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26 November 2024

The Anatomy Of A Broadly Drafted D&O Contract Exclusion

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Wilson Elser Moskowitz Edelman & Dicker LLP

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More than 800 attorneys strong, Wilson Elser serves clients of all sizes across multiple industries. It maintains 38 domestic offices, another in London and enjoys more extensive international reach as a founding member of Legalign Global.  The firm is currently ranked 56th in the National Law Journal’s NLJ 500.
A typical D&O policy's Contract Exclusion readily applies to an insured's potential liabilities for any breach of contract claims. However, for insurers seeking a broadly worded Contract Exclusion...
United States Criminal Law

A typical D&O policy's Contract Exclusion readily applies to an insured's potential liabilities for any breach of contract claims. However, for insurers seeking a broadly worded Contract Exclusion (for example, applying to "any Claim against any Insured based upon, arising out of, or in any way involving1 any actual or alleged liability or obligation under any contract or agreement"), the exclusion can extend well beyond simple breach of contract claims, and even bar coverage for underlying lawsuits2 (1) not containing any contractual causes of action, (2) involving contracts to which the insured is not a party, and (3) involving conduct that occurred prior to the contract itself.

  • First, in order to apply to tort claims (and beyond), the Contract Exclusion cannot be limited to claims "for any contractual liability,"3 but instead needs at least "arising out of" language, or other similarly broad language (see, Endnote 1).
  • Second, the exclusion also needs "actual or alleged" language, or it may be limited to situations involving actual contractual breaches.4
  • Third, the "contract" language should not be modified by "of any Insured," or the exclusion may be restricted to the Insured's contracts.
  • Lastly, the Contract Exclusion should not be limited to claims solely under section I.C., but it should be applicable to all coverage provisions Drafted with such language, the Contract Exclusion will have broad exclusionary powers that should be interpreted to extend beyond merely contractual liability claims. For example, the Ninth Circuit has twice held that a Contract Exclusion applies despite the absence of a breach of contract cause of action in the underlying lawsuit. In Office Depot, Inc. v. AIG Specialty Ins. Co., 829 Fed. Appx. 263, 264 (9th Cir. Nov. 13, 2020), the Ninth Circuit held that a broadly worded Contract Exclusion barred coverage for an underlying lawsuit that contained a single cause of action for violation of California's False Claims Act. So long as the underlying lawsuit "arose out of ... contractual obligations," the exclusion should apply.

Similarly, in AKN Holdings, LLC v. Great Am. E & S Ins. Co., 2022 U.S. App. LEXIS 18903 (9th Cir. July 8, 2022), the Ninth Circuit held a Contract Exclusion applied despite the underlying lawsuit seeking damages solely for fraud representations and fraudulent concealment.5 Indeed, if properly worded, the insured need not even be a party to the contract for the exclusion to apply.

In Radianse, Inc. v. Twin City Fire Ins. Co., 2010 U.S. Dist. LEXIS 106778, *6 (D. Mass. Oct. 6, 2010), the court held it was "of no consequence that [the insured] was not a party to [the] contract" since the contract exclusion did "not state that its application [was] limited to contracts to which [the insured was] a party."6

Further, a broadly worded Contract Exclusion should apply even if the underlying alleged tortious conduct occurred before the relevant contract was entered into. In Fed. Ins. Co. v. KDW Restructuring & Liquidation Servs., LLC, 889 F. Supp. 2d 694, 700-09 (M.D. Pa. 2012), the court rejected the argument that Contract Exclusion was "inapplicable" because negligent misrepresentation and fraud claims arose out of "pre-contractual misrepresentations and omissions" when "the injuries suffered by the class plaintiffs would not have occurred had there been no contracts and no breach thereof."7 This can be important when the goal is to capture all of the related misconduct relating to the contractual lability into the exclusion.

In the end, a Contract Exclusion is an important tool to limit coverage for D&O liability to wrongful tortious acts of directors and officers and entities. Having the ability to avoid coverage for contract-related liability is significant to further these goals of D&O coverage, while avoiding raising premiums for everyone else based on the contract-related decisions, which spur litigation for which D&O coverage is sometimes sought.

Footnotes

1. Even better than "arising out of" is prefatory language that states: "based upon, arising out of, relating to, directly or indirectly resulting from or in consequence of, or in any way involving." Global Fitness, LLC, v. Navigators Mgmt. Co., Inc., 854 Fed. Appx. 719, 721 (6th Cir. 2021) (such language is "staggeringly broad"); Tricor Am., Inc. v. Ill. Union Ins. Co., 351 F. Appx. 225, 227 (9th Cir. 2009) (this language is "plainly intended broadly to exclude coverage").

