Insurability of Disgorgement and Restitution Claims After...

Insurability of Disgorgement and Restitution

Claims After Kokesh, TIAA-CREF, and J.P. MorganPractical Guidance for Policyholder and Insurer Counsel

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WEDNESDAY, SEPTEMBER 25, 2019

Presenting a live 90-minute webinar with interactive Q&A

Theodore A. Keyes, Special Counsel, Schulte Roth & Zabel, New York

Melinda B. Margolies, Partner, Kaufman Borgeest & Ryan, Valhalla, N.Y.

Mikaela Whitman, Partner, Pasich, Los Angeles

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5

Insurability of Disgorgement &

Restitution Claims

Post-Kokesh

About the Speakers• Theodore A. Keyes, Schulte Roth & Zabel LLPTed practices in the areas of insurance law, environmental law and litigation. Ted’s litigationpractice covers a wide range of issues and disputes involving insurance and environmentallaw in state and federal court as well as in the context of alternative dispute resolution. Inaddition to insurance coverage litigation, Ted’s insurance practice includes counseling ofclients concerning various specialty insurance policies, including directors’ and officers’liability, professional liability and specialty pollution products.

• Melinda Margolies, Kaufman Borgeest & Ryan LLPMelinda focuses her practice on insurance coverage and commercial disputes working extensivelywith insurers, brokers and insureds in connection with business and commercial risks particularlyin the areas of Professional Liability, Directors and Officers Liability and Employment PracticesLiability. She works closely with her insurer clients and insureds to manage complex claims anddevelop cost-effective strategies for resolution of claims across many areas of substantive law.

• Mikaela Whitman, Pasich LLPMikaela’s practice focuses on the representation of insureds in all phases of insurancerecovery, from pre-suit negotiations through alternative dispute resolution andlitigation. She also advises insureds on their insurance programs and provides counsel onrisk management strategy.

6Insurability of Restitution and Disgorgement – September 25, 2019

TOPIC OVERVIEW

• Courts have found that disgorgement orrestitution of ill gotten gains from an Insured isuninsurable.

• Over the years, courts have diverged on when toapply this coverage limitation based public policy.

• The question is not whether disgorgement is“uninsurable under the law” as a legal matter.

• The real question is whether the amounts at issueconstitute uninsurable disgorgement.

7

Insurability of Restitution and Disgorgement – September 25, 2019

Restitution/Disgorgement – The Basics

• Disgorgement is the return of ill-gotten gains.

• Considered “uninsurable under the law” because it is against public policy to create a win-win situation for bad actors:– if bad actor keeps ill-gotten gains, a win for the bad actor.

– If bad actor returns ill-gotten gains but gets insurance money, still a win for the bad actor.

• Loss includes damages, settlements, judgments, etc. but not “matters uninsurable under the law”.

• Definition of Loss often carves out fines and penalties

• Profit exclusions with final adjudication requirement.


Basics Continued...• Courts often encounter this coverage limitation with a

number of other coverage defenses.

• Amounts Sought are Labelled:– Restitution

– Disgorgement

– Rescissory Damages

• Labels of settlement or judgement will not control.

• Insurance Coverage, Insuring Agreement, “Loss” Definition, Exclusions and Public Policy as to Insurability are all considered.


History of the Defense – Level 3

• The Seventh Circuit Court of Appealsattempted to limit the scope of insurancecoverage by declaring that “loss” within themeaning of an insurance policy does notinclude restoration of ill-gotten gain.

• Level 3 Communications v. Federal Ins. Co.,272 F. 3d 908 (7th Cir. 2001).

• See also, Bank of the West, Reliance Group


See also,

• Reliance Group Holdings, Inc. v. National Union Fire Ins. Co. of Pittsburgh, P.A., 188 A.D.2d 47 (NY App. Div. 1993) (restitutionary payments by directors and officers in “greenmail” action were uninsurable).

