Into The Breach: Insurance Coverage For Breach Of Contract Claims

If asked, most insurance professionals would say that general liability insurance policies do not cover breach of contract claims. Indeed, numerous courts have held that general liability policies cover only tort liabilities. See, e.g., Windt, Insurance Claims and Disputes, § 11.7, n.2. Those courts premise their holdings on either the insuring agreement (which promises to pay on behalf of an insured all sums the insured becomes “legally obligated to pay as damages”) or the definition of “occurrence” (which is defined, in part, as an “accident”).

This issue arises most commonly in connection with product and work-related claims. In that context, underlying claimants typically assert a broad range of claims for breach of contract, breach of warranty and negligence. Increasingly, insurers deny coverage for such claims by contending that the “gist” of such actions are for breach of contract, which are not covered by their general liability policies. Such denials of coverage, however, are not supported by the language of the policies.

There is nothing in the phrase “legally obligated to pay as damages” that would exclude coverage for breach of contract claims. As cogently explained by the California Supreme Court:

“The expression ‘legally obligated’ connotes legal responsibility that is broad in scope. It is directed at civil liability….[which] can arise from either unintentional (negligent) or intentional tort, under common law, statute, or contract.” (Malecki & Flitner, Commercial General Liability (6th ed. 197) p. 6, italics added.) “The coverage agreement [which] embraces ‘all sums which the insured shall become legally obligated to pay as damages….’ … is intentionally broad enough to include the insured’s obligation to pay damages for breach of contract as well as for tort, within limitations imposed by other terms of the coverage agreement (e.g. bodily injury and property damage as defined, caused by an occurrence) and by the exclusions….” (Tinker, Comprehensive General Liability Insurance-Perspective and Overview (1975) 25 Fed. Ins. Counsel Q. 217, 265).

Vandenberg v. Superior Court, 982 P.2d 229, 245-46 (Cal. 1999) (alterations in original).

Moreover, the definition of “occurrence” does not necessarily preclude coverage for breach of contract. An “accident” is defined as “[a]n unexpected and undesirable” event or “something that occurs unexpectedly or unintentionally.” Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co. , 908 A.2d 888, 897-98 (Pa. 2006) (quoting Webster’s II New College Dictionary 6 (2001). Here again, there is nothing to alert the policyholder that breach of contract claims are not covered.

In contrast to the lack of specific language precluding coverage for breach of contract and warranty claims, general liability policies typically contain language indicating that such coverage is intended. First, general liability policies provide specific coverage for liabilities resulting from the breach of warranties. The Products/Completed Operations Hazard of general liability policies provides specific coverage for liabilities arising out of a policyholder’s “product” and/or “work.” The policyholder’s “product” and “work” are, in turn, defined to include any “[w]arranties or representations made at any time with respect to the fitness, quality, durability, performance or use of” the policyholder’s product or work.

Second, general liability insurance policies contain numerous exclusions for claims arising from breach of contract. “Exclusions, by their very nature, are designed to operate to deny coverage that otherwise would be provided under the definition of an occurrence.” Donegal Mut. Ins. Co. v. Baumhammers, 893 A.2d 797, 819 (Pa. Super. 2006). There would be no need for these breach of contract exclusions if such claims were not covered in the first instance.

In determining whether claims arising from a policyholder’s product or work are covered, the better reasoned decisions do not focus on the contract/tort distinction. As explained by the California Supreme Court, “[c]overage under a CGL insurance policy is not based upon the fortuity of the form of action chosen by the injured party.” See, e.g., Vandenberg, 982 P.2d at 243. Rather, the better reasoned decisions focus on the nature of the damage, the insured risk and the specific policy language. Imperial Cas. and Indem. Co. v. High Concrete Structures, Inc., 858 F.2d 128, 134, n.7 (3d Cir. 1988). In the words of the Third Circuit: “What is at issue here, however, is not the distinction between tort and contract liability but a specific insurance contract that must be interpreted according to well-established rules of construction.”

Coverage should be found when the policyholder’s product or work causes harm to the person or the property of another. This point was best stated by the Supreme Court of Nebraska:
“[A]lthough a standard CGL policy does not provide coverage for faulty workmanship that damages only the resulting work product, if faulty workmanship causes bodily injury or property damage to something other than the insured’s work product, an unintended and unexpected event has occurred, and coverage exists.” Auto-Owners Ins. Co. v. Home Pride Cos., Inc., 684 N.W.2d 571, 578 (Neb. 2004) (citations omitted).

In the end, the proper focus in determining coverage should be on the nature of the injury alleged and not on the claimant’s cause of action. To the extent the policyholder’s product or work cause harm to the person or property of another, coverage should exist, irrespective of the claimant’s choice of cause of action.

Lawyers Are Policyholders (People) Too

In a decision that is sure to warm the hearts of our attorney friends and colleagues, the New York Appellate Division held in favor of our client and attorney in the case of American Guaranty and Liability Insurance Company v. Moskowitz, 870 N.Y.S.2d 307 (App. Div. 1st Dep’t, Jan 6, 2009) (“American Guaranty”). The American Guaranty case involved insurance under a legal liability policy for claims after our client was drawn into litigation filed initially against one of his law firm’s clients. Conopco, Inc. d/b/a/ v. Dina Wein, et al., Civil Action No. 05-CV-9899 (S.D.N.Y.) (“Conopco”). The plaintiffs in Conopco asserted claims for, among other things, RICO violations and fraud.

The insurer, after agreeing initially to defend, denied coverage and filed an action seeking a declaration that it had neither a duty to defend nor indemnify. To make matters worse, the insurer also sought reimbursement of the amounts it had already expended in our client’s defense.

