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

by Cozen O'Connor
Contact

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.

 

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.

© Cozen O'Connor | Attorney Advertising

Written by:

Cozen O'Connor
Contact
more
less

Cozen O'Connor on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.