• Bank of the West v. The Superior Court of Contra Costa County, 833 P.2d. 545 (Cal. 1992) (bank return of unlawfully collected amounts to customers not insurable)


Policy Language Considerations “Loss” and “Damages”

Definition example:

Loss means

The amount that any Insured becomes legally obligated to pay inconnection with any covered Claim, including, but not limited to:

(i) judgments (including pre-judgment and post-judgmentinterest on any covered portion thereof) and settlements;

(ii) damages, including punitive or exemplary damages and themultiple portion of multiplied damages relating to punitiveor exemplary damages. The enforceability of thissubparagraph (ii) shall be governed by such applicable lawthat most favors coverage for such punitive, exemplary andmultiple damages;


Loss/DamagesLoss shall not include, other than Defense Costs: anyamount for which the Insureds are not financially liableor which are without legal recourse to the Insureds;matters which may be deemed uninsurable under the lawpursuant to which this policy shall be construed; civil orcriminal fines or penalties; taxes or tax penalties(whether imposed by federal, state, local or othergovernmental authority); the costs and expenses ofcomplying with any injunctive relief or other form ofnonmonetary relief; compensation, salary, wages, fees,benefits, overhead, charges or expenses of any Insured.


Loss/Damages

Damages means any amount that the Insuredshall be legally required to pay because ofjudgments rendered against the Insured, or forsettlements negotiated with the written consentof the Company provided that such damagesshall not include fines or penalties or othermatters which may be deemed uninsurableunder the law pursuant to which this policy shallbe construed.


Loss/Damages

• Courts query whether the Insured hassuffered a “loss” in the ordinary sense.

• Courts review specific of Policy Lossdefinitions to ascertain whether amounts fallwithin the defined term “Loss.”

– Is the amount “damages”

• Courts address insurability, with the definitionof “Loss” on a most favored jurisdiction basis.


Is it a loss?If an Insured must return an amount they were not entitled to in the first instance, the amount is not a “Loss” in the ordinary sense:No: If company unlawfully profited and was required to return funds, it is not a “loss” see, e.g., In re TransTexas Gas Corp., 597 F.3d 298, 309 (5th Cir. 2010). Any settlement amounts directed at repayment of the excessive compensation is, a “disgorgement of ill-gotten gains and a restitutionary payment.” Yes: Beaumont Hospital v. Federal Ins. Co., 552 Fed.Appx. 494 (6th Cir. Jan. 16, 2014 (MI law).An order to pay unpaid wages not “disgorgement.”


Is it a loss?• a $70 million payment by Credit Suisse First Boston

Corporation (CSFB)

• “as disgorgement” to settle a lawsuit by the U.S. Securities and Exchange Commission (SEC) and an investigation by the NASD Regulation, Inc. (NASDR)

• is not a "loss" under its E&O policy.

The settlement payments representing the disgorgement of funds wrongfully obtained does not constitute "loss". Vigilant Ins. Co. v. Credit Suisse First Boston Corp., 2004 WL 2066353 (N.Y. Sup. Ct. App. Div. Sept. 16, 2004).


Is it “Loss” within the Definition?• Aon Corp. v. Certain Underwriters at Lloyd's of London,

No. 06 CH 16852 (Ill. Cir. Ct. Dec. 3, 2010).

• The underlying action sought only a disgorgement of contingent commissions of Aon. Plaintiffs wanted all amounts allegedly improperly received to be placed into a constructive trust .

• "Loss" definitions of most policies exclude “uninsurable amounts“ as in the Aon case.

• In certain policies, “Loss” will exclude disgorgement and restitution specifically.


Is it Insurable?• Aon v. Certain Underwriter at Lloyd’s of London cont’d.“Loss” covered under the Policy does not include "disgorgement of an ‘ill-gotten’ gain, that is, money of property an insured allegedly had no right to receive in the first place. (Illinois law).• California and New York likewise maintain this position.Contrast, Liss v. Federal Ins. Co., 2006 WL 2844468 (N.J. Super. Ct. App. Div. Oct. 6, 2006). Court held that public policy in New Jersey does not prohibit insurance for intentional acts in circumstances in which "the wrongdoer is not benefited and an innocent third party receives the protection afforded by the insurance.


Labels will not Suffice


Courts have viewed various matters as uninsurable disgorgement, based on findings in the underlying disputes:• “bump up” claims [Level 3];• Initial public offering claims or Section 11 claims [Conseco,

Inc. v. National Union, Indiana Cir. Court Dec. 31, 2002];• Where an insured has “profited” from unlawful conduct.

