The court in Flagship Credit Corp. v. Indian Harbor Ins. Co., No. 11-20408, 2012 WL 2299484 (5th Cir. June 15, 2012), held that statutory minimum damages for violations of the Texas Business and Commerce Code were not “penalties” and, therefore, constituted covered “loss” under a professional liability policy issued to an automobile financing company because the damages were paid to a consumer class rather than to the government.

The plaintiff-debtors in the underlying consumer fraud class action in Flagship alleged that the insured had “substantively and procedurally” failed to provide statutorily-mandated notice regarding the disposition of their collateral pursuant to the Texas Business and Commerce Code.  The plaintiffs sought damages pursuant to a section of the Code that entitles a debtor to recover actual damages (e.g. loss resulting from the debtor’s inability to obtain, or increased costs of, alternative financing) resulting from a proven statutory violation, but also specifies that if the actual damages do not exceed a minimum amount of damages based on a formula contained in the statute, the debtor is entitled to recover the statutory minimum amount of damages.

Indian Harbor denied coverage for the settlement of the class action, contending that statutory damages constitute a “penalty” and, therefore, do not constitute “loss” under the policy, which defines “loss” to exclude “fines, penalties or taxes imposed by law.”  The trial court agreed with Indian Harbor and held that Indian Harbor was not obligated to provide coverage for the settlement.

The Fifth Circuit reversed, holding that the insured’s settlement payment was not a penalty because it was paid to the class rather than to the government.  In so ruling, the court applied the canon of policy interpretation known as noscitur a sociis, which specifies that when a word found within a group of words has is ambiguous or has multiple meanings, it should be construed such that its meaning is consistent with the meaning of its companion words in the group.  Because the term “penalties” was grouped with the words “fines” and “taxes,” both of which are paid only to the government, the court held that “penalties” similarly only includes payments to the government.