Sixth Circuit Limits Scope of Disgorgement Provision in E&O Policy

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In a cutting-edge decision, the federal 6th Circuit Court of Appeals has ruled that an exclusion barring coverage for an insured’s liability for “disgorgement” of “remuneration” or “advantage” is limited to “acquiring” funds as opposed to “retaining” funds. William Beaumont Hospital v. Federal Ins. Co., No. 13-1468, 2014 WL 185388 (6th Cir. Jan. 16, 2014). The Beaumont decision is the first of its kind and, if followed by other courts, narrowly circumscribes the scope of disgorgement exclusions that are typically included in errors and omissions and directors and officers liability policies.

The Underlying Case

The Beaumont case arises from an underlying antitrust class suit that registered nurses brought against eight Detroit-area hospitals. The nurses claimed the hospitals conspired among themselves to suppress their wages. The complaint alleged two causes of action for violations of section 1 of the Sherman Act. The trial court in the underlying case granted summary judgment in the hospitals’ favor on the nurses’ claim for a per se violation of the Sherman Act, but allowed the nurses’ second “rule of reason” claim to proceed. That second claim alleged the hospitals unlawfully agreed to share compensation information in a manner that harmed competition and depressed the nurses’ wages.

Federal insured one of the hospitals (Beaumont) under a policy that, subject to its terms, provided antitrust coverage. Federal agreed to advance defense costs under a reservation of rights, including the right to reimbursement. The case ultimately settled for $11.3 million of which Federal contributed $9 million, again subject to its right of reimbursement.

The Coverage Case

Beaumont sued Federal for a declaration that it was obligated to indemnify Beaumont. Federal counterclaimed asserting that the settlement was a “disgorgement” and therefore not a “loss” as defined in its policy. Federal also argued the settlement was uninsurable as a matter of public policy. Beaumont filed a motion for judgment on the pleadings. The trial court granted that motion and held Federal did have a duty to indemnify Beaumont. The 6th Circuit affirmed. The case was decided under Michigan state law.

The Relevant Policy Term: Loss

The key policy term at issue in the coverage action was the Federal policy’s definition of loss. The Federal policy defined loss, in pertinent part as:

[T]he total amount which any Insured becomes legally obligated to pay on account of each Claim and for all Claims in each Policy Period … made against them for Wrongful Acts for which coverage applies, including, but not limited to, damages, judgments, settlement, costs and Defense Costs.

Solely with respect to any Claim based upon, arising from or in consequence of profit, remuneration or advantage to which an Insured is not legally entitled, the term Loss … shall not include disgorgement by any Insured or any amount reimbursed by any Insured Person.

The 6th Circuit’s Opinion

Federal’s principal argument was that the nurses’ claims arose from Beaumont gaining an “advantage” (namely, payment of lower wages) that it was not legally entitled and therefore the settlement payment was a noncovered disgorgement pursuant to the policy’s loss definition. Federal contended this was so even though the underlying complaint did not use the terms disgorgement or restitution, because the true nature of the nurses’ claim was for return or disgorgement of the advantage it had gained by paying lower wages. For its part, Beaumont argued that disgorgement and restitution are distinct remedies and that per its terms, the Federal policy only excluded disgorgement. Beaumont further argued that money unlawfully “retained” is not the same as money unlawfully “acquired.” Beaumont also noted that the Federal policy used the term restitution elsewhere in the policy and argued that therefore Federal knew the difference between disgorgement and restitution.

The court, applying Michigan law, agreed with Beaumont. In the court’s view, the issue was simply one of contract interpretation and application of the basic rule that exclusions are strictly construed in the insured’s favor. Relying on dictionary definitions, the court concluded that disgorgement means to “give up illicit or ill-gotten gains.” According to the court, gain means to “acquire” or “attain possession.” Applying these definitions, the court held that the amounts paid in settlement of the nurses’ claims were covered compensatory damages because “[r]etaining or withholding differs from obtaining or acquiring.” The court explained that although the hospital’s actions were illicit, the “hospital could not have taken money from the nurses because it was never in their hands in the first place.” The court also observed that antitrust law, itself, undermined Federal’s argument that the settlement represented disgorgement as opposed to payment of damages. Private antitrust actions, the court noted, were created to provide compensation to victims of antitrust violations.

In reaching its conclusion, the court distinguished the 7th Circuit’s decision in Level 3 Communications, Inc. v. Federal Ins. Co., 272 F.3d 908 (7th Cir. 2001) and its progeny. The court observed that Level 3 and those cases that followed it all involved “wrongfully acquiring something.” For example, the underlying settlement at issue in Level 3 represented payment to the claimants of the value of stock the insured had acquired from the claimants through false pretenses. See also In re TransTexas Corp., 597 F.3d 298, 310 (5th Cir. 2010) (return of funds due to a fraudulent transfer was not insurable).

Federal’s secondary argument was that Michigan public policy prohibited coverage for the underlying settlement. Federal argued that if the claim were covered, Beaumont would profit from its wrong and providing coverage would encourage moral hazards because it would incentivize wrongful behavior. The court rejected this argument. The court concluded that the doctrine that an insured may not profit from its wrongdoing only applies to intentional tortious or criminal acts. See, e.g., K&T Enterprises, Inc. v. Zurich Ins. Co., 97 F.3d 171 (6th Cir. 1996). It also rejected the assertion that Michigan has a blanket rule prohibiting insurance coverage for statutory violations. The court then pointed out that Beaumont’s alleged misconduct was not per se illegal because the district court in the underlying case had already dismissed the nurses’ claim for a per se violation of Section 1 of the Sherman Act and only allowed the nurses to proceed on their “rule of reason” claim.

ANALYSIS

The 6th Circuit’s decision, while not officially published, is significant and will likely be cited by policyholders in cases where coverage for disgorgement of ill-gotten gains are at issue. In the author’s view, the Beaumont court’s distinction between the insured’s acquisition and retention of money does not account for the policy term barring coverage for liability arising from advantage the insured improperly obtained. On the facts of the Beaumont case, the insured clearly gained an advantage by paying lower wages even if it did not wrongfully acquire money from the nurse employees.

The Beaumont case has broad implications, but is not definitive, in part because the decision is officially unpublished and applies Michigan law. In addition, much of the Beaumont court’s decision rested on the particular policy terms at issue in that case. Although many policy forms have similar terms, if confronted with disgorgement issues, insurers should carefully examine their specific policy terms to assess whether the Beaumont decision is distinguishable on that basis.

 

Topics:  Board of Directors, D&O Insurance, Disgorgement, Professional Liability, Remuneration

Published In: Antitrust & Trade Regulation Updates, Health Updates, Insurance Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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