Is a company’s action against a corporate executive to recover the costs of defense the company advanced on his behalf “restitutionary” in nature and are the amounts involved therefore precluded from coverage under the D&O insurance policy’s definition of Loss? In an opinion that undoubtedly will gladden the hearts of policyholder-side advocates, a California appellate court held that it is not. As discussed below, there are a number of interesting features to the court’s opinion. The California Court of Appeals’ November 12, 2024 opinion can be found here.
Background
This coverage action arises out of several civil actions filed against Maxim Integrated Products and certain of its directors and officers relating to alleged options backdating. As discussed in detail here, after the company announced in January 2008 that it would be restating prior years’ financials as a result of a special board committee investigation of the company’s stock option practices, shareholders filed a securities class action lawsuit against the company and a derivative suit against the company’s board. The securities class action lawsuit settled for $173 million. As discussed further below, the derivative lawsuit also settled.
In addition to the securities suit and the derivative suit, the SEC filed a civil enforcement action against the Company’s CFO, Carl Jasper. In April 2010, a jury found Jasper liable for fraudulent conduct, securities fraud, and making knowingly false statements and certifications to the SEC. Jasper’s verdict was affirmed by the Ninth Circuit.
After Jasper’s appeal was denied, he sued Maxim alleging it owed him millions of dollars of stock options granted before he resigned in 2007. Maxim counterclaimed against Jasper, seeking, among other things, repayment of the amounts the company had advanced in payment of Jasper’s legal costs, as well as recovery of the amounts the company paid in funding the civil settlements.
At relevant times, Maxim maintained a program of D&O insurance consisting of a $15 million layer of primary insurance and a $15 million layer of excess insurance. In connection with the settlement of the options backdating-related derivative lawsuit, the primary insurer paid its full $15 million policy limit and the excess insurer paid $6 million of its $15 million limit. When the subsequent litigation between Jasper and Maxim later arose, Jasper tendered the counterclaims against him to the excess D&O insurer, which denied coverage.
In connection with the litigation between Jasper and Maxim, Jasper settled with Maxim by assigning his rights under the excess policy to Maxim and dismissing his causes of action; Maxim and Jasper agreed that a referee would decide Maxim’s counterclaims. The referee issued a Statement of Decision finding that the conduct alleged in the backdating litigation was not indemnifiable under Delaware law, and finding Jasper liable for defense costs in the SEC action and the securities class action, as well as for repayment of the class action settlement and pre-judgment interest.
Maxim and Jasper then sued the excess insurer in California state court, alleging that the excess insurer breached its insurance contract and breached the implied covenant of good faith and fair dealing by denying coverage of Jasper’s defense costs in the underlying backdating litigation, refusing to advance Jasper’s costs incurred in defending Maxim’s counterclaims, and refusing Maxim’s offer to settle within the policy’s limit of liability.
The trial court granted the defendant excess insurance company’s summary judgment motion. The trial court agreed that Jasper’s claim was “substantially equivalent” to “restitutionary damages” and therefore excluded from the policy’s definition of covered Loss The trial court also held that California Insurance Code Section 533 prohibited coverage, reasoning that all of Jasper’s liability to Maxim, including legal costs, were caused by Jasper’s willful actions The trial court entered judgment for the insurer and the plaintiffs appealed.
Relevant Policy and Statutory Provisions
The excess policy is a follow-form policy, meaning it followed the provisions, terms, and conditions of the primary policy. The primary policy defined the term “Loss” to mean “damages, judgments … settlements and Defense Costs for which [the Insured] is legally obligated to pay” but not “any amount that represents or is substantially equivalent to disgorgement or restitutionary or rescissionary damages … or … matters which may be deemed uninsurable under the law pursuant to which this Policy shall be construed.”
California Insurance Code Section 533 provides that an insurer “is not liable for a loss caused by the willful act of the insured, but he is not exonerated by the negligence of the insured or of the insured’s agents or others.”
The November 12, 2024, Appellate Court Opinion
In a November 12, 2024 opinion designated “not to be published in official reports,” a unanimous three-judge panel of the intermediate Court of Appeal, in an opinion written by Justice Adrienne Grover, reversed the trial court’s judgment, remanded the case to the trial court, and directed the trial court to vacate the order granting the insurer’s summary judgment motion and enter a new order denying the insurer’s summary judgment order.
In reversing the trial court, the appellate court first addressed the insurer’s argument that Jasper had wrongfully acquired and retained Maxim’s payments for his legal defense such that the obligation to repay Maxim is “substantially equivalent” to “restitutionary damages” and therefore that coverage for these amounts is barred under the Policy. The appellate court rejected the excess insurer’s “broad interpretation” of “restitutionary damages because “it is inconsistent with both the term’s industry-specific usage, and with the language and purpose of the policy.”
