Qui Tam Settlement Is Disgorgement Not Covered Under a D&O Policy

A Pennsylvania trial court has held that amounts paid in settlement of qui tam actions are uninsurable as a matter of law and thus not covered under D&O policies.  Mountainside Holdings, LLC, v. Am. Dynasty Surplus Lines Ins. Co., No. 2003-127 (Penn. Ct. Common Pleas June 30, 2014).  The court also held that an excess insurer had no coverage obligations until the underlying limits were exhausted by actual payment of covered amounts.  It further concluded that a prior litigation exclusion did not apply to a prior qui tam action filed under seal and not served on the insureds.

The insureds, physicians and a medical center, had purchased D&O insurance excess of $10 million in underlying insurance.  Those excess policies contained a prior litigation exclusion that barred coverage for claims related to litigation commenced prior to a specified date.  Before the prior litigation date of the policies, a qui tam action was filed against the insureds for alleged overbilling for medical services, but it was filed under seal and was not served on the insureds until after the prior litigation date.  The insureds settled the qui tam action and sought coverage from the excess insurers for amounts in excess of the $10 million underlying insurance.  The excess insurers denied coverage, and coverage litigation ensued.

On summary judgment, the court held that the excess insurers had no coverage obligation because the underlying limits had not been exhausted by actual payment of covered loss.  The excess insurers had stipulated that the insureds expended approximately $5 million in defense expenses, but the insureds argued that they had expended more than twice that amount in combined settlement and defense costs.  The court rejected the insureds’ position for two reasons.  First, the court held that there was no coverage for the qui tam settlement because the settlement constituted disgorgement of ill-gotten gains and was thus uninsurable as a matter of Pennsylvania law.  The court rejected the insureds’ argument that it was not established in fact that they had received illegal profits given that the action was resolved by settlement, concluding that the settlement amounted to an agreement by the parties that the insureds were unjustly enriched.  As such, amounts paid towards the settlement did not exhaust the underlying limits.  Second, the court held that amounts paid by an entity owned by an individual insured, that was not itself an insured did not exhaust the underlying limits.  Because that entity was separately named in the qui tam action, the court reasoned, counting amounts expended by it in the settlement toward exhaustion of the underlying limits would amount to providing coverage for an entity not insured under the policies.  Accordingly, the court concluded that the excess insurers’ coverage obligations were not triggered.

Finally, the court noted that the policy’s prior litigation exclusion barred coverage for claims related to litigation “brought prior to” the prior litigation date.  The court concluded in dicta that it was unable to determine, either based on the language of the clause or through reference, whether that phrase was meant to include actions filed under seal.

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