A deceased small business owner’s widow sued the business’s two other co-owners for breach of fiduciary duty for failing to apply a life insurance payout to the company to buy out her deceased husband’s shares. The two co-owners submitted the claim to their company’s management liability insurer, which denied coverage for the claim, relying in part on the policy’s contractual liability exclusion. The two co-owners sued the insurer seeking coverage. The district court granted summary judgment for the insurer. On February 19, 2020, the Eighth Circuit, applying Kansas law, affirmed the district court in an opinion that, as discussed below, raises some interesting issues. The Eighth Circuit’s opinion can be found here.



Cates Sheet Metal Industries had three co-owners:  Paul Russell, Daniel Cates, and J. Carson Cates. Daniel’s 2003 cancer diagnosis caused the three to form a written succession plan (the “Stock Agreement”), pursuant to which the company purchased life insurance on all three of the owners, with the understanding that in the event of the death of any of the three, the life insurance proceeds would be used to buy out the deceased owner’s shares.


Daniel died in 2013. The company received the proceeds of Daniel’s life insurance policy and deposited the proceeds into the company’s bank account. However, the company did not purchase Daniel’s shares from Daniel’s widow, Elizabeth Cates.


Elizabeth sued the two surviving owners, Paul Russell and Carson Cates, alleging conversion and breach of fiduciary duty. A jury ultimately concluded that Russell, the company’s CEO, had breached his fiduciary duty and found him liable for over $800,000, plus interest.


The Insurance Coverage Dispute

When Russell and Carson Cates were served with Elizabeth’s lawsuit, they submitted it to the company’s management liability insurance insurer. The management liability policy had multiple coverage parts, including both D&O liability and fiduciary liability. The insurer denied coverage for the claim under the D&O insurance coverage part in reliance on the policy’s personal profit exclusion and contractual liability exclusion. The insurer denied coverage under the fiduciary liability because Elizabeth’s claims against the individuals did not arise in connection with an employee benefits plan.


Russell and Carson Cates filed a coverage lawsuit against the company’s insurer, seeking to establish that the policy did provide coverage for the underlying claim, and also alleging breach of the implied covenant of good faith and fair dealing.


The insurer filed a motion for summary judgment in the insurance coverage action, which the trial court granted. Russell and Carson Cates appealed the trial court’s ruling to the Eighth Circuit Court of Appeals.


The jurisdictional and procedural issues in the insurance coverage action are complicated, and I will not discuss those issues here.



The Relevant Policy Language

The contractual liability exclusion in the policy’s D&O Insurance coverage part provides that the policy will not provide coverage for loss “based upon, arising out of or attributable to any actual or alleged liability under any actual or alleged liability under or breach of any contract or agreement.”


The management liability policy’s Fiduciary Liability Coverage part protects insured persons for claims against them for alleged wrongful acts “in the discharge of their duties in their capacities, or solely by reason of their status, as fiduciaries of any Plan” or — in the case of negligence — “solely in the Administration of any Plan.” A “Plan,” according to the insurance policy, is any “employee benefit plan or program . . . sponsored solely by the Company for the benefit of the employees of the Company.”


The February 19, 2020 Decision

On February 19, 2020, in an opinion written by Judge Steven Grasz for a unanimous three-judge panel, the Eighth Circuit, applying Kansas law, affirmed the district court’s grant of summary judgment in the insurer’s favor.


In ruling in the insurer’s favor with respect to the D&O insurance coverage part, the appellate court said, after quoting the policy’s contractual liability exclusion, that “given the company’s broken promise to pay Daniel’s life-insurance proceeds to Elizabeth, it seems that Liberty has no duty to cover Russell and J. Carson’s liability and defense costs.”


Russell and Carson Cates had tried to argue that the contractual liability exclusion did not apply to preclude coverage because Elizabeth had not asserted a breach of contract claim in the underlying lawsuit; rather, she had asserted claims for conversion and for breach of fiduciary liability. Russell and Cates sought to rely on a Kansas Supreme Court decision (Marquis), in which the court had said that “where the insured’s liability is premised on a legal theory separate and distinct from the liability excluded from the policy, the policy provides coverage for the claim.”


The appellate court rejected this argument, specifically stating that the Marquis decision on which the individuals sought to rely is in “increasing disfavor,” and has been restricted by the Kansas courts to a narrow set of circumstances not relevant here. The appellate court also noted that “In fact, several Kansas cases hold that theories of liability are irrelevant when injuries occur from intentional acts.”


The appellate court added that “If Marquis applied to contract-breach exclusions, someone could intentionally obtain the benefit of a breached contract and — depending on the plaintiff’s legal theory — force his insurer to carry the burden. A prudent insured person would not understand the policy to permit such windfalls.” The appellate court rejected the individuals attempt to try to rely on the Marquis decision to argue that the breach of contract exclusion did not apply.


The appellate court also rejected the individuals attempt to argue that the policy’s Fiduciary Liability coverage part applied to provide coverage for the underlying claim. In seeking to establish that the Fiduciary Liability coverage part applied, the individuals had argued that the Stock Agreement (pursuant to which the three owners had agreed to use insurance proceeds to buy the shares of any deceased owner) was a “Plan” within the meaning of the Fiduciary Liability Coverage part.


The appellate court rejected this argument, saying that “the Stock Agreement benefited primarily company shareholders; its effect on employees is accidental. Employment at Cates Sheet Metal is not required (or even implicitly mentioned) by the Stock Agreement.”