It was insufficient for an insurer to point to the allegations in the underlying complaint as evidence that the settlement represented the return of ill-gotten gains, and required the insurer to provide evidence that the settlement was restitutionary. Gallup Inc. v. Greenwich Ins. Co. 2015 (Del. Super. Feb. 25, 2015); subsequent ruling, 2017 De. Super.)

Labels will not Suffice


• Unified Western Grocers v. Twin City Fire Ins. Co., 457 F3d 1106 (9th Cir. Aug. 14, 2006). – Issue of fact whether amounts sought by bankruptcy trustee were

uninsurable restitution; allocation allowed

• Pan Pacific Retail Properties, Inc. v. Gulf Insurance Co., 466 F.3d 867, amended on rehearing, 471 F.3d 961 (9th Cir. 2006)– Where non-restitutionary theories of relief were available, whether a

damages award constituted a "Loss" would be a triable issue of fact.

• Dobson v. Twin City Fire Ins. Co. 590 Fed Appx. 687 (9th Cir. 2014) Where an element of underlying claim seeks “damages” wrong to deny coverage.

• J.P. Morgan Sec., Inc. v. Vigilant Ins. Co., No. 113 (N.Y. June 11, 2013)* Agreement to pay “disgorgement” without more not sufficient showing as a matter of law.

Disgorgement/Restitution

Defense Rejected


Disgorgement Defense Rejected

• Cohen v. Lovitt & Touche, Inc., 308 P.3d 1196, 1200 (Ariz. Ct. App. 2013).

• U.S. Bank v. Indian Harbor Ins. Co., 68 F.Supp.3d 1044, 1050 (D. Minn. 2014) (applying DE law).

• Burks v. XL Specialty Ins. Co., 2015 WL 6949610 (Tex. App. Nov. 10, 2015).

• In re TIAA-CREF Insurance Appeals, 2018 WL 3620873 (Del. Sup. Ct. July 30, 2018) (applying NY law).


U.S. Bank v. Indian Harbor Ins. Co., 68 F.Supp.3d 1044 (D. Minn. 2014) (applying DE law)

• Beginning in 2009, three class actions were brought againstU.S. Bank alleging unlawful high to low posting of overdraftfees. Class action plaintiffs sought declaratory relief, return ofexcess overdraft fees and damages.

• Class actions settled for $55M and U.S. Bank agreed to pay the $55M into a fund to be allocated among the class members.

• U.S. Bank did not admit any liability on the claims.

• The settlement did not characterize the payment as restitution.


U.S. Bank v. Indian Harbor Ins. cont’d• U.S. Bank sought coverage for the defense and settlement of

the class actions from Indian Harbor under a professional liability policy.

• Indian Harbor denied coverage on the basis that the settlement was not “Loss” but restitution and restitution was uninsurable as a matter of law.

• The parties agreed that the settlement met the requirements for the definition of “Loss,” but disagreed as to whether it fell within an exception to that definition which excluded payments that were “uninsurable” or “any payment for Loss in connection with any Claim made against [U.S. Bank] . . . brought about or contributed in fact by any . . . profit or renumeration gained by [U.S. Bank] to which it is not legally entitled . . . as determined by a final adjudication in the underlying action.”


U.S. Bank v. Indian Harbor Ins. cont’d• Court did not decide the general issue of the insurability of

restitution under DE law finding that the policies unambiguously do not cover restitution. Issue was whether the settlement constituted restitution.

• Holding: Settlement Not Restitution

“The policies unambiguously require that a final adjudication in the underlying action determine that a payment is restitution before the payment is barred from coverage as restitution.”

“If restitution is uninsurable by public policy, the parties may contract to require that payment is actually – and not just allegedly – restitution.”


U.S. Bank v. Indian Harbor Ins. In Summary

• The policies must be read as a whole and if the policies were read to preclude coverage for the settlement of restitution claims, it would nullify the final adjudication provision.

• Based on the clear policy language and the “common sense effect” of a settlement with no admission of liability, there is no presumption that settlement constitutes restitution merely because it resolved claims seeking the disgorgement of ill-gotten gains.

• Under a policy with the final-adjudication language requirement, mere allegations of unlawful activity are insufficient to establish restitution


In re TIAA-CREF Insurance Appeals, 2018 WL 3620873 (Del. Sup. Ct. July

30, 2018) (applying NY law)

• Beginning in 2007, a series of class actions were filed against TIAA, a company that provided financial counseling and investment brokering services to employees of certain educational institutions.

