A recent Delaware Superior Court decision in Clear Channel Outdoor Holdings, Inc. v. Illinois National Insurance Co. adds another feather to the state's pro-policyholder cap. The court held that a payment to the U.S. Securities and Exchange Commission (SEC) labeled as "disgorgement" was nevertheless a covered loss under a directors' and officers' (D&O) liability policy because disgorgement was an equitable remedy, not a civil penalty excluded under the D&O policy's carve-out from the definition of loss.
The Clear Channel court looked not just to Delaware law but also to federal regulation and recent U.S. Supreme Court rulings to interpret the plain meaning of the parties' unambiguous policy exclusion. Delaware's well-developed law on policy interpretation, compared with other states', has led to several policyholder decisions in recent years.
Here, though, the Delaware court's finding that disgorgement was not an excluded civil penalty referred to Supreme Court disgorgement decisions, including the 2020 decision in Liu v. Securities and Exchange Commission. Clear Channel suggests that Delaware courts are willing to consider context-such as Supreme Court interpretation of a federal regulatory scheme as shown in this case-to interpret the plain and ordinary meaning of unambiguous policy language.
This article first reviews U.S. Supreme Court precedent on disgorgement. It then discusses Clear Channel and how the Delaware court's endorsement of insurability under Liu reflects the Supreme Court's law of the land on disgorgement. That is because Liu remains good law after the Court's recent June 4 decision in Sripetch v. Securities and Exchange Commission, which declined to answer the question of whether the SEC's failure to prove actual pecuniary harm to investors reframed disgorgement as a penalty rather than an equitable remedy.
The U.S. Supreme Court's Views on Disgorgement Have Been Evolving
Liu defines disgorgement as equitable relief, not a penalty. The Supreme Court in Liu held that disgorgement is an equitable remedy.
In that case, business operators obtained over $20 million from investors to construct a proton cancer treatment center, but a subsequent SEC investigation revealed they had misappropriated the investors' funds. The SEC filed official charges in the Central District of California, seeking, among other things, disgorgement equal to the full amount received from the investors, and the district court ruled in favor of the SEC. The district court permanently enjoined the business operators, issued a disgorgement award for full repayment of investor payments, and imposed an $8.2 million civil penalty. The business operators appealed to the Ninth Circuit, including in their arguments the question of whether courts can order disgorgement in SEC enforcement proceedings. Liu clarified a question left open three years earlier in Kokesh v. Securities and Exchange Commission.
In Kokesh, the Supreme Court determined that disgorgement was a penalty for purposes of instituting a statute of limitations. But without further challenge, Kokesh arguably stripped federal courts of authority to award any remedy to the SEC-because the applicable statutes allowed only for equitable relief, and Kokesh did not hold definitively that the SEC could seek disgorgement as an equitable remedy. In an 8-to-1 decision, the Supreme Court in Liu clarified that the SEC still has the authority to seek disgorgement, albeit in a limited fashion, because it is a form of equitable relief separate and apart from a type of punitive penalty under the SEC regulatory scheme.
By recasting disgorgement as an equitable remedy, Liu reconceptualized disgorgement as restitution, not a penalty, so long as strict limits were followed. Among these limits are that relief is limited to net profits, could not be imposed in joint and several situations where certain partners did not profit, and is intended to compensate victims.
Liu's treatment of disgorgement as an equitable remedy is good law after Sripetch, as the Supreme Court declined to rule on whether a failure to prove actual harm makes disgorgement a penalty. Most recently, in Sripetch, parties challenged Liu's limitation that disgorgement as an equitable remedy must be intended to compensate victims. In Sripetch, the SEC brought an enforcement action against the developer of multiple penny-stock companies involved in schemes to inflate stock prices and sell shares to unsuspecting investors. The SEC sought $4.1 million in disgorgement. The appellants in Sripetch argued that the SEC must prove actual harm to investors to avail itself of a 15 U.S.C. § 78u(d)(7) disgorgement award. If not, the appellants posited, the recovery acted as a penalty, not an equitable remedy, because it is the proof of harm that establishes restitution to return a proceed to a party with a superior right to it.
