Friday, April 13, 2012

7th Circuit Holds No Coverage for Restitution Claim Under D&O Policy

In its recent decision in Ryerson Inc. v. Federal Ins. Co., 2102 U.S. App. LEXIS 7372 (Apr. 12, 2012), the United States Court of Appeals for the Seventh Circuit, applying Illinois law, had occasion to consider whether an underlying suit seeking rescission of a fraudulent transaction triggered coverage under a directors and officers liability policy.

The underlying facts in Ryerson involved the insured’s allegedly fraudulent sale of a number of subsidiaries to EMC Group.  EMC later sued Ryerson, seeking rescission of the sale and restitution of the purchase price on the theory that Ryerson withheld certain material information concerning one of the subsidiaries.  EMC claimed that Ryerson fraudulently concealed this information in an effort to induce the sale.  EMC also alleged causes of action for breach of contract and breach of warranty.  Federal Insurance Company denied coverage to Ryerson, and Ryerson subsequently settled the matter with EMC for $8.5 million.

Federal’s policy provided coverage for “all LOSS for which [the insured] becomes legally obligated to pay on account of any CLAIM … for a WRONGFUL ACT … .”  Federal argued that “loss” does not and cannot include restitution.  The court agreed, stating that allowing coverage for such claims would, in essence, encourage fraud.  Citing to a number of cases, including its seminal decision in Level 3 Communications, Inc. v. Federal Ins. Co., 272 F.3d 908 (7th Cir. 2001), the court explained that:

If disgorging [the proceeds of ill-gotten gains] is included within the policy’s definition of “loss,” thieves could buy insurance against having to return money they stole.  No one writes such insurance.

The court further explained that regardless of whether the for restitution claim is based on fraud or an innocent mistake is of no consequence.  Rather, the key determination is whether the claim is for compensatory damages or for return of “something that belongs of right not to [the defendant] but to the plaintiff.”  As such, the court noted, it was not a relevant consideration that EMC styled its complaint as one for damages:

EMC was seeking to recover a profit made at its expense by Ryerson’s fraud, which means that if the insurance company were liable to Ryerson, Ryerson would get to keep profits of fraud.  Having to surrender those profits was not a “loss” to Ryerson within the meaning of the insurance policy … .

The court acknowledged that in some instances, a judgment or settlement in a fraud case can include a combination of restitution and damages, the latter of which may be covered.  For instance, the EMC complaint initially sought recovery “transaction costs,” which the court agreed “would not be restitution because Ryerson gained nothing from the money that EMC paid its lawyers and accountants to handle the acquisition [of the subsidiary group].”  The court nevertheless concluded that because the underlying settlement made no effort to allocate as between restitution and such transaction costs, Ryerson forfeited any right it may have had for such amounts.

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