On Monday, November 16, 2018, in AXIS Reinsurance Company v. Northrop Grumman Corporation, Case No. 17-8660 (C.D. Cal.), a federal district court in California ruled that an excess fiduciary liability insurer did not owe coverage to its insured, Northrop, for settlement payments made to the U.S. Department of Labor (DOL) resulting from alleged violations of the Employee Retirement Income Security Act (ERISA).

In granting summary judgment in favor of the fiduciary liability insurer, the court held that: 1) the DOL settlement constituted uninsurable disgorgement, which the insurer was not obliged to cover under California law, and 2) the insurer’s excess policy was not triggered by the underlying insurers’ voluntary decision to pay the DOL settlement amount. The court rejected Northrop’s arguments that the settlement was not “disgorgement,” that the settlement was not an order or “final adjudication” as required by the underlying policies, and that the insurer, as a follow-form excess carrier, was not permitted to take a different coverage position than the primary insurer.

Background

In the underlying class action litigation, the plaintiffs alleged that Northrop charged excessive fees and expenses in connection with a workers’ retirement fund in violation of ERISA. While the underlying litigation was still active, the DOL initiated an investigation of Northrop for potential ERISA violations related to various employee savings plans. In December 2016, Northrop entered into a settlement agreement with the DOL, which required the company to redeposit all funds that it had taken from the employee savings plans. Northrop’s lower level insurers provided coverage for the DOL settlement, which fully exhausted the primary policy limits and eroded the first excess layer limit. In June 2017, Northrop reached a settlement agreement in the underlying litigation in the amount of $16.75 million. The excess insurer agreed to temporarily fund $9.7 million of the underlying litigation settlement, while reserving its right to recoup amounts that may be considered uninsurable disgorgement.

Thereafter, the excess insurer brought suit to recover its portion of the settlement amount attributable to disgorgement damages, arguing that its excess policy was triggered prematurely due to the underlying insurers’ payments for uninsurable amounts.

Discussion

First, the court held that Northrop’s DOL settlement payment, which required the company to redeposit all funds that it improperly seized, met the definition of uninsurable disgorgement under California law despite the absence of the term “disgorgement” in the settlement agreement. The court ruled that it was “well-established” that one cannot insure against the risk of being ordered to return money wrongfully acquired.

Second, the court refused to accept Northrop’s position that, because the underlying carriers had paid out their respective limits, the excess insurer, as a follow-form excess insurer, was required to do so as well. Northrop failed to identify any loss falling within the scope of the excess policy at issue, and, as such, the excess policy had been “prematurely triggered."

The court’s decision reinforces a number of well-known principles. First, the decision upholds the standard that under California law, an insurance policy does not cover amounts that represent disgorgement. Second, an excess insurer is not compelled to offer its policy limit simply because lower layers have paid out their limits. Rather, an excess insurer is liable only for losses covered by the terms of the excess policy. Otherwise, in the words of the court, “any excess insurer could be liable to cover payments totally outside the scope of its excess coverage policy.” Finally, a settlement may be deemed “disgorgement” despite the absence of the term in any formal agreement or settlement documentation.