No Public Policy Against Insurer Funding Settlements of Claims Seeking Disgorgement

There are not a lot of Texas appellate-court decisions on D&O coverage issues. This very recent decision could end up being quite significant. Burks and XL Specialty have since settled, so this is the final decision on the coverage issues involved.

Burks was the CFO of an energy company insured under a D&O policy issued by XL Specialty. The energy company ultimately reorganized through a Chapter 11 bankruptcy.  As part of that reorganization, the plan agent sought recovery from Burks of compensation, bonuses, and benefits transferred to him prior to the Chapter 11 reorganization. Burks requested defense expenses and coverage, which XL Specialty denied on the following bases: (1) the plan agent’s claim was brought outside the policy period and did not relate back to any prior claims made within the policy period; (2) XL had no duty to defend because the plan agent’s claim sought disgorgement, which was not covered under the policy’s “loss” definition; and (3) XL Specialty had no duty to defend Burks for the same reason—the claim was for disgorgement. Burks settled with the plan administrator and pursued a coverage claim against XL Specialty. The policy contained a fairly typical interrelated-acts provision, which stated:

All Claims arising from the same Interrelated Wrongful Acts shall be deemed to constitute a single Claim and shall be deemed to have been made at the earliest time at which the earliest such Claim is made or deemed to have been made pursuant to [the notice conditions].

In analyzing a duty to defend, Texas courts apply the eight-corners rule, which requires the court to look only at the pleadings and the insurance policy to determine whether a duty to defend exists. Allegations in the pleading are considered without regard to their truth or falsity, and they cannot be contradicted with forensic evidence. XL Specialty argued that under the eight-corners rule, the court was prevented from reviewing the prior complaints that had been made during the policy period in order to determine whether, under its policy’s interrelated-claims provision, the plan agent’s claim was, in fact, related. One wonders how XL Specialty would explain how an interrelated-claims provision can be applied to determine potential coverage if one cannot consider the “other claims/lawsuits to which it might related.  In any event, the court rejected XL Specialty’s argument on the ground that, in part, the rationale behind the eight-corners rule does not apply where the insured seeks to establish coverage under an interrelated-claims provision.

The court further reasoned that Burks was not seeking to contradict any of the allegations in the complaint by going outside the eight corners but was, instead, addressing a “pure coverage” question—whether the post-policy Claim was related to a Claim or Claims made within the policy period and thus deemed to be made within the policy period. The court found that Burks raised a fact issue as to whether the plan agent alleged a wrongful act as defined by the XL Specialty policy, and as to whether the plan agent’s complaint alleged wrongful acts that fell within the scope of the policy’s interrelated-claims provision. The court then held that “even if disgorgement is ‘uninsurable under the law of Texas,’ XL has not established that this D&O policy excludes the advancement of defense expenses incurred for defending against such claims.”

Lastly, the court discussed the issue of whether Burks’ settlement was potentially covered by the D&O policy. The court started its analysis by noting that the mere fact of settlement without an admission of the allegations in a complaint does not establish culpability. The court went on to address the larger question of whether disgorgement is uninsurable under Texas law and observed that “no Texas court has held that insuring a settlement of a claim seeking restitution or disgorgement is against public policy or otherwise generally ‘uninsurable under the law’ of Texas.” The court further noted the Texas Legislature has not enacted any legislation on point.

Thus, the court found it could not hold as a matter of law that XL Specialty and Burks intended for a settlement such as Burks’ settlement with the plan agent to be excluded from coverage.  In support, the court cited U.S. Bank National Association v. Indian Harbor Insurance Co., No. 12-CV-3175, 2014 WL 3012969, at *3 (D. Minn. July 3, 2014) for its position that, absent a state statute or case law expressly stating otherwise, settlements for restitution were not uninsurable under Delaware law. The court distinguished the “sweeping” decision in Level 3 Communications Inc. v. Federal Insurance Co.,272 F.3d 908, 911 (7th Cir. 2001) by observing that it had never been cited as authority by a Texas court, and that “even the Seventh Circuit acknowledged that not all settlements in satisfaction of claims alleging ill-gotten gains necessarily would be excluded from coverage.”