Hunton Insurance Recovery Blog

A California appeals court recently reversed a trial court’s determination that a D&O insurer had no duty to reimburse legal fees incurred by a company’s former CFO in defending against an SEC civil enforcement action, shareholder derivative claims, and counterclaims by the company asserting that the CFO breached his indemnification agreement. In doing so, the appeals court rejected the insurer’s argument that the defense costs the company advanced to the CFO were “restitutionary” damages excluded from the D&O policy’s definition of loss.

The court explained that its ruling favoring broad executive protection was consistent with the generally understood purpose of D&O liability insurance—to provide protection for individuals whose business decisions, made in their capacity as the management of a corporation, subject them to the risk of personal liability for losses that the corporation or its shareholders may incur.

Background

Maxim Integrated Products hired a CFO subject to an indemnification agreement requiring the company to advance the CFO’s legal fees subject to the agreement to repay if it was later determined the CFO was not entitled to indemnification. The company also purchased primary and excess D&O liability insurance, which covered the CFO.

The SEC filed a civil enforcement action against Maxim’s CFO for securities violations arising from stock option backdating. A jury found the CFO liable for fraudulent conduct, including securities fraud and knowingly making false statements to the SEC. At the same time, Maxim shareholders filed derivative actions, which were settled by the company, the CFO, and the D&O insurers. Class action complaints filed against Maxim and the CFO were also settled via a $173 million dollar payment by Maxim.

The CFO eventually sued Maxim for unpaid stock options. Maxim counterclaimed, seeking a declaration that it owed no indemnification because the CFO had been found liable for fraud. The company also said that the CFO breached his indemnity agreement by refusing to repay amounts advanced for his legal defense, as well as payments made to fund the civil settlements.

After settling their disputes, the CFO and Maxim sued the D&O insurers for wrongfully disclaiming coverage for the amounts the CFO was obligated to repay to Maxim for advancing his defense costs. Maxim argued that those payments met the policy’s definition of “Defense Costs,” while the insurers asserted that the CFO’s repayment obligations were equivalent to “restitutionary” damages, which are excluded under the policy, because the CFO wrongfully obtained them and was unjustly enriched by the payments. The trial court granted summary judgment for the insurers, concluding that the CFO’s claim for coverage under the D&O policies amounted to “restitutionary” damages.

The Appellate Court Decision

The appeals court in Jasper v. Chubb Nat’l Ins. Co., No. H050804, 2024 WL 4759411 (Cal. Ct. App. Nov. 12, 2024), rejected the insurers’ “restitutionary” damages argument and reversed.

The court first concluded that the policy’s Side A insuring agreement unambiguously covered the CFO’s defense costs because Maxim’s payments for the CFO were intended to provide the broadest possible coverage permitted by law. The court further rejected the insurer’s, broader interpretation of the term “restitutionary” damages because it was inconsistent with industry-specific usage, the policy language, and the understood purpose of D&O insurance, which was to protect individuals from personal liability for losses the corporation or its shareholders might incur as a result of the individual’s decisions in their capacity as corporate management.

In rejecting a narrower view of covered “Loss,” the court agreed with the insureds’ position that restitutionary damages were confined to “traditional claims in equity to retrieve monies wrongfully obtained,” such as disgorgement of money or property through a violation of law. The scenario involving Maxim’s CFO presented no evidence that the executive “wrongfully obtained” anything from Maxim, so the loss did not constitute restitutionary damages.

Finally, the court rejected the argument that recognizing coverage would violate California’s Insurance Code Section 533, which forbids an insurer from providing coverage for losses caused by an insured’s willful acts. The court explained that Section 533 only prohibits indemnity for willful acts, not coverage for defense costs. The insurers’ remaining arguments under various policy exclusions were also inapplicable to the claim for defense costs. The court reversed and remanded, vacating the order granting summary judgment for the insurers and awarding the insureds their costs on appeal.

Discussion

The Jasper decision has several takeaways for policyholders.

First, in narrowly construing restitution, the Jasper court followed other recent insurability decisions rejecting insurers’ refusal to pay D&O losses, especially for defense costs, and construing carve outs for allegedly uninsurable restitution, disgorgement, and return of profits narrowly.

Second, courts have also strictly enforced the burden for insurers to show factually that the challenged loss constitutes restitution, including evidence that the money was wrongfully obtained in the first place. Defenses based on generic or conclusory insurability alone, even if labeled as “restitution” or “disgorgement,” should not control. D&O claims involving insurability questions require nuanced analysis based on the specific policy language, the facts giving rise to the loss, and governing law.

Finally, the court in Jasper rightfully interpreted the claim in line with the core purpose of D&O liability policies to protect individuals from non-indemnified losses making them personally liable for claims in the absence of insurance. In rejecting the insurer’s attempt to exclude coverage, the court in Jasper distinguished cases that “did not involve directors and officers insurance policies.”

The Jasper decision reinforces the importance of maintaining D&O insurance as an essential part of any comprehensive liability insurance program. The failure to acquire D&O insurance can leave a company’s executives at risk of costly personal exposure for non-indemnified legal fees, costs, and other losses. Regardless of an insured’s particular industry or trade, D&O coverage is an important risk mitigation and retention tool to attract and protect boards and C-suite executives who may be targeted individually in claims challenging their decision making in running the company.