One of the seminal no “loss” cases is Level 3 Communications, Inc. v. Federal Ins. Co., 272 F.3d 908 (7th Cir. 2001), penned by the esteemed jurist Judge Richard Posner. This past month, Judge Posner, writing for the Seventh Circuit, issued another no “loss” decision, finding in favor of the insurer. Ryerson Inc. v. Federal Ins. Co., --- F.3d ----, 2012 WL 1216282 (7th Cir. Apr. 12, 2012) (Illinois law).

In Ryerson, the insured sold a group of subsidiaries to EMC for $29 million. The following year, EMC sued the insured, seeking rescission of the sale and restitution of the purchase price. The ground was that Ryerson had concealed an impending development affecting one of the insured’s subsidiaries, i.e., the subsidiary's largest customer had declared that, unless it slashed its 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 the insured. When EMC failed to accede to the demand, the customer, as it had threatened to do, took its business elsewhere. EMC's suit charged the insured with fraudulent concealment intended to induce EMC to buy the subsidiary, breach of contract, and breach of warranty.

EMC and the insured ultimately settled their dispute, with the insured agreeing to make a “post-closing price adjustment” of $8.5 million “reflecting a change in the purchase price paid by EMC to [the insured] for the purchase” of the subsidiary that had gotten into trouble with its customer. According to Judge Posner, “the settlement thus gave EMC a partial refund of the price it had paid for the subsidiaries.”

The insured sought coverage for the $8.5 million settlement and defense costs under an Executive Protection Policy. The insurer denied the claim on the ground that EMC's claim against the insured was not a covered risk.

The policy at issue covered “all LOSS for which [the insured] becomes legally obligated to pay on account of any CLAIM ... for a WRONGFUL Act ... allegedly committed by” the insured. The insurer denied that “loss” included restitution paid by an insured, as distinct from damages, which were expressly denoted in the policy as covered “loss.”

Judge Posner sided with the insurer, holding that EMC was seeking to recover a profit made at its expense by the insured’s fraud, which meant that, if the insurer were liable to the insured, the insured would get to keep profits of fraud. According to Judge Posner, having to surrender those profits was not a “loss” to the insured within the meaning of the insurance policy.

This decision also contains two “sub-holdings” worth mentioning:

First, while noting that EMC restyled its claim against the insured as one for “damages” after it sold the subsidiary, thereby mooting its claim to unwind the purchase, Judge Posner opined, “the label isn't important.”

Second, Judge Posner observed that a judgment or settlement in a fraud case could involve a combination of restitution and damages, in which case the insurer would be liable for the damages portion in accordance with the allocation provision in the policy. Judge Posner noted that, in the case at bar, EMC's complaint against the insured demanded “restitution of the monies paid for [the subsidiary] ... including transaction costs.” (Emphasis added.) Judge Posner stated that reimbursing EMC's transaction costs would not have been restitution because the insured would have gained nothing from the money that EMC paid its lawyers and accountants to handle the acquisition. However, Judge Posner found that the insured “made no effort to allocate its loss between the loss of ill-gotten gains and other costs, so any claim to those costs has been forfeited.”

If you would like to discuss further this decision or would like a copy of the court’s opinion, please contact Ommid C. Farashahi ofarashahi@batescarey.com.