In an unpublished August 18, 2008 per curiam opinion (here), the United States Court of Appeals for the Eleventh Circuit has affirmed the district court’s summary judgment ruling in the CNL Resorts case that a Section 11 settlement is not covered "loss" under a D&O insurance policy. The appeals court reversed and remanded the case on other grounds, as discussed below.


This coverage action arose out of an underlying securities class action (about which refer here), in which the plaintiffs alleged violations of Section 11 of the Securities Act of 1933. The plaintiffs alleged that they had purchased their CNL shares at an inflated price of $20/share. The plaintiffs sought to recover the $8/share difference between what they had paid and the $12/share valuation that was later placed on the company. CNL settled this shareholder action for $35 million. Details regarding the settlement can be found here.


CNL had a $30 million D&O insurance program, arranged in three layers of $10 million each. CNL initiated a declaratory judgment action against the three insurers, seeking a determination of coverage for the settlement as well as related litigation costs and expenses and other amounts. CNL reached a settlement with the primary insurer, but the action proceeded as to CNL’s two excess insurers.


As I discussed in a prior post (here), on March 17, 2007, the district court granted partial summary judgment on behalf of the two excess insurers. The district court held that the $35 million settlement represented a disgorgement of CNL’s "ill-gotten gain," which did not constitute a "loss" under the relevant policy language and therefore is not insurable under applicable law.


In its August 18 opinion, the Eleventh Circuit affirmed this portion of the district court’s rulings. The Eleventh Circuit said that "because we conclude that the payment to the Purchaser Class was restitutionary in nature, the payment was not covered loss" and the excess carriers are "not liable for payment."


CNL had argued on appeal that the $35 million settlement did not represent the return of ill-gotten gains, contending that "without a finding of fraud, it is impossible to conclude that the money was wrongly acquired." The Eleventh Circuit said that "the return of money received through a violation of law, even if the actions of the recipient were innocent, constitutes a restitutionary payment, not a ‘loss’." The Eleventh Circuit also affirmatively held that Section 11 damages are restitutionary in nature.


The Eleventh Circuit also rejected CNL’s argument based on the statement in the settlement agreement that the $35 million was not "restitution or disgorgement." The Eleventh Circuit said that the settlement agreement "is not binding on any third party or this Court. The policy, not the settlement agreement, governs our resolution of this appeal."


The Eleventh Circuit did reverse a separate summary judgment ruling of the district court. The separate ruling related to the question of coverage for the settlement of the claims of a separate plaintiff class, the so-called Proxy Class, which had alleged misrepresentations in proxy materials. CNL had settled with this separate class in an agreement that, among other things, had resulted in its payment of the Proxy Class counsel’s fees of $5.5 million.


The primary insurer, in its separate settlement with CNL, had agreed to reimburse CNL for this $5.5 million settlement. The excess insurers argued, based on language in the primary policy, that the $5.5 million settlement did not represent covered "loss," and therefore the primary policy had not been depleted by payment of covered loss and the excess carriers’ payment obligation had not been triggered. The district court granted summary judgment on this issue for the excess insurers.


The Eleventh Circuit reversed this portion of the district court’s ruling. The Eleventh Circuit remanded the case to the district court for further factual proceedings on the question whether the language on which the excess carriers sought to rely properly is a part of the primary policy. The question to be determined is whether or not the relevant policy endorsement form had been filed with the Florida Office of Insurance Regulation, as the form would be void if not so filed.


At one level, the Eleventh Circuit’s affirmance of the district court’s ruling on the question of coverage for Section 11 settlements represents a significant development. A federal appellate court’s adoption of the position that a company’s Section 11 settlement is not covered loss under a D&O policy certainly reinforces the developing case authority on this point. The possibility that another court might reach a different conclusion seems increasingly remote.


At the same time, there are limitations on the significant of the Eleventh Circuit opinion. The first is that the opinion itself carries the designation "Do Not Publish." This is less of a restriction in the Eleventh Circuit than it might be in other courts; some courts actually prohibit the citation of unpublished opinions. The Eleventh Circuit’s Rule 36-3 (refer here) specifies that "unpublished opinions are not binding precedent, but they may be cited as persuasive authority." Thus, the Eleventh Circuit’s opinion may at least be cited, but it still does not represent binding authority.


There is a practical development that also diminishes the significance of the Eleventh Circuit’s opinion. That is, since the time of the district court’s summary judgment ruling on the question of coverage for Section 11 settlements, most D&O carriers have introduced policy endorsements specifying that they will not take the position that there is no coverage under their policies for settlements under Sections 11 and 12 of the ’33 Act. Not all of these endorsements were created equal, and they are all as yet untested in court, but at a minimum they ought to restrain most carriers whose policies have this endorsement from taking the position that a Section 11 or Section 12 settlement does not represent a covered loss under the policy.


Of course, not all policies have yet been adapted to this new approach, and there are still many claims pending in which the relevant policy does not have this new language. In connection with these existing policies and claims, it is important to note a couple of things.


First of all, even if a company’s Section 11 settlement is not covered under a D&O policy, the company’s expense incurred in defending against the Section 11 claim still ought to be covered.


Second, because the settlement of Section 11 claims against individual defendants (as opposed to the company itself) typically would not represent the return of ill-gotten gains, (since typically they would not have received any of the offering proceeds), a D&O policy ought to provide coverage for the settlement of a Section 11 claims against them, as well as their costs of defense, all other things being equal.


Very special thanks to a loyal reader for providing me with a copy of the Eleventh Circuit opinion.


Auction Rate Settlements: Plaintiffs’ Bar Bummer?: As I noted in a recent post (here), one of the as yet unanswered questions surrounding the high-profile auction rate securities buybacks is what impact these settlements will have on the numerous auction rate securities class action lawsuits (about which generally, refer here).


In an August 18, 2008 Legal Week article entitled "Billions Not for the Plaintiffs Bar" (here), Michael Rivera and Erik Frias of the Fried, Frank, Harris, Shriver & Jacobson law firm suggest that these settlements could have a "debilitating impact on the numerous class actions and other private lawsuits filed since the market seized up." The basis on which the authors reach this conclusion is that as a result of the buybacks and other settlement elements, "the losses of individual investors who might be plaintiffs will now be fully compensated, leaving little to no damages to pursue in court."


The authors suggest that as a result of the buybacks and other reimbursements incorporated into the settlements, the "bottom line" is that the claimants "will be made whole without assistance from the courts." As they put it, "government and industry have worked cooperatively to craft a solution to the auction-rate securities problem in such a way that private litigation will be largely unnecessary and unavailable." As a result, the authors suggest, there may now be "little opportunity for the plaintiffs bar to profit."


The authors may have a point, but I haven’t yet seen the voluntary dismissal of any of the pending auction rate securities lawsuits. The plaintiffs’ lawyers may not go quietly, and one angle I can imagine them trying to work relates to institutional investors, benefits under the various settlements are less defined and less comprehensive.


In any event, there are still a host of auction rate securities lawsuits that have been filed against banks and other institutions that have not yet reached a regulatory settlement. To be sure, it may only be a matter of time before the regulators set their sights on these others. In the interim, the existence of the shareholder lawsuits may represent one additional factor pressuring them to reach a regulatory settlement.


Finally, as I recently noted (here and here), though the settlements have started to mount, auction rate securities lawsuits continue to accumulate. There apparently are some members of the plaintiffs bar who continue to perceive an opportunity to profit from the auction rate debacle. It will certainly be some time before it is all sorted out.