The United States District Court for the Southern District of Texas, applying Texas law, and adopting the recommendation of a magistrate judge, has held that reimbursement of excessive executive compensation constitutes disgorgement and is therefore uninsurable as a matter of law under a directors and officers policy.  Twin City Fire Ins. Co. v. Oceaneering Int’l, Inc., 2017 WL 1160514 (S.D. Tex. Mar. 29, 2017).

The insurer issued a directors and officers liability policy to the insured corporation.  The policy provided specified coverage for “damages,” which did not include “amounts for matters uninsurable pursuant to applicable law.”  The policy also contained a personal profit exclusion precluding coverage for “damages” based upon or arising from the “gaining of any personal profit, remuneration or financial advantage to which such Insured is not legally entitled.

During the policy period, a shareholder filed a derivative action against the insured corporation, alleging that excessive executive compensation was awarded to certain directors and officers, and that these transactions constituted a breach of fiduciary duties.  The lawsuit also advanced several unjust enrichment claims and sought disgorgement.  During settlement discussions, the insured sought coverage from the insurer for any potential settlement amount.  The insurer contended that coverage for any settlement of the lawsuit was precluded because the ultimate settlement amount would constitute uninsurable disgorgement under Texas law, and thus did not constitute “damages” as defined by the policy.  The insured argued that the terms of the personal profit exclusion served to enhance coverage under the policy, and that any settlement amount would therefore be covered under the policy.  The insurer filed a declaratory action seeking, in relevant part, a declaration that disgorgement and/or restitution damages are uninsurable as a matter of Texas law.

The magistrate judge, in a recommendation that was adopted by the district court, granted summary judgment in favor of the insurer.  First, the court concluded that the definition of “damages” contained within the policy is unambiguous and enforceable as written.  The court held that any settlement amounts constituting disgorgement of excessive compensation is uninsurable as a matter of Texas law.  In so holding, the court relied primarily on In re TransTexas Gas Corp., 597 F. 3d 298 (5th Cir. 2010). In TransTexas, the Fifth Circuit explicitly held that loss as defined in insurance contracts does not extend to amounts that are “restitutionary in character.”  Accordingly, the court concluded that any settlement amounts for unfair and excessive compensation constitute disgorgement of ill-gotten gains and restitutionary payments, which are uninsurable under Texas law.

Finally, the court held that the insured’s reliance on the personal profit exclusion was misplaced, as an exclusion cannot create coverage under the policy.  In so holding, the court stated that “[c]onceivably, amounts related to the gaining of personal profit, remuneration, or financial advantage could be insurable under applicable law; in which case, they would fit within the coverage provisions and would be excluded only upon a final adjudication of such gain” pursuant to the terms of the exclusion.