The court said that “not everything that can be labeled ‘restitution’ is necessarily uninsurable.” Coverage is barred, the court said, “only in situations in which the defendant is required to restore to the plaintiff that which was wrongfully acquired.” The specific meaning of the term “restitution” is “reflected in and consistent with the other terms in the same clause, such as ‘disgorgement,’ ‘rescissionary damages,’ and “forfeiture’ … all forms of uninsurable relief associated with unjust enrichment and the return or restoration of money or property that has been wrongfully acquired or retained.” This interpretation, the court said, is consistent with the policy’s broad language, and exclusions preserving coverage for defense costs, which “indicate an unambiguous intent to cover Jasper’s non-indemnifiable legal costs to the fullest extent permissible by law.”
The court went on to hold that the Loss definition’s exclusionary provision precluding coverage for rescissionary damages did not apply, rejecting the excess insurer’s argument that Jasper wrongfully obtained and retained the defense costs that Maxim had advanced on his behalf. Among other things, the appellate court said that there was no evidence that Maxim had paid anything to Jasper directly (as the fees were paid directly to Jasper’s defense firm), nor of Jasper, wrongfully or otherwise, acquiring, receiving, or retaining any money from Maxim. The appellate court also said that the excess insurer “mischaracterizes” the stipulated judgement against Jasper as a “restitutionary award”; Maxim, the appellate court said, did not seek disgorgement or restitution from Jasper, but rather sought money damages for breach of contract.
Finally, the appellate court held that Section 533 did not apply to preclude coverage. The court said that while the statute prohibits the indemnification of loss resulting from willful wrongdoing, it “does not prohibit contracts providing for defense against an action alleging willful misconduct because such an agreement does not provide for indemnification if the insured is found liable.”
Discussion
This decision will gladden the hearts of policyholder-side coverage advocates. The court’s opinion almost audibly rings with the breadth of its expression of the coverage afforded by the D&O policy. The appellate court’s affirmation that not everything labelled as “restitution” is precluded from coverage under the exclusionary language in the definition of loss will also hearten policyholder advocates. And the court’s view that the statutory insurance preclusion for willful misconduct applies only to indemnification and not defense expense will also be welcomed by policyholder-side counsel.
As Hunton Andrews Kurth attorney Geoffrey Fehling noted in his November 20, 2024, LinkedIn post commenting on the California appellate court’s opinion (here), the court, in rejecting the broader reading of the term “restitutionary” that the excess insurer had urged, interpreted the provision in light of California public policy excluding those kinds of losses only when a wrongdoer is required to disgorge money or property obtained in violation of the law. This narrowed view of the term means that labels alone are insufficient to preclude coverage, but rather that that underlying nature of the amounts owed determines coverage.
In determining that the preclusion of coverage did not apply to Jasper, the appellate court found, among other things, that Jasper did not wrongfully obtain or retain the amounts Maxim had advanced as defense costs. The appellate court reasoned Jasper had not done anything wrongful even though he was found to be liable for breach of contract.
The appellate court’s conclusion is interesting to me in light of the fact that Jasper had been found by a civil jury to have committed securities fraud as a result of options backdating, and the fact that the company had been obliged to pay millions of dollars in settlement due to the options backdating. These aspects of this situation arguably make Jasper a less than sympathetic figure. I suspect that this might have had something to do with the trial court’s summary judgment grant. The key here is that whether or not Jasper committed misconduct with respect to stock options, that had nothing to do with whether or not he wrongfully obtained or retained Maxim’s payment of his defense expenses.
Attentive readers may be wondering why coverage for the defense costs is not precluded by the policy’s fraud exclusion (given the jury’s finding that Jasper committed securities fraud), or by the policy’s insured vs. Insured exclusion (given that the action to recover the fees is an action by Maxim against Jasper). The court’s opinion answers this question when it notes that “Defense Costs are specifically exempted from the policy’s exclusions for conduct akin to unjust enrichment, criminal or fraudulent conduct, as well as if Maxim sues Jasper.” The court specifically noted with respect to these coverage carve-backs for defense costs that “we interpret as the parties’ intend to cover Jasper’s legal defense costs as broadly as permitted by law.” The policy’s coverage of Jasper’s legal costs, the court said, “is also consisted with the generally understood purpose of directors and officers insurance,” which is to provide protection for D&Os for business decisions made in their executive capacities.
There is one aspect of this case that will undoubtedly dampen the policyholder-side advocates gladness about this opinion, and that is the fact that the appellate court designated it as not for publication. The California Court of Appeals website (here) states that opinions that are designated not for publication “generally cannot be cited or relied upon in other cases.” (See also California Rules of Court 8.1115, here.) Policyholder-side advocates undoubtedly will drat the court’s decision to designate its opinion as not for publication. The opinion, as heartening as it may be, will be of little use in other cases.
There is one final observation about this opinion, and that has to do with the element of time. The appellate court’s consideration of the issues involved here harkens back to a sequence of events that began more than a decade and a half ago. Readers with a literary inclination will, I am sure, recall that in Hamlet’s famous soliloquy, in which he considers whether it is better to flee from life rather than face its sorrow and troubles, he numbers among life’s tragic burdens the “delays of the law.” He may well have had a case like this one in mind. In that regard, it is worth noting that this coverage dispute is not done – the practical effect of the appellate court’s opinion is that this case will return to the trial court for further proceedings.
Sometimes the music of justice seems to be a song that never ends.
Special thanks to a loyal reader for supplying me with a copy of the court’s opinion.