Defeating Phantom Exclusions in D&O and E&O Coverage: Guidance for Policyholders

Since the Seventh Circuit’s watershed opinion in Level 3 Commc's Inc. v. Federal Ins. Co., professional liability insurers try to deny coverage for liabilities it characterizes as “restitutionary” or subject to disgorgement as ill-gotten gains, even in the absence of an explicit policy exclusion or state law provision making restitutionary payments uninsurable.

D&O and E&O policyholders have seen insurers successfully invoke this phantom disgorgement defense against a wide array of claims involving allegations of wrongdoing. These include claims brought under Section 11 of the Securities Act of 1933, the Foreign Corrupt Practices Act, insider trading, and standard securities fraud against individual officers and their corporations.

Policyholder efforts to rein in insurers’ use of this defense is gaining substantial traction, with a series of holdings across jurisdictions limiting its application. The court’s clarification of disgorgement as a covered loss under standard policy language in the matter of U.S. Bank N.A. v. Indian Harbor Ins. Co. is a prime example of the limitations on the application of this defense.

Listen as our panel of insurance practitioners offers counsel for policyholders guidance on crafting policy language that addresses the phantom disgorgement exclusion and how to overcome its application as an affirmative defense based on recent developments in this body of case law.

1. Disgorgement: exclusion and affirmative defense
   1. D&O provisions
   2. E&O provisions
2. Level 3 Communications v. Federal Ins. Co.
   1. Precedent
   2. Expansion
3. U.S. Bank N.A. v. Indian Harbor Ins. Co.
   1. Impact on D&O exclusions
   2. Impact on E&O exclusions
4. Guidance in procurement

This panel will review these and other crucial issues:

• How can D&O and E&O policyholders address coverage for restitutionary payments?
• How have courts since Level 3 defined “disgorgement” for purposes of determining coverage?
• How can policyholders address coverage determinations for “ill-gotten gains” in the absence of clear state law provisions?