Insurers sometimes maintain that a loss is not covered because, well, it’s not covered. In other words, their position is that the loss is not covered because it is not a scenario that the policy was intended to cover. It is somewhat of a “we know a covered claim when we see one, and this one isn’t” situation.

But courts set out to resolve coverage questions by, first and foremost, interpreting the words of the insurance policy. [Whether they followed through with that promise is likely tied to whether you agree with the outcome.] Based on this, the policyholder’s response is likely “we also know a covered claim when we see one, and this one is because the policy language says so.”

While policy language is of course king, there are some fundamental principles that dictate insurance coverage that are not always based on the policy language. One of these is that an insured cannot obtain insurance coverage for having to return something that it was never entitled to keep in the first place. This issue arises frequently. But if there is no specific policy language to point to that says so, which is often the case, it can sometimes be more difficult to convince policyholders that no coverage is owed for this reason.

Despite a sometimes absence of specific policy language on this point, insurers have generally done well convincing courts of the soundness of this argument on account of it being a general principle of insurance law. While the insurer in Beaumont Hospital v. Federal Insurance Company, No. 13-1468 (6th Cir. Jan. 16, 2014) did not succeed in making this argument, its overall soundness is demonstrated by the court’s need to split hairs to reach its decision. Granted, the issue in Beaumont Hospital arose in the context of policy language – the definition of “loss” did not include “disgorgement.” Nonetheless the case has relevance to those situations where the issue is one of a fundamental principle.

At issue in Beaumont Hospital was a class action suit, brought by two registered nurses, neither of whom Beaumont employed, against eight Detroit-area hospital systems including Beaumont. The nurses claimed that the hospitals had violated certain antitrust laws by conspiring to depress wages of the nurses and exchanging information regarding the compensation of nurses, which had the effect of depressing their wages. In total, the nurses sought approximately $1.8 billion in damages.

To make a long story short, Beaumont settled and Federal Insurance paid approximately $9 million. However, Federal argued that the settlement constituted disgorgement and was not considered a Loss under the policy and thus was uninsurable. Federal made the payment under a reservation of rights and a coverage action would determine if coverage was in fact owed.

The policy at issue expressly provided coverage for antitrust claims. However, that does not affect the case’s relevance to other, more traditional, liability coverages.

Federal’s argument, that no coverage was owed, was exactly what you have expected to see: “[T]he nurses’ claims arose from Beaumont’s gaining of profit, remuneration, or advantage to which it was not entitled and the settlement was a disgorgement of that advantage. Federal argues that the advantage gained was nursing services at below-market compensation and that settlement is clearly disgorgement of the value of that advantage. Consequently, according to Federal, under the Policy, which expressly declines coverage of amounts constituting disgorgement, there is no coverage for what Beaumont’s nurses receive from the Underlying Lawsuit.”

This is the classic, and usually accepted, argument that an insured cannot obtain insurance coverage for having to return something that it was never entitled to keep in the first place. But the Beaumont Hospital court did not do so.

Federal relied on several cases, including, heavily, Level 3 Communications v. Federal Insurance, the Seventh Circuit’s 2001 opinion, authored by Judge Posner, that is the grand daddy case on this issue. The Level 3 court held that, when relief labeled as damages was “restitutionary in character,” it is uninsurable.

Beaumont argued that “money unlawfully retained is not the same in its legal character as money wrongfully acquired. Moreover, money paid to resolve a legal dispute is not necessarily a return of something to which the payor was not legally entitled in the first place.” (emphasis in original).

The court looked at definitions of disgorgement and damages and held that “the hospital never gained possession of (or obtained or acquired) the nurses’ wages illicitly, unlawfully, or unjustly. Rather, according to the nurses’ complaint, Beaumont retained the due, but unpaid, wages unlawfully. This is not mere semantics. Retaining or withholding differs from obtaining or acquiring. The hospital could not have taken money from the nurses because it was never in their hands in the first place. While the hospital’s alleged actions are still illicit, there is no way for the hospital to give up its ill-gotten gains if they were never obtained from the nurses. Therefore, the damages Beaumont paid in settlement of the claim does not constitute disgorgement.” (emphasis in original). The court was also influenced by the fact that the exclusion stated that only disgorgement was not a covered loss. However, because the policy used the term restitution elsewhere, Federal should have been aware of the difference between the two terms.

The court distinguished Level 3 and its progeny on the basis that such cases “all involve wrongfully acquiring something—such as stealing from pension funds, securities fraud, or unlawfully levied taxes. (citations omitted). Thus, the actors in these cases were subject to disgorgement because they retained funds unlawfully.”

Thus, the court held that the settlement did not constitute disgorgement under the policy and was therefore covered.

The court also rejected the argument that Michigan public policy precluded coverage -- no one should benefit from his own wrongdoing. Federal contended that if it had to insure Beaumont, the hospital will profit from its own wrongdoing and transfer the cost of returning money wrongfully withheld to the insurer. Federal further argued that providing coverage for the settlement would encourage moral hazards because it would incentivize wrongful behavior.

Rejecting the moral hazard argument, the court saw it this way: “Here, in addition to the damage to the reputation of Beaumont, the hospital also faced up to $1.8 billion in damages. The Policy limit for anti-trust claims is $25 million—far less than the threatened $1.8 billion which the plaintiffs sought jointly and severally from Beaumont. No insured is likely to bet on a gain of $25 million against a loss of $1.8 billion.”

The court got this decision wrong. There is no other way to say it. Call it what you want, but the settlement was for the hospital’s payment of wages for nursing services for which it benefitted. The correct payment of the nurses wages was simply delayed on account of their need to prove that the hospital short-changed them. In the end, Federal was forced make some of the hospital’s payroll.