District Court Finds No “Loss” Under D&O Policy When Insured Had Pre-Existing Duty to Pay For Tips in Dispute in Underlying Lawsuit


    In The Kittansett Club v. Philadelphia Indemnity Ins. Co., No. 11-11385 (Sept. 10, 2012), the District of Massachusetts ruled that a D&O insurer does not owe defense or indemnity to its insured when the insured had a duty prior to committing the alleged Wrongful Act to pay the amounts at issue.  The insured, The Kittansett Club, a golf club, was sued by its servers and bartenders for failing to distribute the full proceeds of gratuities owed to the servers under Massachusetts law.  The servers and the Club eventually settled the suit.

    In the meantime, the Club brought an action against Philadelphia seeking a declaration of coverage.  Philadelphia had issued a Policy to the Club containing D&O and Employment Practice Liability insurance.  The Policy covered “Loss from Claims made against [the Insureds] for D&O Wrongful Acts,” which included “any actual or alleged act, error, omission, misstatement, misleading statement, neglect, breach of duty…committed…by an Individual Insured; or by the Organization.”  The Court held that the Club’s failure to pay tips constituted a D&O Wrongful Act within the plain and ordinary meaning of the Policy.

    However the term “Loss” was defined in the Policy as “Damages” and “Defense Costs,” but not “criminal civil fines or penalties imposed by law.”  “Damages” in turn was defined as “a monetary judgment, award or settlement including punitive, exemplary or multiple portion thereof.”  Following Republic Franklin Ins. Co. v. Albemarle County School Board, 670 F.3d 563 (4th Cir. 2012), the Court concluded that “the resulting obligation to pay back wages may not be a loss arising from that wrongful act because the obligation to pay arose from the statute and predated the wrongful act.”  In other words, a judgment ordering an insured to pay money it was already obligated to pay, either by contract or statute, is not a covered “Loss” under this Policy.

    The Court allowed that attorney’s fees may have been included in the settlement of the underlying action, and because they are compensatory and not restitutionary, they may be included in the definition of Loss.  However, both attorneys’ fees were excluded by the “Earned Wages” Exclusion in the Policy, which excluded coverage for “any Claim related to, arising out of, based upon, or attributable to the refusal, failure or inability of any Insured(s) to pay Earned Wages.”  This exclusion also operated to preclude coverage under the Employment Practices Act section of the Policy.

    The Kittansett Club joins a series of cases from scattered jurisdictions (including Republic Franklin from the Fourth Circuit and Pacific Ins. Co. v. Eaton Vance Management, 369 F.3d 584 (1st Cir. 2004) from the First) that hold that when an insured is only being forced to return that which it never had a legal right to either receive or retain, insurance is not available.  Insurers should remember to look to the definition of “Loss” in their policies, as well as case law in the relevant jurisdiction on the insurability of restitution, when handling such a claim.

    The order from the District of Massachusetts can be found here.

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