In response to our client’s motion to dismiss, the Magistrate Judge in the underlying Conopco case recommended dismissal, without leave to re-plead, of all claims against our client for failure to state a cause of action. Thereafter, the Conopco plaintiffs dismissed all such claims with prejudice. Notwithstanding the complete exoneration of our client, the insurer continued to insist that it owed no duty to defend and was entitled to reimbursement of all costs expended in our client’s defense.

In response to the parties’ cross-motions for summary judgment, the trial court in the insurance coverage action held entirely in our client’s favor. Not only did that court hold that the insurer had a duty to defend, it also held that our client was entitled to reimbursement of all costs expended in defending against both the underlying Conopco Action as well as the insurance coverage action. Those holdings were thereafter affirmed in their entirety by the Appellate Division.

The holdings in American Guaranty, in and of themselves, are unremarkable. In finding a duty to defend on American Guaranty’s part, the courts applied the nearly universal rule that requires an insurer to defend whenever the allegations of the underlying complaint “suggest [a] reasonable possibility of coverage….” American Guaranty, 870 N.Y.S.2d at 308 (quoting Automobile Ins. Co. of Hartford v. Cook, 7 N.Y.3d 131, 137 (2006)). Likewise, a policyholder in New York is entitled to recover the costs of defending against its insurer’s declaratory judgment action. See U.S. Underwriters Ins. Co v. City Club Hotel, LLC, 3 N.Y.3d 592 (2004); Mighty Midgets, Inc. v. Centennial Ins. Co., 47 N.Y.2d 12 (1979).

What is remarkable and troubling is the aggressive stand that the insurer took in response to a claim by an attorney who was in a better position than most to protect his rights. In light of the failing economy and the already increased pressure on insurance company profits, tactics like these can be expected to increase, especially in connection with less sophisticated policyholders. As always, vigilance, persistence and occasionally litigation are the best defense to an insurer’s wrongful denial of claims.

On the Defensive: Excess Insurers And The Duty To Defend

When one thinks of excess insurance (and who doesn’t) the duty to defend is probably not the first thing that crosses the mind. The duty to defend is typically associated with primary insurance, not excess insurance that provides coverage above underlying layers of primary or other excess insurance. Not all excess insurance is the same, however, and certain excess insurance policies, especially excess umbrella insurance policies, expressly impose a duty to defend on the excess insurer.

Umbrella insurance policies have been referred to as “hybrid” policies because an umbrella policy “combines the characteristics of both a primary and a following form excess policy.” An umbrella insurance policy typically promises to defend occurrences covered by the terms of the umbrella policy, but not the underlying primary policy. That duty to defend is set forth in the Defense Settlement provision of certain umbrella policies.

Beyond defense coverage for occurrences not covered by underlying insurance, some umbrella insurance policies also promise to defend the policyholder upon the exhaustion of underlying insurance. Courts have focused on three policy provisions in determining that umbrella excess insurers have such a duty to defend: (1) Underlying Insurance; (2) Retained Limit-Limit of Liability; and (3) Assistance and Cooperation.

Starting with the last provision first, an Assistance and Cooperation provision in an excess insurance policy with no duty to defend will typically provide that the insurer “shall not be called upon to assume charge of the settlement or defense of any claim, suit or proceeding….” Assistance and Cooperation clauses in umbrella policies that include a duty to defend provide differently, as follows:

Except as provided in Insuring Agreement II (Defense, Settlement) or in Insurance Agreement VI (Retained Limit-Limit of Liability) with respect to the exhaustion of the aggregate limits of underlying policies listed in Schedule A, or in Condition J [Underlying Insurance] the company shall not be called upon to assume charge of the settlement or defense of any claim made or proceeding instituted against the insured; but the company shall have the right and opportunity to associate with the insured in the defense and control of any claim or proceeding reasonably likely to involve the company. In such event the insured and the company shall cooperate fully.

Thus, pursuant to this form of the Assistance and Cooperation clause, the insurer is obliged to defend pursuant to the three provisions identified in the clause. As discussed above, the Defense Settlement provision requires the umbrella insurer to defend claims covered by the umbrella policy, but not the underlying insurance policy. Pursuant to the remaining two provisions, the umbrella insurer is obliged to defend upon the exhaustion of underlying insurance.

As for the effect of the Underlying Insurance provision, one court concluded that the plain terms of the provision imposed defense obligations:

"All three policies contain a clause imposing an obligation to assume charge of and pay for [the policyholder’s] defense under certain circumstances. Specifically, [the Underlying Insurance provision of] the policies provide:

If underlying insurance is exhausted by any occurrence, [the Excess Insurer] shall be obligated to assume charge of the settlement or defense of any claim or proceedings against the insured resulting from the same occurrence, but only where this policy applies immediately in excess of such underlying insurance without the intervention of excess insurance of another carrier.

Accordingly, by its plain terms, the policies impose defense obligations upon the insurers where the immediately underlying insurance has been exhausted by a single occurrence."

The Eighth Circuit Court of Appeals also relied on the Underlying Insurance provision in concluding that the insurance policy expressly imposed defense obligations on the insurer.

The Retained Limit-Limit of Liability provision provides, in pertinent part, that the excess policy “shall continue in force as underlying insurance,” in the event of “exhaustion” of the aggregate limits of liability of the underlying policies. In accordance with this language, an excess insurer must function as a primary insurer upon exhaustion of the underlying primary policy. Of course, functioning as a primary insurer includes the assumption of the duty to defend that was previously shouldered by the primary insurance before the exhaustion of the primary policy.

Accordingly, it would be a mistake to blindly assume that an excess insurance policy contains only a duty to indemnify, and no duty to defend. As always, the policy language controls, and policyholders should not hesitate to take advantage of all of the benefits the duty to defend offers.