Duplicitous and Overbroad Insurer Constructions of Exclusions Improperly Deprive Policyholders of Coverage Benefits

Insurers, incentivized to avoid their duty to defend policyholders in lawsuits, have sometimes embraced the idea that even one connection between a policy exclusion and a claim is enough to relieve them of that duty. While a policy may state that it does not indemnify certain alleged offenses by the insured, the insurer should not be able to deny a defense where those allegations comprise only a portion of an otherwise covered suit.

Overbroad Reading of an Exclusion to Presume its Application to Fact Allegations is Baseless

No case law justifies an insurer’s overbroad and expansive reading of an exclusion to encompass fact allegations which presumptively could be amended to assert a claim that falls within a policy exclusion. Such a legal standard may apply in assessing whether the facts alleged implicate a duty to defend (for example, under “insuring agreement” provisions), but may not apply in analyzing whether a particular exclusion bars a defense. Such a denial of defense, based on mere inferences drawn from the facts alleged, would embody a radical departure from precedent. Decades of settled case law requires a narrow construction of exclusionary language.

Policy language often necessarily focuses on whether the facts alleged establish liability. Contemplating such a situation, the court in Bridge Metal Indus., LLC. v. Travelers Indem. Co.[1] reasoned:

The operative act giving rise to recovery. . . was the alleged copying of National’s designs, not the breach of the confidentiality agreement. . . . Under New York law, such an exclusion is governed by a "but for" test, such that the exclusion applies only if the advertising injury suffered . . . would not exist but for the breach of contract . . .. [O]nly then would [the insurer] not be obligated to indemnify [the insured].

Courts are likewise unwilling to find that the inference of an excluded claim nested within other allegations is sufficient to deny indemnity or a defense. In St. Paul Mercury Ins. Co. v. Tessera, Inc.,[2] the court wrote:

St. Paul argues that the intellectual property exclusion clause is triggered by PTI’s allegations that Tessera breached the TCC License. St. Paul’s theory is that Tessera conveyed intellectual property right to PTI via license agreement, and that PTI’s [possible] allegations of breach constitutes a claim for damages resulting from infringement violation of such rights…[However] a patent “does not provide the patentee an affirmative right to practice a patent but merely the right to exclude” … a patentee may enforce its right to exclude by bring an action for infringement… In Paragraph II.A of the TTC Licensing, Tessera grants PTI “a world-wide, non-exclusive, non-transferable, non-sublicensable, limited license to Tessera patents to assemble ICs into TCC Licensed Products or use or sell such TCC license products…”… St. Paul’s argument boils down to the assertion that any use of the term “patent rights” or “intellectual property rights” in a license agreement creates an affirmative intellectual property right, that a claim brought under the agreement constitutes a claim for “infringement or violation” of such rights…Because PTI acquired a nonexclusive license under the agreement, PTI’s claims for breach sound in contract- rather than intellectual property rights- and do not trigger the intellectual property exclusion.

No cases analyzing analogous policy language preclude a defense absent either a labeled claim or clear fact allegations that support imposition of liability for the excluded offense.

Even with the Possibility of Excluded Offenses, Broad Construction of Exclusion Shows Ambiguity

Terms of art like “infringement” and “violation” are not construed according to a lay person’s definition. Indeed, cases such as Town of Massena have sought to effectuate “litigation insurance” and satisfy the insured’s “reasonable expectations.”[3] Massena concluded that “while a trial. . . could result in a determination revealing no indemnification obligation. . . [the insurer] has a duty to defend under the HPL policy.”[4]

Further, amendment of the fact allegations to incorporate claims that fall within an exclusion does not destroy the duty to indemnify, particularly where the core of the dispute is the covered offense rather than the new, excluded one. A lawsuit whose base is a dispute over a license agreement, for example, cannot be transmogrified in to one for trademark infringement.

