Morgan Securities Inc. v. Vigilant Insurance Co., No. 61, 2021 N.Y. slip op. 06528 (N.Y. Nov. 23, 2021), and Astellas v. Starr Indemnity, No. 17-cv-8220 (N.D. Ill. Oct. 8, 2021), the courts looked beyond the labels of “restitution” and “disgorgement” affixed to the insureds’ settlement payments to determine whether such payments were covered by each insureds’ respective insurance policies.
Last week’s post on The Policyholder Perspective took an in-depth look at Vigilant Insurance Co. This week we consider how Vigilant, in tandem with Astellas, demonstrates a trend in how courts interpret labels on payments in an insured’s settlement agreement.
In Astellas, the insured (Astellas) entered a settlement agreement relating to a False Claims Act investigation and agreed to pay $100 million plus interest to the United States, with $50 million of such settlement labeled as “restitution to the United States.” In a similar vein, the insured (Bear Sterns) in Vigilant Insurance Co. entered a settlement agreement with the SEC for alleged illegal trading practices and made a $160 million “disgorgement” payment – $140 million of which was an estimate of the profits gained by Bear Sterns’ clients – and a $90 million payment for “civil money penalties.” Astellas submitted a claim to its insurers for the $50 million “restitution to the United States,” and Bear Sterns submitted a claim for the $140 million “disgorgement” payment reflecting its clients’ profits gained.
At issue in both cases was whether these settlement payments were excluded from the policies’ definitions of “loss.” Astellas’ policy excluded from its definition payments “uninsurable under applicable law.” Bear Stearns’ policy excluded “fines or penalties imposed by law.” In each case, the policy at issue did not contain an exclusion for “restitution” or “disgorgement.” Likewise, in each case, the courts held that it was the insurers’ burden to demonstrate that coverage did not extend to the settlement payments at issue. Each court rejected the insurers’ argument that the labels of “restitution” and “disgorgement” were dispositive in demonstrating that the settlement payments were “uninsurable.” Instead, both courts found the following three factors to be important in determining the existence of coverage:
- How the settlement amount was calculated. The courts analyzed how the insureds’ settlement payments were calculated to determine if the payments truly were uninsurable “restitution” or “disgorgement.” In Astellas, the insurer argued that the settlement payment was uninsurable disgorgement of an ill-gotten gain. However, the court found that the insured’s settlement payment did not operate as such disgorgement because the parties calculated the settlement payment using the government’s alleged losses, not the insured’s alleged ill-gotten gains. Similarly, in Vigilant Insurance Co., the court rejected the insurer’s argument that the settlement payment was a “penalty,” in part, because the $140 million disgorgement payment “was calculated based on wrongfully obtained profits as a measure of harm or damages caused by the [insured’s] wrongdoing.”
- Remedial framework available to the government and SEC. Each court found significant what remedial framework was available during settlement negotiations. The False Claims Act was designed to allow “only for civil penalties and compensatory damages, not for restitution in the form of disgorgement,” and the SEC viewed “disgorgement payments…as an equitable remedy and not a monetary penalty.” This demonstrated that the labels on the settlement agreements did not necessarily push the insureds’ payments into the “loss” definition exclusions.
- Why the parties labeled the settlement payments as restitution and disgorgement. Notably, each court examined why the parties labeled their settlement payments as “restitution” and “disgorgement.” In Astellas, the court found significant that the insured and the government labeled its payment as “restitution to the United States” to satisfy requirements for tax deductibility. In Vigilant Insurance Co., the court found it important that “the SEC’s primary enforcement remedies were injunctive relief, disgorgement, and monetary penalties,” and therefore the “disgorgement” label stemmed from what remedies were available to the SEC. The fact that the $140 million “disgorgement” payment did not constitute a penalty was reinforced by the fact that Bear Sterns also paid $90 million to the SEC for “civil money penalties.”
Typical D&O and E&O policies do not contain “restitution” or “disgorgement” exclusions. While Level 3 Communications and its progeny encouraged insurance companies to try to create such exclusions, perhaps at this point the industry will finally recognize that the label attached to settlement payments is not coverage determinative.