In a 9-0 decision, the Supreme Court affirmed, holding that the SEC can seek disgorgement without proving actual harm. In doing so, it upheld Liu's holding that disgorgement remains an equitable remedy. The Supreme Court rejected the assertion that a failure to prove pecuniary harm treated disgorgement as a penalty to the wrongdoer. Instead, the Sripetch Court held that if the SEC did so, it raises questions about section 78u(d)(7)'s deviation from equitable principles. However, the Supreme Court found that the question was not before the Court and had no bearing on the fact that the SEC need not prove pecuniary harm to investors to avail itself of an equitable disgorgement award as demanded in Liu.
Clear Channel Supports Treatment of Disgorgement as a Covered Loss
Delaware law, as clarified in Clear Channel, echoes the Supreme Court's view, in Liu and now Sripetch, that disgorgement is a securities remedy distinguishable from a civil penalty.
This is significant for D&O policyholders who face present or potential SEC investigations, enforcement actions, or similar claims raising disgorgement remedies because Delaware's position supports defense and indemnity coverage for such losses. More broadly, Clear Channel reinforces that Delaware is in the minority of states willing to consider context and surrounding circumstances in a plain and ordinary meaning interpretation of unambiguous policy language such as to evaluate a penalty exclusion.
While a willingness to consider context was helpful to the policyholder in Clear Channel, time will tell whether considering surrounding circumstances is always as advantageous. For instance, if a policyholder in a D&O dispute argues for the application of a dictionary meaning, a court such as in Delaware may side with the insurer's argument that additional context should be injected to determine the word's meaning.
Below we discuss the SEC investigation leading to Clear Channel and analyze the court's ruling on how disgorgement was considered a covered loss under the policy.
SEC investigation and settlement. Mass media and communication company Clear Channel learned that an employee and other individuals at its Chinese subsidiary had misappropriated funds. Clear Channel disclosed the misappropriation to the SEC two months later. This prompted the SEC's investigation into the alleged misappropriation, which lasted for several years. The SEC ultimately issued a cease-and-desist order, which sought disgorgement and civil penalties as two separate monetary remedies.
The parties settled in 2022. Clear Channel agreed to pay approximately $16.35 million in disgorgement of profits and a $6 million civil monetary penalty.
Coverage dispute with AIG. Illinois National Insurance Company (AIG) issued a D&O policy to nonparty iHeartMedia, Inc., which controlled Clear Channel.
The policy covered "Loss of any Organization...arising from any Securities Claim made against any such Organization for any Wrongful Act of such Organization." The policy defined "Loss" to include "settlements" and to "specifically include...punitive, exemplary and multiple damages." However, the definition of "Loss" had several carve-outs, including for "civil or criminal fines or penalties imposed by law" and matters "deemed uninsurable" by "the law pursuant to which this policy shall be construed."
AIG denied coverage on the basis that the disgorgement and prejudgment interest payments to the SEC were both excluded penalties and uninsurable under Delaware law. Clear Channel filed suit disputing that denial. In the parties' cross-motions for summary judgment, Clear Channel asserted that the settlement, including any disgorgement payment, was a covered loss, and AIG argued that disgorgement was an excluded penalty.
Clear Channel Considered Context in Applying the Plain Meaning Rule
The Delaware Superior Court ruled in favor of Clear Channel and disagreed with AIG's denial of coverage, holding that Clear Channel's disgorgement was a covered loss under the policy. In doing so, the court placed disgorgement remedies in a separate category from civil penalties, just as the U.S. Supreme Court had done in Liu.
The court looked expressly to the "securities regulation context" to interpret the plain meaning of AIG's unambiguous civil penalties exclusion. First, the court found that AIG's insuring grant-covering "Loss for a Securities Claim," defined in the policy to mean an enforcement or regulatory proceeding brought by the SEC-covered the disgorgement loss.