2. Depending on the Policy's definition of "Claim," the Contract Exclusion can apply to the "entirety of Underlying Action, not just the individual causes of action...thus the provision excludes coverage of the entire case based on the clear allegations dealing with contractual liabilities of 'an Insured Person under any contract [or] agreement.'" Paraco Gas Corp. v. Ironshore Indem., Inc., 2023 U.S. Dist., LEXIS 14628, *13 (S.D.N.Y. June 22, 2023), aff'd, 2024 U.S. App. LEXIS 14628 (2d Cir. June 17, 2024).

3. See, e.g., GE HFS Holdings, Inc. v. Nat'l Union Fire Ins. Co. of Pittsburgh, 2009 U.S. Dist., LEXIS 147629, *9 (D. Mass. Sept. 28, 2009) ("the policy language could not have been broader. It excluded claims 'arising from' any contract or agreement, rather than excluding claims 'for' any contract or agreement. An exclusion with the 'for' wording makes it clear that insurers do not intend to pick up the insured company's contractual liability, without necessarily extending the exception to tort claims against individuals") (italics in original); U.S. TelePacific Corp. v. U.S. Specialty Ins. Co., 2019 U.S. Dist., LEXIS 101848, *23 (C.D. Cal. June 18, 2019) ("Some of the Policy's exclusions apply to claims 'arising out of, based upon or attributable to'...while others are limited to claims 'for' ...[t]his dichotomy suggests that the Policy, and thereby the parties, contemplated when exclusions or exceptions should apply to broad or narrow sets of circumstances.") (emphasis added).

4. See, e.g., KM Strategic Management, LLC v. American Casualty Co. of Reading, PA, 156 F. Supp. 3d 1154, 1171 (C.D. Cal. 2015) ("the [Contract] exclusion could have been written more broadly so as to cover all claims for injury arising out of any 'alleged' breach of contract," but instead the exclusion only applied to "an actual breach — not an alleged breach") (emphasis in original); Mede Analytics, Inc. v. Fed. Ins. Co., 2016 U.S. Dist., LEXIS 21377, *16 (N.D. Cal. Feb. 19, 2016) (exclusion "arising out of breach of contract," did not utilize "actual or alleged" language, yet "other exclusions in the Policy here incorporate such 'actual or alleged' language."); Saoud v. Everest Indem. Ins. Co., 551 F. Supp. 3d 777, 794 (E.D. Mich. 2021) ("other exclusions expressly use the word 'alleged,'" but the at issue "exclusion does not use the phrase 'actual or alleged,' the Court is not persuaded that the language of the exclusion unambiguously restricts the inquiry to what was alleged in the state court complaints").

5. Although the original lawsuit included certain contractual remedies, the "amended complaint only alleged claims for fraudulent representations and fraudulent concealment." AKN Holdings, LLC v. Great Am. E & S Ins. Co., 2021 U.S. Dist, LEXIS 142777, *5 (C.D. Cal. May 14, 2021).

6. See also, AKN Holdings, LLC v. Great Am. E & S Ins. Co., 2021 U.S. Dist., LEXIS 142777, *11-12 (C.D. Cal. May 14, 2021) ("[Insured] Plaintiff also emphasizes that it was 'not even a party to the disputed agreements.' But the exclusion applies to claims involving 'any actual or alleged breach of contract or agreement,' not just breaches of contracts to which Plaintiff was a formal party"), aff'd, 2022 U.S. App. LEXIS 18903 (9th Cir. July 8, 2022); Carolina Cas. Ins. Co. v. Sowell, 603 F. Supp. 2d 914, 931 (N.D. Tex. Feb. 17, 2009) ("The Contract Exclusion also cannot be reasonably read, as [insured] Ellis urges, to apply only to claims involving a contract to which Ellis was a party. The exclusion bars coverage of claims made against any insured based upon 'any...contract or agreement,' not based only on a contract to which the specific insured is a party.").

7. See also, AKN Holdings, LLC v. Great Am. E & S Ins. Co., 2021 U.S. Dist., LEXIS 142777, *10 (C.D. Cal. May 14, 2021) ("Plaintiff tries to untether the fraud claims from the agreements, noting that the underlying complaints allege that Plaintiff 'committed actionable fraud before any contract any was ever entered into,'" but "the broad language of the exclusion is not so limited: the fraud claim need only be 'related to any actual or alleged breach of contract or agreement.'"), aff'd, 2022 U.S. App. LEXIS 18903 (9th Cir. July 8, 2022).

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.

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