Restitution By Insured in Fraud Case Did Not Constitute Covered Damages

By Elizabeth M. McGarry, Esq. of Tressler LLP

 

An insurance policy did not cover the amount that the insured agreed to refund to a purchaser of subsidiaries to settle fraud claims. The Seventh Circuit held that if the insured could obtain reimbursement for the settlement amount “it will have gotten away with fraud.” The court found that a covered “loss” does not include restitution paid by an insured, and is distinct from damages, which are expressly denoted as covered under the policy. Ryerson Inc. v. Federal Insurance Company, 2012 U.S. App. LEXIS 7372, (7th Cir. April 12, 2012) (applying Illinois law).
 
In 1998 Ryerson, Inc. sold a group of subsidiaries to EMC Group, Inc. for $29 million. The following year EMC sued Ryerson seeking rescission of the sale and restitution of the purchase price. EMC argued that Ryerson concealed an impending development affecting one of its subsidiaries. The subsidiary’s largest customer had declared that unless it cut prices, the customer would build its own plant and stop buying from the subsidiary. The customer repeated the demand for a price cut to EMC when EMC acquired the subsidiary from Ryerson. When EMC failed to accede to the demand, the customer took its business elsewhere. EMC’s suit charged Ryerson with fraudulent concealment intended to induce EMC to buy the subsidiary, breach of contract, and breach of warranty.
 
At the time of suit, Ryerson was insured by an insurer under an “Executive Protection Policy.” The policy covered “all LOSS for which [the insured] becomes legally obligated to pay on account of any CLAIM … for a WRONGFUL Act [elsewhere defined in the policy to include a ‘misleading statement’ or ‘omission’] …. allegedly committed by” the insured. Ryerson demanded coverage for the EMC Lawsuit. The insurer refused on the ground that EMC’s claim against Ryerson was not a covered risk.
 
Three years into EMC’s suit against Ryerson, the parties settled, with Ryerson agreeing to make “a post-closing price adjustment” of $8.5 million. The insurer maintained that EMC’s claim against Ryerson was not a covered risk. Ryerson brought a declaratory judgment action seeking a finding that the policy covered the $8.5 million that Ryerson refunded to EMC to settle the lawsuit.
 
In the declaratory action, the insurer argued that a “loss” covered by the policy does not include restitution paid by the insured, as distinct from damages, which are expressly denoted in the policy as a covered loss. The Seventh Circuit agreed. The court noted that a claim for restitution is a claim that the defendant has something that belongs of right, not to him, but to the plaintiff. A claim for “damages,” on the other hand, is claim for the monetary equivalent of the harm that was done to the plaintiff.
 
The court noted that Ryerson received $29 million from EMC for the subsidiaries and agreed to give back $8.5 million to settle EMC’s fraud claims against it. The refund represented a return of part, or maybe all, of the profit that Ryerson had obtained by inducing EMC to overpay. If Ryerson could obtain reimbursement of that amount from the insurance company, it would have gotten away with fraud. The court reasoned that if “disgorging such proceeds is included within the policy’s definition of ‘loss,’ thieves could buy insurance against having to return money they stole.” The court pointed out that no one writes such insurance, and no state would enforce such an insurance policy if it were written. A person cannot, at least for insurance purposes, sustain a “loss” of something it does not (or should not) have. Furthermore, there is no insurable interest in the proceeds of fraud. Because EMC was seeking to recover a profit made at its expense by Ryerson’s fraud (i.e. a claim for restitution), the claim was not covered by the policy.
 
The court made a point to note that a judgment or settlement in a fraud case may involve a combination of restitution and damages. Under those circumstances, the insurance company would be liable for the damages portion in accordance with the allocation formula in the policy. However, because Ryerson made no effort to allocate its loss between the loss of ill-gotten gains and other costs (i.e. transaction costs), any claim to those costs had been forfeited.
 
Tressler Comments: This case illustrates the important distinction between restitution and covered “damages.” Insurers generally are not bound to reimburse an insured for any and all monetary judgments and/or settlements. Rather, based upon the explicit language of the policy, an insurer will likely only be responsible for indemnifying its insured for those amounts that can properly be categorized as “damages.” An insurer should carefully examine the basis for a monetary judgment or settlement against its insured, particularly in cases involving fraud claims, to determine if the amount constitutes covered “damages.” 

 
Elizabeth M. McGarry, Esq. of Tressler LLP M. McGarry is an associate in the Chicago office of Tressler LLP (http://www.tsmp.com/elizabeth-mcgarry/; 312.627.4102; emcgarry@tresslerllp.com
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