As Schlather, Stumbar, Parks & Salk, LLP v. OneBeacon Ins. Co.[5] explained:

Although the Policy does not define the term “arising out of,” in the context of insurance exclusions, New York law defines the term as “originating from, incident to, or having connection with. . ." Moreover, this term “should be interpreted as narrowly as possible in an insurance exclusion, because any ambiguities in insurance contracts should be resolved in favor of the insured.”[6]

An Exclusion Must Be Clear and Conspicuous Read in the Context of the Whole Policy

“To negate coverage by virtue of an exclusion, an insurer must establish that the exclusion is stated in clear and unmistakable language, is subject to no other reasonable interpretation, and applies in the particular case.”[7] The New York Court of Appeals has enforced “policy exclusions only where [they] found them to ‘have a definite and precise meaning, unattended by danger of misconception…’”[8]

As the Second Circuit explained in Hugo Boss Fashions, Inc. v. Federal Ins. Co.[9]:

[S]o long as the claims [asserted against the insured] may rationally be said to fall within policy coverage, whatever may later prove to be the limits of the insurer's responsibility to pay, there is no doubt that it is obligated to defend.” . . . [Any factual or legal uncertainty about the defense duty] will ultimately be resolved by courts or juries – and often in favor of the insurer, thereby precluding coverage and the duty to indemnify.

Policy Language Cannot Add Words of Limitation to an Exclusion under the Guise of Interpretation

Where policy language relates back to the implicit definitions of those same words elsewhere in the policy, the use of the same phrases must have the same meaning in each location. A contrary construction of the same language, where the layperson’s definition would encompass multiple reasonable constructions, is not colorable. Constructions that render the other instances inconsistent or unintelligible are disfavored, as are those that render policy language redundant and superfluous.[10] Indeed, any reasonable construction will establish why a defense duty arises.[11] “Thus, an insurer that wishes to rely on an exclusion has the burden of proving, through conclusive evidence, that the exclusion applies in all possible worlds.”[12]

Conclusion

Policyholders should be wary of insurers’ reflexive attempts to deny coverage, and should not be cowed simply because an insurer points out that some component of a lawsuit falls under an exclusion. Exclusions do not excuse insurers from a duty to defend or indemnify as automatically as they might like to think. Savvy coverage counsel can help in finding all of the ways a lawsuit may yet trigger the insurer’s duty to defend.

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[1]  559 Fed. App’x 15, 19-20 (2nd Cir. (N.Y.) 2014) (alterations and emphasis in original) (internal citations and quotations omitted).

[2] 2016 U.S. Dist. LEXIS 81464, *9-14 (N.D. Cal. 2016), aff’d 624 F. App’x 535 (9th Cir. 2015).

[3] Town of Massena v. Healthcare Underwriters Mut. Ins. Co., 834 N.Y.S 2d. 736, 739 (2007).

[4] Id. at 740.

[5] 2011 U.S. Dist. LEXIS 147931 at *19-20 (N.D.N.Y. Dec. 22, 2011) (emphasis added).

[6] Id. (quoting Gluck v. Executive Risk Indem., Inc., 680 F. Supp. 2d 406, 419 (E.D.N.Y. 2010)) (emphasis added). California law embraces the same rule. See My Choice Software, LLC v. Travelers Cas. Ins. Co. of Am., 823 Fed. App’x 510, 512 (9th Cir. (Cal.) August 10, 2020).

[7] Hotel des Artistes, Inc. v. Gen. Accident Ins. Co. of Am., 775 N.Y.S. 2d 262, 268 (App. Div. 2004).

[8] Pioneer Tower Owners Ass’n v. State Farm Fire & Cas. Co., 12 N.Y.3d 302, 307 (2009).

[9] 252 F.3d 608, 620 (2nd Cir. (N.Y.) 2001).

[10] Int’l Multifoods Corp. v. Commercial Union Ins. Co., 309 F.3d 76, 86 (2d. Cir. 2002).

[11] MacKinnon v. Truck Ins. Exch., 31 Cal. 4th 635, 655 (2003) (“[E]ven if [the insurer’s] interpretation is considered reasonable, it would still . . . have to establish that its interpretation is the only reasonable one.  ‘[W]e are not required, in deciding the case at bar, to select one “correct” interpretation from the variety of suggested readings.’ ”) (citation omitted).

[12] Atlantic Mut. Ins. Co. v. J. Lamb, Inc., 100 Cal. App. 4th 1017, 1039 (2002); Nat'l Fire Ins. Co. v. E. Mishan & Sons, Inc., 650 F. App'x 793, 796 (2d Cir. 2016) (“Under New York law, the Insurers have a ‘duty to defend,’ under which they are ‘obligated to defend the insured until the applicability of the exclusions is determined.’ CGS Indus., Inc. v. Charter Oak Fire Ins. Co., 720 F.3d 71, 77 (2d Cir. 2013)”).