A significant body of case law has developed concerning the extent to which liability insurance covers claims seeking damages for amounts the policyholder allegedly had a pre-existing contractual or statutory duty to pay. One of the most frequently cited cases on this topic is Pacific Insurance Co. v. Eaton Vance Management. 1 In Eaton Vance, and the cases discussed in Eaton Vance, the court held that an insured cannot secure coverage for amounts paid to resolve a third party claim—whether by judgment or settlement—where the amount paid constitutes nothing more than what the contract (or statute) already required the insured to pay (referred to herein as "the Eaton Vance rule").2

The problem that this article addresses is the manner in which some courts have misunderstood the Eaton Vance rule as precluding liability coverage for a much broader set of claims seeking damages of any type for an alleged breach of any pre-existing obligation. Relying on these cases, it is now relatively common for insurers to disclaim indemnity coverage for any claim seeking damages based on an alleged breach of a duty imposed by contract or statute. By way of example, the following is a representative list (taken from real coverage position letters) of the kind of overly broad coverage positions that insurers have taken in reliance on the cases discussed herein:

  • "Liability policies do not cover breach of contract damages."
  • "Liability insurance policies do not provide coverage for a preexisting statutory or contractual obligation."
  • "There is no indemnity coverage available under the Policy for [the insured]'s liability for its alleged failure to meet contractual and/or statutory obligations."
  • "Damages based on a breach of a pre-existing contractual obligation are uninsurable as a matter of Massachusetts law."
  • Damages for the insured's failure to "compl[y] with statutory and regulatory obligations is not a Loss resulting from a Claim for a Wrongful Act. Defendants cannot convert such obligations to a Loss under a liability insurance policy."

Even the venerable Holmes' Appleman on Insurance 2d § 146.6 (2003) includes the statement that "even in the absence of an express exclusion, courts have held that a claim alleging breach of contract is not covered under a professional liability policy because there is no 'wrongful act' and no 'loss' since the insured is simply being required to pay an amount it agreed to pay."3

These statements are wrong. As noted, there is nothing wrong with the general rule—the Eaton Vance rule—that liability policies (or at least most of them) do not extend coverage to damages that the insured has or had an established preexisting legal obligation to pay. But it is not true that damages arising from the breach of any pre-existing duty are not covered. Such a rule would render liability coverage for "wrongful acts" illusory, since all "wrongful acts" for which an insured might be held liable involve the breach of a pre-existing duty to the claimant. As the Fourth Circuit put it in a case addressing the Eaton Vance rule, "Every duty breached or violated is necessarily a preexisting duty, and it is the breach or violation of that duty which constitutes a wrongful act."4 As discussed herein, when the claimed damages represent amounts the insured would have no liability to pay unless and until it is found liable for a "wrongful act," the Eaton Vance rule simply has no relevance. Such losses clearly do "result from" the claim for a wrongful act, since there is no other source for the insured's obligation to pay.

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This article begins with an in-depth look at Eaton Vance and the cases it relied on to ascertain the real holding in each of those cases.5 Particular scrutiny is given to Judge Posner's decision in May Department Stores Co. v. Federal Insurance Co., 6 which is the source of much of the confusion that has developed in subsequent cases purporting to apply the "Eaton Vance rule."7 Relying on Judge Posner's faulty analysis in May Department Stores, numerous other courts have badly mischaracterized—and in some cases misapplied—the Eaton Vance rule.8

The article then addresses two fundamental limitations on application of the Eaton Vance rule. First, the rule applies only to amounts the insured had a pre-existing obligation to pay, not amounts that the insured may become liable to pay as a result of its breach of some other pre-existing obligation.9 Second, the rule applies only when the insured's pre-existing obligation to pay has been established or admitted, not when the insured settles a claim merely alleging a disputed obligation.10 Finally, the article concludes with a discussion of the so-called "moral hazard" problems that many courts have sought to address by wrongly expanding the Eaton Vance rule beyond its proper application. To be sure, insurers' (and courts') concerns about "moral hazard" may be legitimate, but any such problems readily can be solved through more precise policy language that insurers could, and sometimes do, include in their policies to make clear what risks they will and will not insure—e.g., settlements of claims alleging breach of a pre-existing obligation. But in the absence of such specific exclusionary language, policyholders should expect, and be willing to fight for, coverage of such claims. See Section IV.

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Footnotes

1. Pac. Ins. Co. v. Eaton Vance Mgmt., 369 F.3d 584 (1st Cir. 2004)

2. As discussed herein at Section I.C, one of the cases discussed in Eaton Vance—May Department Stores Co. v. Federal Insurance Co., 305 F.3d 597, 600 (7th Cir. 2002)—went beyond this narrow result and found no coverage even for other compensatory "expectation damages" arising from a breach of contract.

3. Courts have cited this provision of Holmes' Appleman on Insurance for the overly broad proposition that "liability policies do not cover breach of contract damages." See, e.g., Waste Corp. of Am. Inc. v. Genesis Ins. Co., 382 F. Supp. 2d 1349, 1354 (S.D. Fla. 2005); Krueger Int'l, Inc. v. Royal Indem. Co., 481 F.3d 993, 996 (7th Cir. 2007) (noting that "insurance policies are presumed not to insure against liability for breach of contract"); Newman v. XL Spec. Ins. Co., No. C-1-06-781, 2007 U.S. Dist. LEXIS 74293, at *9, *16 (S.D. Ohio Sept. 24, 2007) (accepting insurer's argument that "liability insurance policies are not interpreted to cover breach of contract claims" and holding that, "[u]nless the insurance policy explicitly states that it covers breach of contract actions, such an interpretation should not be read into the policy").

4. Republic Franklin Ins. Co. v. Albemarle Cnty. Sch. Bd., 670 F.3d 563, 566 (4th Cir. 2012) (emphasis in original).

5. See infra Sections I.A, I.B.

6. May Dep't Stores Co. v. Fed. Ins. Co., 305 F.3d 597, 601 (7th Cir. 2002).

7. See infra Section I.C.

8. See infra Section I.D.

9. See infra Section II.

10. See infra Section III.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.