An insurance broker’s settlement of claims for disgorgement of undisclosed contingent commissions does not represent covered loss under a combined lines professional liability insurance policy, according to a December 3, 2010 decision of the Illinois (Cook County) Circuit Court. A copy of the December 3 opinion can be found here.

Background

Aon Corporation was first sued in 1999 in a class action lawsuit brought on behalf of its customers who alleged the firm had acted improperly with respect to its receipt of certain contingent commissions from insurance carriers. This class action lawsuit came to be known as the Daniel action. Aon was also the subject of certain regulatory investigations from several states’ Attorneys General based on the same allegations.

As originally pled, the Daniel action sought damages as well as other relief. However, the Daniels action was amended multiple times. As ultimately pled, the Daniel action sought only a disgorgement into a constructive trust of the amounts allegedly improperly received.

On March 4, 2005, AON entered into a settlement with the Attorneys’ General in which it agreed to deposit $190 million into a fund to be paid to former clients of the firm. The agreement specified that the firm would not seek indemnification from its insurers for the funds paid in the settlement.

On March 9, 2005, AON entered a separate settlement in the Daniel action, in which the firm agreed to pay an additional $38 million. The Danies action was approved by the Court.

Aon sought indemnification from its insurers for the amounts paid in settlement of the Daniels case as well as defense expenses incurred in the Daniel case and the Attorneys General action.

Aon’s insurance program included a Combined Lines Policy which combined certain lines of professional liability insurance, including directors and officers liability insurance, errors and omissions insurance and other lines as well. The Combined Lines Policy insurance program consisted of a layer of primary insurance and multiple layers of excess insurance.

In August 2006, AON initiated an action in Illinois (Cook County) Circuit Court seeking a judicial declaration of coverage under the Combined Lines Policy for loss incurred in connection with the Daniels action and related matters. The parties filed cross motions seeking to establish whether or not the Danies settlement and the defense costs incurred in the Daniel and the Attorneys General actions represented covered loss under the Combined Lines Policy.

The December 3 Order

In arguing that there was no coverage under the Combined Lines Policy for the settlement and defense expenses, the carriers argued that "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." The insurers argued that the Daniel plaintiffs sought only a constructive trust, not individualized damages, making it clear "that they were seeking disgorgement as their only remedy." The carriers also argued that it would be against Illinois public policy to allow the firm to pay restitution or fund a constructive trust with insurance proceeds.

AON in turn argued that there were genuine issues of material fact whether or not the remedies the Daniel plaintiffs sought were restricted solely to restitution. AON argued further that even if the pleadings as amended sought only restitutionary relief, the original pleadings had sought damages, and therefore the firm was entitled to its costs of defending the original pleadings. AON also argued that there was a genuine issue of fact whether the Attorneys General actions sought only restitutionary relief.

In her December 3 opinion, Judge Kirie Kinnaird rejected AON’s arguments and held that the relief sought in the Daniel action was "restitutionary and not an insurable loss." Judge Kinnaird rejected the firm’s contention that it was entitled to the defense expenses incurred before the pleadings were amended to remove the damages allegations, since the ultimately operative complaint, and the one to which AON filed its motion to dismiss, sought only restitutionary relief.

Judge Kinnaird also rejected AON’s argument that because there had been no determination in the Daniel action that the contingent commissions were "ill-gotten," the commissions represented amounts the firm was entitled to receive, and therefore the Daniels settlement represented covered "Loss." Judge Kinnaird said:

Insurability does not depend on whether a claim has merit, but rather what the settled claim sought….This Court will not make a finding or determination of whether AON’s alleged actions in the Daniel litigation were "ill-gotten gains" or unlawful. The lawfulness of collecting contingent commissions was not at issue in the Daniel litigation and is not relevant here. It was the Daniel plaintiffs’ allegation that AON failed to disclose its eligibility to receive the contingent commissions and the retention thereof that gave rise to AON’s potential liability.

Finally, Judge Kinnaird held that the firm was not entitled to recover its expenses incurred in defending the Attorneys General actions because the matters were in the nature of disgorgement and restitution. Judge Kinnaird rejected AON’s argument that the way that the claims were characterized in the settlement documents altered this conclusion. Because the underlying claims were not covered, the expenses incurred in the defending the matters likewise were not covered.

Discussion

There is an extensive body of case law holding that D&O insurance does not cover disgorgement or amounts incurred that are restitutionary in nature. What makes this holding interesting is Judge Kinnaird’s express observation that the question of coverage for the amounts AON sought does not depend on whether or not the amounts themselves were "ill-gotten."

Rather, the Judge held, the question of coverage for the amounts sought depending solely on the fundamental nature of the relief sought. Because the relief sought in both the Daniel action and the Attorneys General action was fundamentally restitutionary in nature, there was no coverage under the policy at issue.

The part of Judge Kinnaird’s holding worth thinking about is the ruling with respect to defense expenses. I think most would accept that liability insurance can’t be used as a way for insured’s to finance their repayment of amounts that were not the insured’s in the first place. However, the determination of noncoverage for the amounts incurred in defending against wrongful acts may or may not be as obviously reasonable to many observers.

I would be interested in knowing readers’ thoughts on the defense expense question. I think there may be some difficult issues there to consider, especially with respect to individual defendants (particularly in the bankruptcy context).

Special thanks to a loyal reader for providing me with a copy of the AON decision.

SafeNet’s Excess Carrier’s Rescission Action to Go Forward: On December 7, 2010, Southern District of New York Judge Naomi Buchwald denied the motion to dismiss an action to determine whether or not there is coverage under SafeNet’s excess D&O insurance policy for the settlement of the company’s options backdating related securities class action lawsuit. A copy of the opinion can be found here.

The excess carrier’s action seeks to rescission. In her December 7 opinion, Judge Buchwald held that neither the underlying carrier nor individual directors and officers who had not been named as defendants in the rescission action were indispensible parties to the rescission action.

Judge Buchwald also rejected the argument that the rescission action was not yet ripe, because the primary policy had not yet been exhausted by payment. She held that the rescission action represented a ripe controversy notwithstanding the fact that the underlying limit had not been exhausted because the securities class action lawsuit settlement presented the "practical likelihood" that the excess limits would be called upon.

Semtech Options Backdating Securities Class Action Lawsuit Settles: On December 8, 2010, Semtech announced that it had settled what is one of the last remaining options backdating-related securities class action lawsuits. As reflected in Semtech’s December 8 press release, which can be found here, the case has settled for $20 million.

I have added the Semtech settlement to my running tally of options backdating related class action lawsuits, which can be accessed here.

According to data compiled by Adam Savett of the Claims Compensation Bureau, of the 39 options backdating related securities class action lawsuits, seven (or 18% were dismissed) and 31 have been settled or partially settled. The total value of all options backdating related securities class action lawsuit is $2.38 billion. The average settlement is $68.7 million, and the median settlement is $14 million. Savett’s data also reflects average and median insurer settlement contributions.