Applying New York and Delaware law, the Superior Court of Delaware has held that a retirement benefits provider’s settlement of three class actions seeking payment of alleged profits did not constitute disgorgement and was insurable under the provider’s professional liability policies.  TIAA-CREF Individual & Institutional Servs. LLC v. Illinois Nat’l Ins. Co., 2016 WL 6534271 (Del. Super. Ct. Oct. 20, 2016).  The court also held that the two later class action lawsuits “related back” to the first lawsuit, that a commingling exclusion did not apply, and that the insured’s decision to self-fund defense costs did not make the costs per se reasonable.

The insured retirement benefits provider purchased primary and excess professional liability insurance policies for the 2007-2008 and 2009-2010 policy years.  In October 2007, the insured was sued by claimants alleging that it failed to timely process transfer or withdrawal requests, and that it withheld profits that accrued to accounts during the transfer process.  In May 2012, the insured settled the 2007 class action, agreeing to pay each class member who filed an approved claim “an individual amount calculated according to a formula” set in the settlement.  Two other class action lawsuits with similar allegations were filed in 2009 and 2012 and likewise were settled.

In the coverage action, the insurers asserted that the settlements of the three class actions constituted uninsurable disgorgement, arguing that they were payment of “ill-gotten gains.”  The insured contended that the settlement amounts were not disgorgement because it had not been “ordered to return funds.”  The Superior Court granted the insured’s motion for summary judgment, noting that New York cases addressing disgorgement were distinguishable because “all involve[d] conclusive links between the insured’s misconduct and the payment of monies.”  According to the court, such connections were lacking in this case where the insured “settled and expressly denied any liability” and did so following “lengthy litigation,” as opposed to situations addressed in the New York cases that involved SEC and/or other governmental investigations.

The court also held that the two later class actions related back to the first suit under the plain language of the policy, explaining that “the allegations in the Underlying Actions arise out of, and are attributable to the same type of conduct—[the insured’s] business practice that resulted in failure to pay customers their gains during delays in processing.”

Furthermore, the court rejected the insurers’ argument that the commingling exclusion, which provided “the policy will not apply to any claim made against the insured arising out of, alleging, or any way involving, directly or indirectly, the commingling of funds or accounts,” should apply.  The court held that (1) the insured’s agreements stated that the profits would be “allocated among other accounts”; (2) “clients could readily calculate the value of their gain”; and (3) the insured “did not mix clients’ funds with its own funds, the hallmark of comingling, nor did it use those funds for its own private benefit.”

Finally, the court rejected the insured’s argument that its defense costs were per se reasonable because they were paid for out-of-pocket.   The court noted that Delaware and New York require a multi-factor analysis to determine the reasonableness of defenses costs and self-funding may be one of many factors.