New York High Court Finds Restitution Payment Insured ‘Loss’ Rather Than Uninsurable ‘Penalty’ | Jones Day


Reversing the New York Appeals Division, First Department, the New York Court of Appeals, in a landmark 6-1 decision, ruled that a $ 140 million rebate payment is an insured “loss”, after a long history of insurance companies mistakenly characterizing such a payment as a “penalty” and, therefore, uninsurable in law. JP Morgan Sec. Inc. v. Vigilant Ins. Co., no.61, 2021 WL 5492781 (NY, November 23, 2021).

Amid allegations of “facilitation[ing] Late Transactions and Deceptive Market Timing Practices ”, stockbroker Bear Stearns reached a settlement with the United States Securities and Exchange Commission (“ SEC ”) in 2006 that included a restitution payment of $ 140 million. dollars. Bear Stearns successor companies sued their insurers after coverage for the rebate payment was denied under Bears Stearns (“E&O”) “wrongdoing” liability insurance policies. The policies provided coverage for “loss”, but not for “penalties imposed by law”.

In an earlier 2013 ruling, the New York Court of Appeals agreed with the policyholder “that a large portion of the payment, although labeled as disgorgement by the SEC, did not actually represent the disgorgement of its own benefits ”. The Court of Appeal therefore ruled that the rule prohibiting the reimbursement coverage of the policyholder’s illicit earnings did not apply to this part of the “reimbursement payment”.

After the dismissal, the insurers argued that the rebate payment was a “penalty” and uninsurable under New York public policy. In a detailed opinion issued on November 23, 2021, the Court of Appeal concluded that insurers had failed to meet their obligation to prove that the rebate payment constituted a “penalty” so that they could avoid coverage.

The Court of Appeal treated the dispute as a dispute over the interpretation of insurance contracts, explaining that the specific language used in insurance policies must be “consistent with the reasonable expectations of the average insured”, in the moment of conclusion of the contract, any ambiguity being interpreted in favor of the policyholder. It was concluded that the term “fine” did not refer to a compensatory indemnity for the injured parties, but rather to a punitive or dissuasive pecuniary penalty: “A reasonable insured who takes out a policy for wrongdoing would expect to receive an indemnity. or a settlement for compensatory purposes and measured by the losses of an injured party and the gains of third parties to fall within its granting of coverage and, concomitantly, not to be considered a penalty. “

According to the Court of Appeal, the $ 140 million restitution payment could not be classified as a “penalty” because (i) it was determined by the SEC-led assessments of client gains and investor losses as a measure of the harm caused by Bear Stearns. an alleged wrongdoing; (ii) Bear Stearns was not required to treat the rebate payment as a penalty for tax purposes, and the payment could be used to offset private claims against the Company; (iii) E&O “wrongdoing” liability insurance policies expressly covered “settlements and other amounts relating to investigations by a government regulatory body; And (iv) at the time of contracting, the SEC viewed the rebate payments as “a fair remedy and not a monetary penalty”. In light of these considerations, insurers’ arguments characterizing the refund payment as a “penalty” would defeat an insured’s reasonable expectations of coverage.

The Court of Appeal further held that the decision of the Supreme Court of the United States in Kokesh v. DRY did not control because the term “penalty” in Kokesh has not been interpreted in the context of insurance coverage. Thereby Kokesh, decided after the signing of the insurance policy, could not have enlightened the parties’ understanding of its meaning. Notwithstanding the arguments put forward in the Court of Appeals’ dissent alone, the majority noted that the United States Supreme Court has since clarified that “the disgorgement ordered by the SEC is not always properly characterized as a sanction in the measure where the SEC can seek the “disgorgement” of a net gain defendant for compensatory purposes as a “fair remedy in civil actions”. The case has been referred to the New York Appeals Division, First Department, to resolve the outstanding issues. While policyholders can expect insurers to continue their efforts to avoid covering these types of losses, the New York Court of Appeals ruling strongly rejects attempts by insurers to convert losses covered by ” restitution ”into uninsured“ penalties ”and to ignore reasonable expectations. of their policyholders.


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