In an unpublished October 5, 2015 opinion (here), the Eleventh Circuit, applying Florida law, held that a D&O insurance policy’s contractual liability exclusion precluded coverage for negligence claims asserted against persons insured under the policy. The contract exclusion was written with a broad “based upon, arising out of” preamble wording. As discussed below, the decision highlights concerns about the use of the broad preamble in D&O insurance policies’ contractual liability exclusion. An October 28, 2015 post on the Wiley Rein law firm’s Executive Summary Blog about the Eleventh Circuit’s ruling can be found here.
Land Resource LLC (LRC) built residential subdivisions in the southern U.S. Robert Ward was LRC’s CEO. The municipalities in which LRC built the subdivisions required LRC to obtain surety bonds to guarantee performance. Beginning in 2003, Bond-Lexon issued subdivision bonds to LRC. In connection with the issuance of the bonds, Ward and LRC executed a General Agreement of Indemnity (GAI), in which LRC and Ward indemnified Bond-Lexon from claims, demands, liabilities that the surety company might incur as a result of having executed the bonds.
In Summer of 2008, LRC stopped making progress on the subdivision construction. The municipalities sent Bond-Lexon notices of default. Bond-Lexon paid to settle the municipalities’ claims on the bonds. In October 2008, LRC filed for bankruptcy.
In 2011, Bond-Lexon filed a two-count federal court complaint against Ward and other directors and officers of LRC, alleging (1) a breach of the contractual duty to indemnify under the GAI; and (2) negligence by Ward and other individual defendants. Ward submitted the lawsuit as a claim to LRC’s D&O insurer. The insurer denied coverage for the claim in reliance on the insurance policy’s contractual liability provision. Following the insurer’s denial, Bond-Lexon and Ward negotiated a settlement of the federal court lawsuit in which Ward assigned all of his rights under the D&O insurance policy to Bond-Lexon and Ward agreed to the entry of a consent judgement against him.
Bond-Lexon amended its complaint so as to delete the contractual liability claim, and asserting only a negligence claim. The negligence claim asserted that Ward was negligent in managing the subdivision improvements. The claim also asserted that Ward negligently failed to disclose to Bond-Lexon LRC’s financial condition, including its cash flow problems beginning in 2005.
Bond-Lexon submitted the amended complaint to the D&O insurer, which denied coverage for the amended complaint in reliance on the contractual liability exclusion. The district court then entered a stipulated judgment for Bond-Lexon against Ward in the amount of approximately $40.4 million. Bond-Lexon then filed an action in Florida state court against the D&O insurer seeking a judicial declaration that the insurer was liable to Bond-Lexon for the amount of the judgment. The insurer removed the action to federal court and moved for summary judgment. The district court granted the insurer’s motion for summary judgment and Bond-Lexon appealed.
The policy’s contractual liability exclusion, Exclusion 4(h), provides 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 5 Opinion
On October 5, 2015, in an unpublished per curiam opinion, the Eleventh Circuit, applying Florida law, affirmed the District Court, holding that the D&O insurance policy’s contractual liability exclusion precluded coverage for Bond-Lexon’s claim.
Bond-Lexon had argued on appeal that its negligence claims against Ward, in particular its negligent misrepresentation and inducement claims, sounded in tort and not contract, and also that these tort claims necessarily predated the bonds, rather than any subsequent contractual liability of Ward or LRC. The Eleventh Circuit disagreed. Among other things, the appellate court noted that the amended complaint expressly alleged that Ward’s negligent supervision of the subdivision improvements caused LRC to default on it contractual obligations to the municipalities, which, the Eleventh Circuit said belies Bond-Lexon’s assertion that its claims rest solely on the Ward’s negligent misrepresentations prior to the issuance of the bonds.
In any event, the appellate court said, Bond-Lexon’s assertion of a claim sounding in tort “does not alter the fact that all of the asserted losses arise from Ward’s and LRC’s contractual breaches of the development contracts and the GAI.” The “plain language” of the contractual liability exclusion, the appellate court said, “does not limit its applicability to loss in connection with only contract claims.” Citing Florida courts’ broad interpretation of an exclusion preamble based on “arising out of” language, the appellate court said that “we find sufficient causal connection between Bond-Lexon’s purported negligence claim and the contractual liability of Ward and LRC to enforce the exclusion according to its terms.”
Stated another way, the court said, “under the particulars of this case, the alleged negligence and misrepresentations, which form the basis of the tort claim, had a clear nexus with the development contracts, and the tort claim is inextricably intertwined with the circumstances surrounding the development contracts, plus the resolution of the tort claim required consideration of the losses and duties under the development contracts.”
In several prior posts on this blog (refer for example here), I have argued that the proper preamble for the contractual liability exclusion found in most private company D&O insurance policies is the narrower “for” wording, rather than the broader “based upon, arising out of, or in any way relating to” type preamble wording often found in these policies, including the policy at issue here.
I know that my insurance company-side colleagues would argue that this dispute shows exactly why the broader preamble is necessary. Not only did these parties enter into a set-up type settlement but after entering the settlement the bond company amended its complaint to assert claims calculated to try to create coverage, event though the real nature of the dispute between Bond-Lexon, on the one hand, and LRC and Ward, on the other hand, was an effort by Bond-Lexon to assert its contractual rights under the indemnification provision.
