Fifth Circuit Reverses District Court’s Broad Reading of Contract Exclusion

Fifth Circuit Reverses District Court’s Broad Reading of Contract Exclusion

By David A. Gauntlett*

Introduction

After years of litigation, the dispute between SXSW and its insurer has been resolved via settlement. The parties reach an agreement following a reversal by the Fifth Circuit that adopted a narrow reading of the policy’s Contract Exclusion.[1] The court concluded that a defense was owed in the underlying class action lawsuit against SXSW following cancellation of the 2020 South by Southwest Festival due to COVID restrictions implemented by the city of Austin, Texas where the event is held each year.

SXSW’s Construction of Contract Exclusion Was Reasonable

The underlying case sought recovery of money spent on tickets for the cancelled festival despite a no-refund clause in the purchasing terms and conditions. The plaintiffs asserted causes of action for Breach of Contract, Unjust Enrichment, and Conversion. After receiving notice of the complaint, the insurer denied any duty to defend, relying primarily on the policy’s Contract Exclusion. It provided:

The Company shall not be liable for Loss on account of any Claim against an Organization: . . . based upon, arising from or in consequence of any liability in connection with any oral or written contract or agreement to which an Organization is a party . . . .[2]

SXSW’s arguments against the exclusion’s applicability focused on the phrase “liability in connection with any . . . contract.” In SXSW's view, the question was not whether the contracts were the but-for cause of the underlying action, but whether the claims in the complaint alleged liability under a contractual obligation. Such a claim could include breach of contract, which the underlying plaintiffs asserted in the complaint. But they also brought claims for unjust enrichment and conversion—two state law causes of action that do not arise from contracts.[3]

The court determined that this construction of the exclusion was reasonable. As it noted, “[t]he Bromley Plaintiffs could have asserted their claims of unjust enrichment and conversion even absent a contract between them and SXSW.”[4] Because those counts were not necessarily excluded, the insurer was obligated to provide a defense for at least the Unjust Enrichment and Conversion claims. The court did not explicitly address whether the Breach of Contract cause of action independently implicated the insurer’s duty, but Texas law requires that an insurer defend an entire suit if any portion is potentially covered.[5]

Insurer’s Preferred Reading of Exclusion Was Not Considered

The court acknowledged a different interpretation offered by the insurer:

SXSW contracted with the ticket purchasers who later sued in the Bromley class action. As Federal sees it, those contracts were the but-for cause of the litigation liability that SXSW later resolved by settling the class action. . . . Without the ticket purchase contracts, no purchaser litigation would have ever occurred. Since “the entire [Bromley Complaint] has a causal and incidental connection to [the purchase contracts],” . . . Federal believes it can deny coverage under the Contract Exclusion.[6]

Despite reciting this alternative construction, the court offered no analysis of its reasonableness. As it noted, no such analysis was necessary or proper.

We need not consider Federal's understanding of the exclusion because SXSW's reading of it is plainly reasonable. Gilbert Tex. Const., 327 S.W.3d at 133 (insured's reasonable reading of exclusion controls, even if insurance company's reading is better).

. . .

As the insured, SXSW has proffered a reasonable interpretation of the Contract Exclusion. Under Texas law, we must accept that interpretation. . . . The Contract Exclusion does not bar coverage for two of the claims in the Bromley Complaint: unjust enrichment and conversion.

 The same standard—asking only whether the insured’s construction is reasonable without considering whether the insurer offers a more reasonable one—is employed by many jurisdictions across the country.[7] The SXSW decision provides an example of how proper application of that standard can simplify the necessary analysis for determining whether a claim is potentially covered. Through its use, courts can avoid the complicated determination of which of two reasonable interpretations is more reasonable.

Insurers Other Arguments Were Deemed Without Merit

In addition to the Contract Exclusion, the insurer asserted three other grounds for denial: (1) the policy’s Professional Services Exclusion, (2) late tender, and (3) non-recoverable nature of restitution claims. The court rejected each in turn.

