## Facts

- Federal Insurance issued Level 3 a directors’ and officers’ (D&O) liability policy providing coverage for directors and officers and reimbursement coverage to Level 3 when it indemnified them.
- Level 3 acquired another corporation by purchasing shares from existing shareholders.
- Those shareholders later sued Level 3 for securities fraud, alleging they sold their shares because of Level 3’s fraudulent misrepresentations.
- The securities-fraud action settled for $11.8 million; on remand the district court found $1.8 million was attributable to Pompliano (a former director of a Level 3 subsidiary and an insured) and $10 million to the remaining plaintiffs.
- After Federal refused to indemnify the settlement, Level 3 sued in federal court under diversity jurisdiction.
- In an earlier appeal, the court held the insured-versus-insured exclusion did not bar the entire claim; Pompliano’s portion could be excluded while leaving the remainder potentially covered.
- On remand, the district court held the settlement (minus Pompliano’s share) was a covered “loss” and entered judgment that Federal owed Level 3 $10 million.
- Federal appealed, contending the settlement was restitutionary (return of value wrongfully obtained) and therefore not a covered “loss.”

## Issues

1. Whether a securities-fraud settlement payment constitutes a covered “loss” under a D&O policy when the underlying claim seeks disgorgement or restitution of value allegedly obtained by fraud.
2. Whether inclusion of “settlements” in the policy’s definition of “loss” requires coverage for a settlement that functions as restoration of an ill-gotten gain.

## Decision

- The Seventh Circuit reversed the judgment for Level 3.
- The court held that a “loss” under the policy does not include amounts paid to restore money or value improperly acquired by the insured.
- Because the underlying action sought restitutionary relief—forcing Level 3 to give up the benefit of allegedly fraudulently acquired shares—the settlement amount was not covered, and Federal had no duty to indemnify.

## Legal Principles

- Insurance coverage for “loss” generally excludes payments that amount to disgorgement or restitution of ill-gotten gains, even if made via settlement.
- A payment can be an out-of-pocket expenditure yet not an insurable loss if it represents surrender of a benefit the insured was not entitled to retain.
- Contract language defining “loss” to include “settlements” does not compel coverage for settlement payments that function as restitution rather than compensatory damages.
- Public policy disfavors permitting insurance to shift the cost of returning wrongful gains, because such coverage would reduce deterrence of fraud.

## Conclusion

The Seventh Circuit held that Level 3’s securities-fraud settlement was restitutionary in substance and therefore not a covered “loss” under the D&O policy, reversing the district court’s award and relieving Federal of any indemnity obligation for the settlement payment.


Level 3 Commc’ns, Inc. v. Fed. Ins. Co., 272 F.3d 908 (7th Cir. 2001)