• The class action plaintiffs were investors who used TIAA brokers to invest in different funds. They sought the return of Transactional Fund Expense (TFE’s) gains by TIAA-- the difference in share price from time of sale order to actual sale.


In re TIAA-CREF cont’d

• Beginning in 2007, a series of class actions were filed against TIAA, a company that provided financial counseling and investment brokering services to employees of certain educational institutions.

• The class action plaintiffs were investors who used TIAA brokers to invest in different funds. They sought the return of Transactional Fund Expense (TFE’s) gains by TIAA-- the difference in share price from time of sale order to actual sale.


In re TIAA-CREF cont’d

• TIAA settled with the investors and sought coverage under its claims-made liability policies.

• Insurers denied coverage contending that the settlements were not “Loss” under the policies because they were “disgorgements” which are not insurable under NY law as a matter of public policy.


In re TIAA-CREF cont’d• Under NY law, “public policy prohibits the

enforcement of insurance agreements in cases involving disgorgement where the payment is conclusively linked, in some fashion, to improperly acquired funds in the hands of the insured.”

• But, NY cases barring the insurability of disgorgement are distinguishable from TIAAbecause TIAA disputed and defended itself against the class action claims and there were no findings that it received any ill-gotten gains.


Disgorgement/Restitution Defense Rejected – Takeaways

• Cohen – Rejects assertion that state public policy prohibits coverage for restitutionary payments. Uses Restatement as evidence.

• U.S. Bank – If a policy has final adjudication language, the settlement of restitutionary claims can be insurable.

• TIAA-CREF – The Court will not limit insurance recovery for a settlement where an insured did not profit from alleged wrongdoing. There must be some evidence that policyholder received ill-gotten gains.


Disgorgement / Restitution

Defense Accepted


Disgorgement Defense AcceptedTwin City v. Oceaneering Int’l. Inc., USDC for the Southern District of Texas (Feb. 28, 2017)• Shareholder files derivative action against Oceaneering directors

alleging they paid themselves excessive compensation.• Shareholder plaintiff sends settlement demand with damages based

in large part on the amount of excessive compensation.• Court: Any settlement amount based on the amount of excessive

compensation is disgorgement of ill-gotten gains and therefore uninsurable.

• Allocation of what portion of settlement constituted disgorgement left for another day.

• Also, personal profit exclusion not relevant; need to get within scope of coverage before considering exclusions.


Disgorgement Defense AcceptedPhiladelphia Indemnity v. Sabal Ins. Grp., Inc., USDC for the Southern District of Florida (Sep. 28, 2017)• State of Florida charged insured with grand theft in connection with

worker’s comp payments.• Insured settled with State and paid $300,000 “settlement sum”.• Insured argued that since there was no admission of guilt and

payment was not labelled “disgorgement,” settlement was covered.• “Payments made to resolve this claim can only be said to disgorge

Defendants of property to which they were allegedly not legally entitled.”

• As a matter of law, Loss does not include restoration of ill-gotten gains. Labels, or lack thereof, are not determinative.

• Also, rejects U.S. Bank’s personal profit exclusion position.


Disgorgement Defense AcceptedPhiladelphia Indemnity v. Sabal Ins. Grp., Inc., USDC for the Southern District of Florida (Sep. 28, 2017)• State of Florida charged insured with grand theft in connection with

worker’s comp payments.• Insured settled with State and paid $300,000 “settlement sum”.• Insured argued that since there was no admission of guilt and

payment was not labelled “disgorgement,” settlement was covered.• “Payments made to resolve this claim can only be said to disgorge

Defendants of property to which they were allegedly not legally entitled.”

• As a matter of law, Loss does not include restoration of ill-gotten gains. Labels, or lack thereof, are not determinative.

• Also, rejects U.S. Bank’s personal profit exclusion position.


Disgorgement Defense AcceptedJP Morgan Dispute - J.P. Morgan Securities, Inc. v. Vigilant Ins. Co., 84 N.Y.S.3d

436 (1st Dep’t 2018)

• SEC alleged that the Bear Stearns violated the securities laws by facilitating“late trading” and deceptive “market timing” for certain customers.

