A February 13, 2013 decision from the U.S. District Court for the Southern District of Illinois clarifies the line between the uninsured business risks of a public entity, and true covered “loss” or “damages.”

Public entities issue fines, charge fees, set utility rates and levy taxes. When citizens challenge these activities and seek the return of money, the line between insured “loss” or “damages” and the uninsured business risk of the city can often be blurred. Recently, the U.S. District Court for the Southern District of Illinois clarified that the return of fines and fees charged by a city do not typically give rise to covered “damages.” This decision, OneBeacon Am. Ins. Co. v. City of Granite City, No. 12-CV-00156-DRH-DGW, 2013 WL 556533 (S.D. Ill. Feb. 13, 2013), as well as related cases, are discussed below.

In Granite City, a class action suit against the City complained that the City charged an unfair processing fee that auto owners were required to pay simply to appear at the City’s towing facility to pay the actual towing fee. The underlying lawsuit sought return of the City’s alleged wrongfully assessed fees. The City sought a defense against the suit from its liability insurer, One Beacon.

One Beacon filed a motion for summary judgment claiming that its insurance policy insures only against “damages,” not against restitution or restoration of monies wrongfully obtained by the insured. The Court looked to the leading precedent in Level 3 Communications, Inc. v. Fed. Ins. Co., 272 F.3d 908 (7th Cir. 2001) and Ryerson Inc. v. Fed. Ins. Co., 676 F.3d 610 (7th Cir. 2012), to conclude that the City’s potential liability to return the fees is not a “loss” or “damages” covered by the One Beacon policy. Therefore, the Court found that One Beacon did not have a duty to defend or indemnify the City.

The holding in Granite City, is consistent with the holdings of other courts which have considered whether the return of money wrongfully collected by a public entity constitutes “loss” for purpose of insurance coverage. These other jurisdictions have uniformly held that the repayment of funds wrongfully withheld by a public entity is not a “loss” for which the insured is entitled to insurance coverage. Town of Brookhaven v. CNA Ins. Cos., No. CV–86–3569, 1988 WL 23555 (E.D.N.Y. February 24, 1988); Cent. Dauphin School Dist. v. Am. Cas. Co., 426 A.2d 94 (Penn. 1981).

In Town of Brookhaven, three school districts sued the town alleging that the town violated the Suffolk County Tax Act in the manner in which it distributed taxes that were owed to the school districts. The school districts alleged that, although they ultimately received the full amount of taxes they were owed, the town distributed the amounts more slowly than it was required by statute, thus depriving the school districts of revenue. Brookhaven, 1988 WL 23555, at *1. The town sought coverage for these allegations under its Public Officials Liability Policy. The court held that such payments were not a “loss” under the policy stating, “[s]ince the town was never entitled to the use of those funds, disgorgement of them does not cause ‘injury or damage’ to the town within the meaning of the policy.” Brookhaven, at *3.

Similarly, Central Dauphin concerned the return by a school district of taxes it had improperly collected. The Supreme Court of Pennsylvania in Central Dauphin addressed both the concept of “loss” as well as the express reference in the policy’s “loss” definition to “matters . . . deemed uninsurable.” The court held that $529,000 in taxes which the school district was ordered to return to certain taxpayers as a result of an improper tax did not constitute a “loss” within the meaning of the school district’s insurance policy. Central Dauphin, 426 A.2d at 96. The court held that it would be against public policy to permit a taxing body to obtain insurance for the return or repayment of amounts to which it was not entitled.

While the prohibition against insurance coverage for restitution in the cases above arose in the context of public entities, the same analysis has been broadly applied outside the public entity context. For example, in Local 705 Int’l. Brotherhood of Teamsters Health & Welfare Fund v. Five Star Managers LLC, 735 N.E.2d 679, 684 (Ill. App. 2000), the Illinois Appellate Court was asked to determine whether the settlement of an underlying suit alleging improper transfer of $16.5 million from a pension fund to the insured Health & Welfare Fund (“H&W”) was covered under H&W’s insurance policy. H&W sought a defense from its insurer for the underlying suit and ultimately sought coverage for the $16.5 million settlement. The insurer denied coverage and declined to undertake H&W’s defense. The Illinois Appellate Court held that there was no coverage for the underlying suit. The Local 705 court specifically addressed the portion of the definition of “loss” which expressly stated that “loss” would not include “matters uninsurable under the law.” The Illinois Appellate Court held that, under Illinois law, H&W’s repayment of the $16.5 million “to which it was not legally entitled can well be included among such ‘matters uninsurable.’” Local 705, at 684.

For comments or questions on these cases, or other issues relating to public entity insurance coverage, please contact Adam H. Fleischer at AFleischer@BatesCarey.com or Joanna G. Swartout at JSwartout@BatesCarey.com