Not So Powerful: When a Compensatory Damages Award Becomes an Excluded Disgorgement

Insurance Law

Insurance coverage often turns on strange questions. The Eleventh Circuit’s decision this summer in AEGIS Electric & Gas International Services Limited v. ECI Management LLC, 967 F.3d 1216 (11th Cir. 2020), is one of those cases.

In that case, the strange question was if a “deposit” is fungible: Is it, as one judge suggested, a discrete thing, like a pair of sunglasses, that exists and is known, or is it the component amount that can be “returned” if the same amount is provided, even if the thing making up the amount returned is not the same as what was provided? To one circuit judge, a deposit is a pair of sunglasses, loaned out. If that exact pair of sunglasses is not returned, and instead an identical pair is provided, the sunglasses have not been returned; so too, if the amount of money comprising the deposit is provided but not the exact deposit itself, then the deposit cannot be said to have been returned. To two other circuit judges, however, the deposit is money, so that if the same amount is provided, the deposit has been returned.

The nature of a deposit mattered to these judges, and the litigants, because insurance coverage turned on it: If the deposit could be “returned” under Georgia’s security deposit law, Ga. Code § 44-7-30 et seq., then the amount that could be returned was excluded from coverage.

The Eleventh Circuit’s analysis may have broader implications.

AEGIS arises out of a common story that security deposit laws were enacted to prevent: Tenant leases apartment, landlord demands security deposit, tenant provides it, landlord doesn’t return it. Because Georgia has a security deposit law, one tenant brought a putative class action seeking to write a new ending to the story. Under Georgia’s law, landlords must provide tenants with a post-termination inspection and an itemized list of damage to the property. If not, the landlord forfeits the right to withhold any of the security deposit and is liable to the tenant for the amount withheld; or three times that, plus attorney’s fees, if the landlord cannot prove its error was unintentional and the result of a bona fide mistake. (The attorney’s fees are covered under the policy, according to the court, and the insurer was obligated to defend as a result.)

Facing that potential liability in a putative class action, the landlord demanded a defense and indemnity under its professional liability insurance policy, which excludes coverage for “disgorgement, return, withdrawal, restitution or reductions of sums” and “punitive, exemplary, treble damages or any other damages resulting from the multiplication of compensatory damages.” So the insurer denied coverage, and the landlord sued, and the case reached the Eleventh Circuit.

In a 2-1 decision, the court decided that there is no coverage for the primary claim for the allegedly wrongfully withheld security deposit funds.

To the court, the issue is a simple three-step analysis under Georgia’s security deposit law: Security deposits must be held in escrow (demonstrating they remain the tenant’s property); a landlord that does not provide the final damages list forfeits its right to keep the deposit; and any suit under the law therefore could result in the return of the property, triggering the coverage exemption. But wait, says the dissenting judge: The law does not call for the return of the security deposit. Instead, it makes a landlord “liable to the tenant in the amount of” the not-yet-returned deposit when the money is withheld by mistake. Thus, because the law speaks of “amounts,” if the landlord’s conduct is unintentional or a mistake, the coverage exclusion for disgorgement or return of funds does not apply. The award the tenant would receive is an ordinary damages award—a remedy not excluded by the coverage exclusion—because the tenant is a judgment creditor who can recover out of the assets and not just the escrow: “This wording represents a conscious choice by the state legislature to expand the tenant’s remedy.” (Left unsaid is the possibility that the funds were never escrowed and thus can’t be returned.) By footnote, the majority opinion asserts the ipse dixit view that compensatory damages are set as the “sum erroneously withheld,” “underscor[ing]” that it is a return not covered by the policy, even though (as the dissenting judge points out) coverage exclusions are to be construed narrowly and the award or judgment will be for damages, not a remedy of return or disgorgement.

Consequently, reading the majority and dissenting opinions together suggests viewing exclusions through their underlying economic reality and not the words used to describe judgments and awards. The court is undoubtedly correct that the purpose of the law is to secure for tenants the return of their deposit, and the legislature chose to do that through a damages award set as that amount and not through a restitutionary or disgorgement judgment. An aggrieved tenant, after all, is unlikely to care if the amount at issue is repaid in exactly the same form. A dollar is a dollar, no matter the form in which it is sent.

In evaluating coverage, claims should be viewed for their economic reality: Is the goal of the claim to recover some amount lost by the plaintiff because of the defendant-insured’s alleged wrongful conduct? If so, the economic remedy is a return or disgorgement, even if that legal remedy is not available, and could include paying a premium for front row seats at a concert, even though those seats were obstructed view, or buying a sweater at an outlet with a “compare at” price tag, even though the sweater never sold at that price, or anything else that could be framed as a return of a price premium paid. In short, if the insurer can demonstrate that an award to the plaintiff is or must be tied to an amount that the plaintiff initially paid to the defendant-insured, AEGIS provides a sound basis to question coverage.

Manatt’s broad-based insurance practice, led by Christopher A. Lisy, has decades of experience representing all types of insurance industry participants, including life, annuity, and disability, property and casualty, health, long-term care, and reinsurance lines. Our team includes members of Manatt’s litigation, corporate, health, government and regulatory, and privacy and data security practices, and we cover a wide range of issues faced by the industry, including complex disputes and arbitrations, regulatory guidance and advocacy, advice and counseling on transactions, product development, and governance. Please reach out to us to learn more about how we might be able to assist your company.



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