• Customers earned hundreds of millions of dollars in profits at the expense ofmutual fund shareholders.

• Bear Stearns agreed to pay disgorgement in the total amount of$160,000,000.

Bear Stearns sought insurance coverage for most of this amount ($140 M):*amount of profits earned by its customers*settlement amounts paid to resolve private party class actions*defense costs*prejudgment interest.


Disgorgement Defense AcceptedEarlier Ruling: J.P. Morgan v. Vigilant Insurance,NY Court of Appeals (June 11, 2013)

▪ NY Court of Appeals agreed with Bear Stearns(and trial court, but not First Department)

▪ A fact issue existed and discovery required on:▪ Whether amounts sought were disgorgement?

▪ Whether disgorgement of Bear Stearns’ own gainsor whether the payment represented gains of BearStearns’ customers?

▪ Thus, not ill-gotten gains of Bear Stearns?


Disgorgement Defense AcceptedDiscovery Presented

• The trial court twice ruled in favor of BearStearns.

• The Court concluded that the $140mrepresented third-party gains, rather than BearStearns’ own gains, such that the amount didnot constitute “disgorgement” even if it hadbeen labeled as such by the SEC.


Disgorgement Defense Accepted

U.S. Supreme Court DecisionKokesh v. SEC, 137 S. Ct. 1635 (2017):• The U.S. Supreme Court held that SEC disgorgement

constitutes a penalty, and is therefore subject to the five-year statute of limitations of 28 U.S.C. § 2462.

• The Court highlighted that SEC disgorgement is:(i) imposed for wrong committed against the public,(ii) serves to punish the violator and deter others(iii) in many cases, does not compensate the victims forsecurities violations and instead the wrongdoer pays thedisgorged funds to the district court, which has discretion todetermine how and to whom to distribute the money.


Disgorgement Defense Accepted

In light of Kokesh – New York Court (AppellateDivision – First Department) Finds the BearStearns Settlement Uninsurable

• On appeal from the trial court, Insurers arguedthat the recent Kokesh decision conclusivelydefined the nature of SEC disgorgement as apenalty.

• Earlier Court of Appeals decision from 2013 didnot resolve this issue.


Disgorgement Defense Rejected – No Ill Gotten Gain by Insured

• The Court agrees that the $140m disgorgement

payment constituted a “penalty” and not covered

“Loss.”

• The Appellate Division explained• Kokesh “applies with equal force to the issue of whether the

disgorgement paid by Bear Stearns, even if representing third-party

gains, was a ‘Loss’ within the meaning of the policy and whether

public policy bars insurance companies from indemnifying insureds

paying SEC disgorgement.”

• Kokesh establishes that SEC disgorgement is a

penalty, “whether it is linked to the wrongdoer’s

gains or gains that went to others.”


Policyholder Considerations • Pay attention to the nature of the claims (i.e., fiduciary duty

claims, class actions, security enforcement actions) and the specific type of damages sought.

– In re TIAA-CREF Insurance Appeals: settlement payments labeled as disgorgement were not uninsurable disgorgement even though labeled as such.

– Kokesh – argument that it only applies to “SEC disgorgement”

• Modify policy language in renewals

– “Final Adjudication” language

– Limited carve-outs for “penalties”

• Consider alternative remedies with the SEC

– Consider options other than disgorgement

– Tie payments closer to compensation of allegedly wronged parties


Disgorgement Take Away

• It is generally well accepted and settled that disgorgement is “uninsurable under the law” and not covered Loss.

• The real issue courts struggle with is whether a settlement, judgment or order constitutes disgorgement.

• If the insured received ill-gotten gains as the result of alleged wrongdoing and is returning such gains, then you have a potential disgorgement coverage defense.

• The personal profit exclusion does not supersede the Insuring Agreement language. You don’t get to exclusions until you get within the scope of coverage. Exclusions do not create coverage.

• When presented with detailed factual evidence of the nature of payment, Courts may rule on other coverage limitations in the Policy.


Questions


Thank You


Theodore A. KeyesSchulte Roth & Zabel [email protected]

Melinda MargoliesKaufman Borgeest & Ryan [email protected]

Mikaela WhitmanPasich [email protected]

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