A frequently recurring D&O insurance coverage question is whether the insurance policy provides insurance against claimed damages that are restitutionary in nature. The argument against coverage is under a public policy principle that the insured persons should not be able to obtain insurance protection against the return of so-called ill-gotten gains. This question was considered again in a recent insurance coverage decision out of a Connecticut trial court. In a decision that apparently is one of first impression in Connecticut, the court held both that the policy’s uninsurability clause and the policy’s personal benefit exclusion precluded coverage for the amount of a stipulated judgment in the underlying action. A copy of the Connecticut court’s August 23, 2024, opinion can be found here.

Background

Back9 Network, Inc. was a multimedia company for golf fans. During the period 2012-2014, William Ghio and others (the Ghios) were induced to invest in Back9. The court in the insurance coverage action subsequently found that the total amount of the Ghios investment was $860,000. The Ghios alleged in a lawsuit they filed against Back9 and certain of its directors and officers that their investment had been induced by material misrepresentations and omissions, in violation of the Connecticut Uniform Securities Act (CUSA).

Back9 submitted the Ghios’ lawsuit to its directors and officers’ liability insurer. Subject to a reservation of its rights under the policy, the insurer provided the Back9 defendants with counsel to defend the action, Joshua Berman. Berman was a so-called Cumis counsel (that is, counsel selected by the insured but paid for by the insurer, in light of the potential conflict of interest arising from the insurer’s reservation of rights).

The underlying case ultimately moved toward settlement. Berman suggested to the insurer’s claims representative that the insureds could get “settlement leverage” if the insurer were to send the insured a letter disclaiming coverage. The insurer’s monitoring counsel accordingly sent a letter stating, in reliance on the policy’s uninsurability clause and on the personal benefit exclusion, that there was no coverage under the policy for any judgment or settlement. The letter stated that because the plaintiffs in the underlying action sought rescission of their investment or the return of the consideration they paid for their Back9 securities, the amount is an uninsurable loss.

Once Berman had the insurers’ declination letter, he contacted the Ghios lawyer and negotiated a stipulated judgment in the underlying action. The stipulated judgment was in the amount of approximately $1.9 million, consisting of $860,000 [that is, the amount of the Ghios investment], statutory interest of $275,000, $350,000 in attorneys’ fees, and offer of judgment interest of $415,856. The Ghios also agreed that they would not seek satisfaction of the judgment from any of the individual insureds but would seek satisfaction exclusively from the insurer. The insured persons assigned their rights under the policy to the Ghios.

The Ghios, acting as assignees, then commenced an action in Connecticut state court seeking to recover the amount of the stipulated judgment from the insurer. The insurer moved for summary judgment on the ground that the underlying judgment did not represent a “loss” under the policy because the relief sought was restitutionary in nature and thus uninsurable under Connecticut law and the policy. The insurer also argued that coverage for the judgment was barred by the policy exclusion precluding coverage for any amounts related to any insured gaining any personal profit, remuneration, or advantage to which they were not legally entitled.

The Relevant Policy Language

The policy’s definition of Loss provides that “Loss means the amount which the Insureds become legally obligated to pay on account of Claims made against them for the Wrongful Acts for which coverage applies, including but not limited to … judgments… Loss does not include ….(4) matters uninsurable under the law pursuant to which the Policy is construed.”

The Personal Benefit Exclusion provides that the insurer shall not be liability under any insurance clause for “Loss on account of any Claim made against any Insured: … 7. based upon, arising from, or in any way related to and Insureds gaining any personal profit, remuneration, or advantage to which they were not legally entitled, if a final adjudication establishes that such Insureds gained such personal profit, remuneration or advantage.”

The Court’s August 23, 2024, Decision

In an August 23, 2024, opinion, Judge Cesar A. Noble granted the insurer’s motion for summary judgment, holding that coverage for the underlying judgment was precluded by the policy’s uninsurability clause and the personal benefit exclusion.

The court began its analysis of the insurer’s summary judgment motion by noting that it was unable to find any Connecticut appellate authority on the subject of the uninsurable clause. The insurer urged the court to follow Judge Posner’s 2001 opinion in the Seventh Circuit’s decision in Level 3 Communications v. Federal Insurance Co., in which the court held under Illinois law that a “Loss” within the meaning of an insurance contract does not include the restoration of an ill-gotten gain. The restitution seeks to deprive the defendant of the net benefit of an unlawful act, to which insurance should not apply as a matter of public policy.

The court considered extensive authority from other jurisdictions as well, after which it said that it “adopts the reasoning of our sister courts and concludes that in Connecticut, claims for restitution, as this term is used in this context, are not insurable as a matter of public policy.” Because the “main damages” – that is, the $860,000 part of the judgment representing the Ghios investment in Back9 – are “restitutionary in nature,” and because the remaining amounts “are derivative of the restitution sought,” the amounts, the court held, are “not insurable” and granted summary judgment to the insurer on that basis.

The court also granted the insurer’s motion under the personal benefit exclusion as well. The exclusion, the court said, “mirrors the ‘restitution’ theory … as based on the insured’s acquisition of profit or gain to which it was not entitled.” The $860,000 part of the judgment represented a gain or profit to which Back9 was not entitled and therefore no coverage applies under this exclusion.”

Discussion

On one level, the court’s ruling here arguably is not surprising. The court followed extensive authority from other jurisdictions on the uninsurabilty issue, include Judge Posner’s well-known opinion in the Level 3 case.

Just the same, I find myself worrying about the Ghios. They got hosed twice here. They allegedly got hosed by the Back9 defendants, who allegedly induced the Ghios to invest in Back9 based on material misrepresentations or omissions. The Ghios were out the entire amount of their investment. They gave up their right to try to seek to recover their damages from the Back9 defendants in exchange for assignment of the Back9 defendants’ rights under their policy. Now, they are getting hosed again, because they are precluded by public policy from recovering the amounts. The Ghios get nothing.

It was not inevitable that the court here would conclude that Connecticut law requires that the insurability of the damages sought here were against public policy. Other courts – for example, Delaware – have held that there is no public policy in their state precluding coverage of amounts that arguably are restitutionary in nature. (Refer here for discussion of the Delaware court’s take on this issue). The Delaware courts hesitated to “find” public policy where none previously existed, which the Connecticut court could have also chosen to do.

And as for whether the personal benefit exclusion applies, I note that the exclusion here is written on an after-adjudication basis (that is, the exclusion applies only if there has been a judicial determination that the precluded conduct took place). Others more familiar with the record here that I am may know better, but I wonder whether the sequence of events around the stipulated judgment in fact represents an adjudication that the precluded conduct occurred. Was there in fact (or perhaps in law) that the amounts involved were Ill-gotten?

All of that said, I recognize that the court here followed the weight of authority. Many courts before this one have found Judge Posner’s Level 3 opinion irresistible. So in that sense, as I noted above, the Connecticut court’s opinion here is unsurprising. I just do worry about the poor Ghios, who surely feel ill used after all.

Many thanks to a loyal reader for supplying me with a copy of the Connecticut court’s opinion.