In an October 20, 2014 opinion (here), Middle District of Florida Judge Roy B. Dalton, Jr., applying Florida law, entered summary judgment for a D&O insurer, holding that the insurer was not liable for the stipulated judgment its insured had entered because the policy’s broad contractual liability exclusion precluded coverage for the underlying claims of negligence and misrepresentation that had been asserted against the insured.
Land Resources LLC (LRC) was a land development company that eventually went bankrupt. James Robert Ward was an executive of LRC. In connection with certain land development projects in Georgia, Tennessee and North Carolina, two bond companies issued subdivision bonds on behalf of LRC to guarantee the completion of the projects. As part of the bond issuance, Ward and LRC executed a General Agreement of Indemnity (GAI) under which they indemnified the bond companies for liabilities and costs the bond insurers incur in relation to the bonds.
LRC defaulted on the bonds and the bond issuers sued Ward alleging that he was liable for the bond issuers’ losses. The bond issuers alleged that Ward had caused LRC to default by negligent acts errors and omissions (the negligence claim) and had induced the bond issuers to issue to bonds by negligently failing to disclose LRC’s financial condition to the bond issuers (the misrepresentation claim). The bond issuers’ initial complaint also included a claim against Ward for indemnification under the GAI, but the bond issuers’ amended complaint omitted the indemnification claim.
Ward submitted the lawsuit to LRC’s D&O insurer. The D&O insurer denied coverage for the claim under the policy’s contractual liability exclusion. Ward entered into a settlement of the underlying lawsuit whereby he agreed to a stipulated judgment of $40 million and assigned his rights under the policy to the bond issuers. The bond issuers then sued the insurer seeking to recover the amount of the judgment. The D&O insurer moved for summary judgment, arguing that there was no coverage under its policy for the bond issuers’ claims against Ward.
Exclusion 4(h) of the policy provided that the insurer “shall not be liable to make any payment for Loss in connection with a Claim made against an Insured … alleging, arising out of, based upon or attributable to any actual or alleged contractual liability of the Company or any other insured under any express contract or agreement.”
The October 20 Opinion
In moving for summary judgment, the insurer argued that Exclusion 4(h) precluded coverage for the claims against Ward because the losses claimed in the underlying action arose out of Ward’s and LRC’s breaches of their contractual obligations under the GAI and the bonds. The bond issuers argued that the defendants’ arguments take construction of the Policy “to a tortured extreme, arguing that the mere utterance of the word ‘bond’ or ‘contract’ by Plaintiffs in this action sucks the claim in the protective ambit of the exclusion” and ignores the “legal legitimacy of Plaintiffs’ tort claim which stand independently of any contractual liability.”
Judge Dalton agreed with the insurer, saying that “this court finds that the phrase ‘arising out of’ as used in Exclusion 4(h) is unambiguously broad and preclude coverage for purported tort claims that depend on ‘the existence of actual or alleged contractual liability’ of an insured ‘under any express contract or agreement.’”
He added that the insurer had introduced evidence that the “purported negligent misrepresentation claim” in the underlying lawsuit “depended on (and was not merely incidental to) Ward’s and LRC’s contractual liability under the GAI, the Bonds and the various developmental agreements.” He also noted that the bond issuers conceded that their tort claim arose out of defaults on the Bonds, their losses arose from the contractual liability of Ward and that they would have suffered no losses had Ward performed his obligations. He also found that the bond issuers’ argument that “there never would have been any contracts” were it not for Ward’s negligent misrepresentations “finds no support in the cited deposition testimony and interrogatory responses.”
Although he did not need to reach the issue, he went on to rule that even if there were coverage under the policy, the insurer would be entitled to summary judgment because the settlement of the underlying lawsuit (which took the form of a so-called Coblentz agreement between the claimant and the insured and involved the insured’s assignment of policy rights) “was reached by collusion or an absence of effort to minimize liability.” He noted a “plethora of evidence indicating that enforcement of the Coblentz agreement in this case would be contrary to Florida law.”
In reaching this conclusion about the settlement agreement, Judge Dalton noted, among other things that Ward obtained benefits “beyond the mere conclusion of the Underlying Action”; that Ward had not “endeavored to minimize the amount of the judgment” (and noting that Ward had settled with two bond issuers for relatively nominal amounts); and that Ward had defenses to the underlying action.
I suspect that many readers will find the outcome of this case surprising, as claims of negligence and negligent misrepresentation are the very sorts of claims for which policies of this type are purchased. But as I noted in a prior post discussing an earlier decision in which another court held that the contractual liability exclusion precluded coverage for a negligent misrepresentation claim, the outcome of the coverage analysis is attributable to the sweeping breadth of the exclusion’s omnibus preamble. In the prior case as in this case, the courts held that coverage was precluded because of the breadth of the “based upon, arising out of” language.
The disconcerting thing about this application of the exclusion is that it implies that the exclusion could preclude coverage for any claim in which any sort of a transaction is involved. The trouble is that many of not most D&O claims involve some sort of a transaction that includes some sort of a contract or agreement or understanding. If the “based upon, arising out of language” sweeps as broadly as Judge Dalton’s opinion seems to imply, the exclusion potentially could block the coverage for which the policy was intended.
One remedy for the potential over-breadth of the exclusion would be to substitute the word “for” in lieu of the “based upon, arising out of language.” However, many carriers will insist on using the broad preamble for the contractual liability exclusion and will refuse the narrower “for” language. Given the extent of the preclusive effect that courts have found in interpreting contractual liability exclusions with broad omnibus preambles, policy forms using the narrower “for” wording are, in this respect, superior from the policyholder’s perspective, particularly if carriers whose policies have the broader wording try to apply the exclusion to preclude a broad range of types of claims.
As I suggested in my earlier post, I think the “for” wording is more consistent with the purposes for including a contractual liability exclusion in a D&O policy. An exclusion with the “for” wording makes it clear that insurers do not intent to pick up the insured company’s contractual liability, without extending the exclusion’s preclusive effect to a broad range of tort claims alleging different types of wrongful misconduct.
From my days as a coverage attorney on the insurance company side, I retain a basic dislike for the kind of settlement Ward entered with the bond insurers. These kind of deals always felt like an attempt to try to set up the insurer. Just the same, I found Judge Dalton’s conclusion that the settlement agreement here was collusive a little unexpected, and not just because he didn’t need to reach the issue. While I see his point about the $40 million amount of the stipulated judgment, the rest of his reasoning to me seems off the mark.
The insurance company had denied coverage, Ward had to look out for his own interests as best he could, no thanks to the insurer. What obligation did he have to try to negotiate a better deal for the benefit of the insurer? What possible expectation could the insurer have in that in reaching a settlement he should have to “minimize” the amount of the settlement or try to assert defenses he may have? Why shouldn’t he be able to extract as many benefits out of the settlement as he could? The amount of the settlement arguably may support a conclusion that the settlement was conclusive, but I am not as persuaded by the other grounds on which Judge Dalton relied support his conclusion that the settlement was collusive.
An earlier post in which I set out a broader overview of the contractual liability exclusion can be found here.