My view is that Bond-Lexon did in fact assert not just contractual liability claims but also claims sounding in tort. And not only did Bond-Lexon assert tort claims, but it asserted misrepresentation and inducement claims, which are the very type of claim for which the D&O insurance policy was intended to provide coverage.
My insurance industry-side colleagues will assert that notwithstanding the existence of the claim that nominally sounded in tort, what this dispute is really about is a fight over the parties’ indemnification agreement. That is, they would argue, this case is at its heart a contractual liability dispute, and the exclusion should be applied based on that basic reality about the claim.
My view is that, while the contractual liability exclusion appropriately should be applied to preclude coverage for the indemnity claim, it is not appropriate to extend the contractual liability exclusion’s preclusive effect to preclude coverage for the tort claim.
To be sure, when exclusion has the type of broad preamble the policy here used, the exclusion arguably does extent even to the tort claim. But that is why I think these types of exclusions should use the “for” wording rather than the broad preamble, so that the exclusion does not reach beyond the type of claims for which it appropriately should preclude coverage, to preclude coverage for claims for which coverage should not be precluded. The arguments that this case was “mostly about” the contractual dispute, or at its heart is a contractual dispute, are allocation arguments. Even if the weight of the allegations in the complaint argues for an allocation heavily in favor of the excluded contractual liability claims, there should still be some coverage under the policy for the claims that are and that should be covered under the policy.
My problem with the use of broad preamble in the contractual liability exclusion is that it allows insurers to routinely use the exclusion to preclude coverage for claims that are and ought to be covered under the policy. I know that my insurance industry-side colleagues would contend that if this policy or other policies used the “for” wording that it would allow coverage under the policy for claims that are primarily or at their heart contractual claims, for which the policy should not be providing coverage. My view is that if a claim is asserted against an insured person that is covered, then the policy should provide coverage, even if there is also a contractual dispute between the claimant and the insured. The fact is that the vast majority of private company D&O claims involve in part a fight over a breach of some type of agreement. Merely because a complaint includes claims that are precluded from coverage should not mean that all claims asserted in the complaint should be precluded from coverage. If there are both covered and noncovered claims, there should be an allocation.
Here is where I think insurers go off track in their analysis of the contractual liability exclusion. They forget how things worked before there was an express contractual liability exclusion. In those days, before the exclusionary language was added, the insurers still argued that the contractual liability claims were not covered, because contractual liability is a voluntarily undertaken liability, rather than a liability imposed by law. Liability insurance policies, the insurers would argue, were intended to provide insurance only for liabilities imposed by the law, not for voluntarily undertaken liabilities like those based on a contract.
When entity coverage became a standard part of D&O insurance policies, as a precaution the carriers added an express contractual liability exclusion. However, rather than restricting the scope of the exclusion to preclude coverage only to those voluntarily undertaken liabilities, the carriers worded the exclusion broadly, so as to preclude claims that assert liabilities imposed by law – that is, the very types of claims for which the policy was intended to provide coverage.
My view is that the contractual liability exclusion should be applied so as to preclude coverage only for the voluntarily undertaken liabilities, but not to preclude coverage for the liabilities imposed by law. For that reason, the appropriate preamble for the contractual liability exclusion should be the “for” wording rather the broader “based upon, arising out of” wording.
I know that in the current marketplace environment, most insurers’ policies use the broader preamble wording for the contractual liability exclusion and most insurers are unwilling to modify the preamble to the “for” wording. Though the marketplace is out of sympathy with my position on this issue, I am going to continue to agitate about this, for the simple reason that time after time after time, I see insurers’ claims adjusters using the broadly worded contractual liability exclusion to preclude coverage for claims that ought to be covered under the policy and indeed that represent the very type of claims for which the insurance exists. All too often, as applied by aggressive claims handlers, the contractual liability exclusion becomes a preclusion that swallows up the coverage that the policy should be providing.
My insurance industry-side colleagues might well ask here if I really think the insurer here should have to the whole of the judgment amount in what was clearly a set up deal between the claimant and the insured, based (the insurers would argue) on a manipulative complaint calculated to mischaracterize the parties’ dispute and to try to capture coverage that did not otherwise exist.
In my view, if the policy’s contractual liability exclusion had the “for” wording, this entire claim would have played out differently. If the exclusion had the narrower wording, coverage for the claimant’s indemnity claim would have been precluded, but there would have been coverage for the claimant’s tort claim. The coverage afforded would have been partial coverage, and allocating the losses between the covered and noncovered claims would have been difficult. But though the allocation might have been difficult, there would have been a very different resolution of the claim from the outset.
The bottom line for me is that the contractual liability exclusion should be worded so that it precludes coverage only for those voluntarily undertaken liabilities, but not for imposed by law liabilities, and for that reason, the proper preamble wording for the exclusion is the “for” wording, not the “based upon, arising out of” exclusion. The contractual liability exclusion should not be precluding coverage for negligent misrepresentation and inducement claims.
I know that readers of this blog may have very different views than those that I have expressed here. I encourage readers to post their views on this post using the blog’s comment feature.