The appellate court also noted that the Fiduciary Liability coverage part applied solely to wrongful acts alleged in insured persons capacities as fiduciaries of a Plan. The two individuals, the appellate court said, “were not sued for breaching their duties as employee-benefit-plan fiduciaries; they were sued (and Russell found liable) for breaching their duties as fiduciaries of the company and its shareholders.” The appellate court affirmed the district court’s conclusion that the fiduciary liability coverage part did not apply to provide coverage for the underlying claim.



It is hard to read the appellate court’s decision and not get the feeling that the court was influenced by a perception that the two surviving owners had dealt the deceased owner’s widow a dirty deal, by receiving and keeping the insurance proceeds while failing to buy out the deceased owner’s shares. It may be that this is in fact what happened, although I wonder whether there might be more to the story. In the underlying lawsuit, the defendants contested the widow’s claim all the way through a jury verdict, and in this insurance coverage proceeding, the individuals fought for coverage all the way to the appellate court. I just wonder whether there might be another side to the story. I also worry that the appellate court’s views about the tenor of the underlying lawsuit affected its perception of the coverage issues.


Whatever might have been the merits of the underlying claim, I do think it is relevant that the claimant in the underlying claim did not assert a claim for a breach of contract. Instead, she asserted the kinds of claims for which the D&O insurance policy typically provides coverage. Indeed, a breach of fiduciary duty claim is the very kind of claim for which D&O insurance buyers purchase their policies. Yet the contractual liability exclusion was applied to preclude coverage.


The fact that the contractual liability exclusion operated to preclude coverage is actually a good illustration of what is wrong with contractual liability exclusions that have the broad “based upon, arising out of ” preamble, rather than the narrower “for” preamble. The preclusion of claims for contractual liability is fair as persons ought not be able to shift to their insurer their voluntarily undertaken contractual liabilities. However, other types of liability that are imposed by law – such as, for example, liability for breach of fiduciary duty – ought not to be precluded merely because the underlying circumstances happen to also involve a contract.


Regular readers know that the overbroad application of the contractual liability exclusion is a long-standing hobby-horse issue of mine, as discussed here. Indeed, and as I noted in a recent post, at least one federal appellate court has said that the application of a contractual liability exclusion with a broad “based upon, arising out of” preamble in order to preclude coverage for a claim of the very type for which the insured purchased the policy renders the policy’s coverage “illusory.” I have long argued that it is time to put an end to the broadly worded contractual liability exclusion, in favor of an exclusion with the “for” wording.


The appellate court’s analysis here did not expressly depend on the exclusion’s broad “based upon, arising out of” wording, but if the exclusion here had had the narrower wording, the individuals seeking coverage might have had firmer grounds on which to seek coverage, and might not have been reduced to trying to rely on a discredited Kansas Supreme Court opinion to argue that the exclusion didn’t apply to claims based on legal theories other than breach of contract.


It is also important to note that the contractual liability exclusion at issue here lacked a relatively standard additional provision that, had it been a part of this exclusion, also might have helped to preserve coverage. Many contractual liability provisions will also include a final clause stating that the exclusion’s preclusive effect does not apply “to the extent that liability would have existed in the absence of contract.” This situation seems to me like a classic case where the insured could argue that his individual liability – for breach of fiduciary duty – would have existed even in the absence of contract. This argument may or may not have succeeded, but it might have permitted the individuals to attempt to argue (as they tried to do in reliance on the discredited Marquis decision) that the contractual liability exclusion should not be applied to claims asserted on legal theories other than on a breach of contract theory.


The appellate court’s analysis of the Fiduciary liability coverage issue is clearly correct as the underlying dispute did not involve the individual defendant’s breach of a duty in connection with their activities relating to an employee benefits plan.


However, I still think the court’s analysis of the fiduciary liability issues is noteworthy because it addresses a concern that sometimes comes up; the concern comes from the confusion that can arise between the coverage afforded – that is, fiduciary liability — and claims that often are asserted against corporate directors and officers for breach of fiduciary duty. The differing use of the word “fiduciary” is what can create confusion for persons not immersed in insurance issues. The appellate court’s analysis correctly identifies and explains the reasons why a fiduciary liability policy is irrelevant to claims for breach of fiduciary duties that arise outside the context of employee benefit plans.


I will say that this case does provide an interesting example of how claims can arise even with respect to closely held private companies. I frequently hear from private company owners that their company only has a very small number of owners, so how could they get a D&O claim? The standard answer to this question is that claims can come from many directions other than from owners (customers, competitors, vendors, suppliers, regulators, etc.). But as this case shows, even in very closely held private companies, ownership disputes can arise. Although this might not be the best example to use, given that the trial court and appellate court concluded that there is not coverage for this claim. Just the same, the case does show how disputes can arise.


One thing about this case that I don’t understand is how was the company able to procure life insurance insuring the life of Daniel Cates after he was diagnosed with cancer in 2003? I suppose the answer is that insurance insuring his life was more costly that were the policies insuring the other two individuals. But just the same, given that it was the owners’ brush with Daniel’s mortality that motivated them to purchase the policies, it is interesting that they were nonetheless able to purchase policies insurance Daniel.


One final thing I wondered about in reading this opinion is why Elizabeth Cates did not assert a breach of contract claim. I am guessing that the reason there was no breach of contract claim because Daniel entered the Agreement in his own right, while following his death his shares were held by his estate or a trust that for whatever legal reason could not assert a contract claim. The fact that the Russell was found liable even without a breach of contract claim being asserted clearly shows that his liability did not depend on the contract — and therefore the standard contractual liability exclusion carve back for liabilities that exist even in the absence of contract clearly could have been relevant to this coverage dispute.