(Article from Insurance Law Alert, November 2021)
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Reversing an intermediate appellate court decision, the New York Court of Appeals ruled that a $140 million settlement payment to the Securities and Exchange Commission (“SEC”) was not an uninsurable penalty. J.P. Morgan Sec. Inc. v. Vigilant Ins. Co., No. 61 (N.Y. Nov. 23, 2021).
The insurance dispute arose out of a settlement between the SEC and Bear Stearns & Co. Under the settlement, Bear Stearns agreed to pay $160 million as “disgorgement” and $90 million as a civil penalty in connection with deceptive trading claims. When Bear Stearns sought indemnification for $140 million of the disgorgement portion of the settlement (it did not seek coverage for $20 million of the payment), its insurers denied coverage on the basis that the disgorgement payment was uninsurable as a matter of public policy.
A New York trial court ruled that the disgorgement payment was a covered “loss” under the policy because it represented third-party gains. An appellate court reversed, ruling that the disgorgement payment was not a covered “loss,” defined by the operative liability policy to exclude “fines or penalties imposed by law.” (See September 2018 Alert). The appellate court relied on the United States Supreme Court’s ruling in Kokesh v. S.E.C., 137 S. Ct. 1635 (2017), which classified SEC disgorgement payments as penalties rather than losses in the context of a statute of limitations dispute.
This month, the New York Court of Appeals reversed, finding that the insurers failed to meet their burden of establishing that the $140 million payment was an excluded “penalty imposed by law.” The court explained that a penalty is distinct from compensatory and punitive damages in that it is “not measured by the losses caused by the wrongdoing.” Relying on the content of the communications between Bear Stearns and the SEC, including the valuations of investors’ injuries, the court concluded that the record established that the payment “was calculated based on wrongfully obtained profits as a measure of the harm or damages caused by the alleged wrongdoing.” The court contrasted the disgorgement payment from the $90 million penalty, “which was not derived from any estimate of harm or gain flowing from the improper trading practices.”
Finally, the court rejected the appellate court’s reasoning that the disgorgement payment must be considered a penalty under Kokesh. The court explained:
Kokesh does not control here. Initially, the Supreme Court was not interpreting the term “penalty” in an insurance contract (much less one governed by New York law) and, as we have cautioned, the meaning of that term may vary based on context. Indeed, the Supreme Court has since clarified that SEC-ordered disgorgement is not always properly characterized as a penalty insofar as the SEC may seek “disgorgement” of a defendant’s net gain for compensatory purposes as “equitable relief” in civil actions. Moreover, Kokesh—decided nearly two decades after the parties’ executed the relevant insurance contracts—could not have informed the parties’ understanding of the meaning of the term “penalty.” (Citations omitted).