Settlement Paid to States to Resolve HIPAA and Consumer Protection Law Claims Constitutes Non-Covered “Fines and Penalties”

Applying Washington law, the United States District Court for the Western District of Washington has held that an insured’s payment to resolve claims brought by state attorneys general for HIPAA violations and consumer protection laws constituted “fines and penalties” excluded from coverage under a CGL policy. Atl. Specialty Ins. Co. v. Lexington Ins. Co., 2022 WL 355111 (W.D. Wash. Feb. 7, 2022). The court also held that the CGL insurer, which had funded the settlement pursuant to a reservation of rights, could pursue a claim against its insured’s E&O insurers for equitable subrogation.

A CGL insurer paid $2.7 million toward the settlement of lawsuits brought by thirty states’ attorneys general against its insured under HIPAA and the states’ respective consumer protection laws. Subsequently, the CGL insurer asserted a subrogation claim against its insured’s E&O insurers, asserting that (1) the CGL policy’s “fines and penalties” exclusion precluded coverage for the settlement; and (2) coverage for the settlement was owed under the E&O policies. The E&O insurers asserted that the subrogation claim failed because the CGL insurer acted as a volunteer when it paid the settlement.

In the ensuing litigation, the court held that the CGL policy’s “fines and penalties” exclusion (which barred coverage for “any obligation to pay fines and penalties”) was unambiguous and applied to exclude coverage. Here, the court noted that the black-letter definition of “penalty” is “punishment imposed on a wrongdoer, in the form of imprisonment or fine; esp., a sum of money exacted as punishment for either a wrong to the state or a civil wrong (as distinguished from compensation for the injured party’s loss);” and “fine” means “a pecuniary criminal punishment or civil penalty payable to the public treasury.” Because the settlement consisted of payments to the “public treasury” exacted as “punishment for a wrong to the state,” the settlement constituted fines and penalties.

Although the court would not decide the merits of the subrogation claim on the CGL insurer’s motion for judgment on the pleadings, it rejected the E&O insurers’ counter-motion for judgment that the subrogation claim necessarily failed because the CGL insurer acted as a “volunteer” in making the settlement payment. In this regard, the court reasoned that the payment was made expressly pursuant to a reservation of the right to subrogate, and it could reasonably be inferred that the CGL insurer made the payment to avoid potentially breaching its duty of good faith to its insured.

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