 The Professional Services Exclusion precluded claims “based upon, arising from, or in consequence of: . . . the rendering of, or failure to render, any Professional Services by an Insured.”[8] “Professional Services” was defined as “services which are performed for others for a fee.”[9] SXSW argued, and the court agreed, that the exclusion did not extend to SXSW's actions in refunding or not refunding ticket purchases, which were not services SXSW performed for a fee. Because the underlying complaint arose from SXSW's refusal to offer refunds—a decision that did not constitute a “professional service”—the Professional Services Exclusion did not apply.[10]

 The court’s final footnote in analyzing the exclusions is also significant as it highlights the impropriety of recent rulings that fail to demonstrate deference to the application of state coverage law.[11] Rejecting Federal’s reliance on various federal court decisions, it stated:

[T]hese authorities are worth relatively little in this case. Our focus is on Texas law as interpreted by the Texas state courts. See Starr Indem. & Liab. Co. v. SGS Petroleum Serv. Corp., 719 F.3d 700, 702 (5th Cir. 2013) (“In deciding an issue of Texas state law, we rule as we believe the Texas Supreme Court would rule.”). Given the manner in which the Texas state courts have approached contract exclusions, we believe SXSW's narrower interpretation better reflects Texas law.[12]

            The late tender argument was quickly dismissed as the court observed that the policy called for notice to be provided within thirty days of SXSW’s receipt of a claim. Evidence demonstrated that SXSW provided notice three days after it received notice of the underlying complaint, which the court determined was clearly timely.[13]

Finally, the court rejected the insurer’s argument that restitution claims could not be insured. As the court noted, Texas law distinguishes between restitution claims arising from illegal acquisition of funds and those arising from ordinary business transactions.[14] Only the former is potentially uninsurable.

Conclusion

The Fifth Circuit focused on whether the insurer’s preferred reading of the Contract Exclusion was the only reasonable construction rather than the most reasonable construction. By doing so, it simplified the analysis necessary to resolve the dispute. Broad enforcement of that same standard is consistent with the universally accepted rule that exclusionary language and limitations on coverage must be strictly construed against insurers. This rule also offers greater predictability for both insurers and policyholders as it avoids the need to weigh which of two reasonable interpretations is superior.

*David A. Gauntlett is a principal of Gauntlett & Associates and represents policyholders in insurance coverage disputes regarding intellectual property, antitrust, and business tort claims, as well as in the underlying actions. Mr. Gauntlett can be reached at (949) 553-1010 by voicemail or dag@gauntlettlaw.com. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.

[1] SXSW, L.L.C. v. Fed. Ins. Co., No. 22-50933, 2024 WL 1216560 at *6 (5th Cir. Mar. 21, 2024).

[2] Id. at *4.

[3] See City of The Colony v. N. Tex. Mun. Water Dist., 272 S.W.3d 699, 731 (Tex. App.—Fort Worth 2008) (“Generally speaking, however, when a valid, express contract covers the subject matter of the parties’ dispute, there can be no recovery under a quasi-contract theory, such as unjust enrichment.”)

[4] SXSW, L.L.C. v. Fed. Ins. Co., 2024 WL 1216560 at *5.

[5] Id. (“[B]ecause the complaint contains at least one covered claim, Federal ‘must defend the entire suit.’ Zurich Am. Ins. Co., 268 S.W.3d at 491.”)

[6] SXSW, L.L.C. v. Fed. Ins. Co., 2024 WL 1216560 at *4.

[7] See, e.g., 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); Kelleher v. Admiral Indem. Co., 958 N.Y.S.2d 308 (Sup. Ct. 2010) (“‘When the issue is the appropriate construction or interpretation to be placed upon an exclusionary clause in a policy, the carrier must establish that its construction or interpretation of the policy is the only construction that can fairly be placed thereon.’”) (quoting Am. Home Assur. Co. v. Port Auth. of New York & New Jersey, 412 N.Y.S.2d 605, 609 (1979)) (emphasis in original).

[8] SXSW, L.L.C. v. Fed. Ins. Co., 2024 WL 1216560 at *5.

[9] Id.

[10] Id.

[11] See David A. Gauntlett, Facts vs. Labels and Potential for Amendment Govern in New York, https://www.gauntlettlaw.com/news/facts-vs-labels-and-potential-for-amendment-govern-in-new-york (Mar. 14, 2024); David A. Gauntlett, California District Court Fails to Accept Deposition Testimony as Extrinsic Evidence, https://www.gauntlettlaw.com/news/california-district-court-fails-to-accept-deposition-testimony-as-extrinsic-evidence (Feb. 29, 2024).

[12] SXSW, 2024 WL 1216560 at *5, n.4.

[13] Id. at *6.

[14] Id. (citing Nortex Oil & Gas Corp. v. Harbor Ins. Co., 456 S.W.2d 489, 493–94 (Tex. Civ. App. 1970)).