Commercial insurance policies often are contractually complex. Many insurance policies include multiple endorsements modifying provisions of the base insurance policy form. Interpreting the way that the various parts of the policy work together is an important part of determining insurance coverage. When it is unclear how the parts relate uncertainty results. In a recent decision, the Eighth Circuit found that where multiple policy endorsements modified the same policy exclusion, the net effect of the endorsements was ambiguity, resulting in the conclusion that the exclusion did not apply at all. The appellate court’s decision is a cautionary tale for anyone involved in the insurance placement process.
Verto Medical Solutions is a headphone manufacturer. Seth Burgett is Verto’s founder, president, and CEO. Verto agreed to an asset sale to Harman International. The sales agreement contained provisions allowing Verto to obtain certain “earn out” amounts, subject to the company hitting certain financial goals. In order to gain approval of the deal from Verto’s shareholders, Burgett agreed to allocate a portion of the payments to them. A dispute later arose between Harman and Verto about the payments ultimately resulted in Harman’s agreement to make a one-time payment of $3.5 million to Verto.
The Verto shareholders filed a lawsuit alleging that Verto and Burgett had failed to distribute the funds according to the agreement with shareholders. Verto and Burgett submitted the shareholder lawsuit to their D&O insurer, which denied coverage for the claim. Verto and Burgett ultimately spent over $600,000 defending the shareholder claim. Verto and Burgett sued the D&O insurer seeking reimbursement for the defense costs. The insurer filed a motion to dismiss. The district court judge ruled that the contractual liability provision in the insurer’s policy unambiguously precluded coverage. Verto and Burgett appealed.
Relevant Policy Language
As later recited by the appellate court, the contractual liability provision in the base policy form (Exclusion D) provides that the insurer will “not cover any Loss in connection with any Claim … based upon, arising from, or in any consequence of any actual or alleged liability of any Insured under any express contract or agreement.”
Two different policy endorsements modified Exclusion D. Endorsement 11 (which the appellate court called “New D”) deleted exclusion D and replaced it with a new contractual liability provision, labelled with the letter “D”; as the appellate court said, New D “includes different exceptions but it otherwise is identical to original D.
Endorsement 13 to the policy states that “Exclusions A., B., C. and D. … are deleted in their entirety and replaced” with a list of three new exclusions labeled “A,” “B,” and “C,” none of which directly addresses contractual liability.
The May 11, 2021 Opinion
On appeal, the Eighth Circuit held, in a short, succinct May 11, 2021 opinion (here), written by Judge David Stras for a unanimous three-judge panel, that as a result of the potentially conflicting effects of the two endorsements to Exclusion D, that the policy is ambiguous, and therefore the appellate court reversed the district court.
The appellate court opened its analysis by stating “[i]f the insurance policy seems unclear, it is.” The court said that Endorsement 13 “injected uncertainty” by deleting Exclusion D, but then failing to specify which Exclusion D it meant to delete: the original D, new D, or both.
The court said “we cannot rule out the possibility … that the endorsements deleted and replaced original D and new D, leaving the policy without a contractual-liability exclusion.”
The policy, the court said, is “reasonably open to at least two different constructions” – that Endorsement 11 replaced original D with New D, and Endorsement 13 replaced D with nothing. As the appellate court said, “with one reasonable construction potentially covering contractual-liability claims and the other excluding them, the policy is ambiguous.”
Given this ambiguity, the appellate court applied contra preferentem principles under Missouri law, requiring the court to adopt the construction against the drafter (in this case, the insurer) – which in this case meant adopting the interpretation in which neither original D or new D exists. The appellate court remanded the case to the district court, noting that on remand, the insurer can continue to argue that other exclusions apply, just not original D or new D.
This case is a cautionary tale for anyone involved in insurance transactions of any complexity. The fact is that many insurance policies — like the one at issue here — are complex contracts with many moving parts. It is a regular feature of many commercial insurance policy that the contract documents contain multiple endorsements modifying provisions of the base policy. If nothing else, this case serves as a potent reminder of the need to review the policy documents closely and carefully to ensure that the various policy parts are working together as intended.
These circumstances also highlight the perils that can arise when multiple policy endorsements address the same policy provision. Again, it is not uncommon in commercial insurance policies to have multiple endorsements that modify, say, different parts of an exclusionary provision. As the case shows, how these various provisions are supposed to work together is not always obvious. While this potential lack of clarity is arguably of greatest risk for the insurer (in light of contractual interpretation provisions that the appellate court cited here), the potential for conflict among the provisions creates a risk for all parties to the contract that the provisions might be applied differently than assumed or expected.
One of the underappreciated and least glamorous parts of the insurance placement process is the basic policy review that must attend policy issuance. For both the insurer and the insured’s representatives, this indispensable process provides the means by which policy disputes like the one involved here potentially can be avoided. Policy review may sometimes feel like drudgery, but the fact is, as this case shows, it is indispensable. And, as the Hunton, Andews & Kurth law firm said in a May 25, 2021 post on its Insurance Recovery blog about the Eighth Circuit’s opinion in this case (here), for policyholders the opinion “underscores the importance of paying close attention to endorsements purporting to modify, amend, or completely delete key insuring agreements, definitions, and exclusions.”