It then turned to the civil penalty exclusion. The court found that the words in the penalty exclusion "mirror those in securities law statutes concerning civil monetary penalties, and not those concerning disgorgement." The court noted that SEC regulation "separately delineates" penalties from equitable relief and disgorgement. Because the AIG policy's penalty exclusion did not reference disgorgement, its most natural reading was that it concerned what the securities laws call a "civil penalty" and not another remedy not referenced in the exclusion.
Clear Channel's reference to the outside context of securities regulation is a departure from most jurisdictions, which look to the policy text as written or, at most, a dictionary meaning to interpret an unambiguous provision's "plain meaning." In fact, the court rejected AIG's dictionary definition, reasoning that because the provision excluded civil penalties "imposed by law" (i.e., securities law), the SEC's regulatory scheme must be considered to glean plain meaning.
AlG's exclusion, the court found, was drafted to mirror the securities statute authorizing the SEC to seek civil penalties, which was not the same as the separate provision authorizing the SEC's authority to seek disgorgement. The court found that the "securities regulation context" provides "the most natural reading" of the AIG penalties exclusion in that it "concerns the remedy the securities laws call a 'civil penalty,' not the other remedy that the exclusion does not reference." As a result, AIG's policy covered the insured's disgorgement payment from its SEC settlement because the policy covered "loss" arising from a "securities claim."
Finally, the court turned to Liu to support the principle that the SEC has two different remedies available to it by statute-on the one hand, disgorgement was an equitable remedy under 15 U.S.C. § 78u(d)(5), (7), and on the other hand, the SEC could also seek civil penalties under section 78u(d)(3).
Liu's holding that disgorgement and punitive penalties are separate underscored the explanation in Clear Channel that disgorgement did not fall under Al G's civil penalties exclusion and was a covered loss.
Delaware's "Context" Approach to Plain Meaning Can be Advantageous but Fluid
The contextual approach to the plain meaning rule is broadly comprehensive, taking into consideration "all of the circumstances surrounding the drafting, negotiation, and performance of the insurance policy."
Delaware's willingness to consider context in interpreting unambiguous policy provisions-while generally good for policyholders as it was in Clear Channel-may not always be beneficial. For instance, had the Supreme Court in Sripetch taken the opposite view that a failure to prove actual harm redefined disgorgement as a penalty, this "context" could have complicated how Delaware courts distinguish between disgorgement remedies and penalties.
Accordingly, it is imperative that companies and their in-house legal and risk management teams consider the applicable law enacted before the parties contracted. At least where Delaware law governs policies issued to Delaware corporations, as the Delaware Supreme Court has suggested, it is worthwhile to determine whether the broader "context" against which a policy provision may be analyzed-like the SEC's regulatory framework to a penalty exclusion-is advantageous. But if other governing law may control and that state's law takes a narrower view of plain-language interpretation, then policyholders and insurers alike may be more restricted in what extrinsic evidence is relevant to the analysis. And, of course, contract interpretation may be affected by express provisions governing choice of law or venue, or if the "context" shifts in courts, the legislature, or state or federal agencies.
Strong Policy Language Remains lnperative
All of this leads to the question of what the intersection of state-law policy interpretation and federal courts' treatment of federal regulation means for policyholders seeking cover for SEC disgorgement payments under Delaware law. The short explanation? The policy contract still controls.
Policyholders should demand precise policy language from insurers when insurance is procured and renewed and, if needed, request changes to clarify or improve terms. Here, it could mean negotiating "disgorgement" out of any carve-outs from the definition of "loss." If a term or phrase is unclear, insureds can ask insurers to clarify the term or phrase and ask what is excluded from its application to the policyholders' situations. This is best done in the underwriting phase, but amendatory endorsements can also be made after the policy is written. And if a provision suggests reference to applicable law, which is what caused the court to consider securities law in Clear Channel to interpret meaning, policyholders should be keenly aware of the law to which a provision refers and how courts in the jurisdiction governing a policy's interpretation fall on that issue.
As always, timing is critical. Policyholders should seek to work with their attorneys, brokers, and other risk professionals proactively to secure appropriate coverage when policies are being negotiated or coming up for renewal. Proactive measures are paramount to helping mitigate the risk of a surprise denial by an insurer.
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