Insurers Must Establish That Exclusions Apply in “All Possible Worlds”

Insurers Must Establish That Exclusions Apply in “All Possible Worlds”

By David A. Gauntlett[*]

Introduction

Insurers’ often combat policyholders’ quests for potential coverage of lawsuits by asserting exclusions that bar a defense based on the “gravamen” of the suit.[2] The principal focus of a lawsuit characterized by insurers as “what the suit is about” or equivalent phrasing purportedly bars a defense because of various exclusions. Courts, which typically look to the tort claims asserted to discern what the lawsuit is about, believe that determining if potential coverage exists requires no more than a common sense view of what the lawsuit is about. That approach, however, is not the legal test in evaluating the duty to defend. It is therefore not uncommon for appellate courts to routinely reverse district court decisions that fail to apply the proper legal analysis called for in addressing whether there is any possibility that coverage will arise.

Many of these coverage reversals apply in cases where insurers have failed to establish that the exclusions they relied upon preclude coverage in “all possible worlds.”[3] Typical exclusions that generate these reversals include those for “Breach of Contract,” “Failure to Conform,” “Knowing Violation,” and “Intellectual Property.”

Breach of Contract

In Autodistributors, Inc. v. Nationwide E&S Specialty, the Plaintiffs admitted in their Complaint that “‘[u]nder the Franchise Agreement, Auto Distributors was granted the right to use and was obligated to use Sixt's distinctive marks, slogans, advertising material, color scheme, and other intellectual property in Auto Distributors' business operations, including but not limited to its marketing, advertising, and website.’”[4] The court ruled in favor of the insurer because “any potential liability . . . necessarily arises out of the breach of the franchise agreement and is excluded from coverage.”[5]

A more policyholder-friendly decision came in AAA Cabinets & Millworks, Inc. v. AMCO Insurance Co., where the court properly applied the “all possible worlds” approach finding that the “Breach of Contract” exclusion did not bar a defense.[6]

Failure to Conform

Many older decisions take a simplistic view of this exclusion.[7] A recent Third Circuit case applying Pennsylvania law, however, adopted a more nuanced analysis concluding that a defense arose despite a broadly worded exclusion exclusion. In Vitamin Energy, LLC v. Evanston Insurance Co., the court correctly looked past the underlying complaint’s “claims against Vitamin Energy for its representations about its own products' ‘steroid-like’ performance and vitamin content.”[8] In doing so, it embraced a view akin to J. Lamb’s “all possible worlds” interpretation of the exclusions at issue.[9]  

Knowing Violation

Vitamin Energy also addressed application of the “Knowing Violation” exclusion, eschewing the broad construction approach[10] and denying the insurer’s attempt to overreach.[11] Allied Property & Casualty Insurance Co. v. Armadillo Distribution Enterprises, a case decided just last month, adopted the same approach where the insurer could not demonstrate the exclusion’s preclusive effects on the fact allegations in the entire underlying complaint.[12]

Intellectual Property

In H&H Insurance Services v. Endurance American Specialty Insurance Co.,[13] a woman left her employer to start her own business in the same field. She allegedly improperly solicited employees and engaged in unfair competition, injuring her former employer in that effort.[14] The court denied potential coverage in an expansive application of the “Intellectual Property” exclusion due to its inclusion of “arising out of,”[15] a policy Legion rebuffed.[16] Other cases gave primacy to supreme court case law requiring the narrow construction of exclusions. Thus, in Sprint Lumber, Inc. v. Union Insurance Co., the court rejected the insurer’s argument to deny coverage for an entire lawsuit merely because a singular IP claim was included.[17]

Conclusion

Despite insurers’ best efforts to convince courts that an exclusion justifies a denial whenever it applies to the heart or predominant focus of a complaint, recent decisions see past that obfuscation. It is still an uphill battle to convince courts to look past decades of bad case decisions. But there is light at the end of the tunnel as J. Lamb’s “all possible worlds” view of coverage gains traction among judges who properly apply principles applicable to the evaluation of the duty to defend.

If you enjoy this content, you can find my full list of blogs here: https://docs.google.com/document/d/1N3YsMmn0Ii1GqHWSBEE1pPzh1jQbU6htkJZ2e55Y2eM/edit?usp=sharing

[*] 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. He also serves as an expert witness on insurance coverage issues and represents policyholders and their counsel on a range of fee dispute issues with their insurers. Mr. Gauntlett can be reached at (949) 514-5662 or dag@gauntlettlaw.com. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.

[2] Curtis-Universal, Inc. v. Sheboygan Emerg. Med. Servs., Inc., 43 F.3d 1119, 1122 (7th Cir. (Wis.) 1994) (Posner), cited in Cincinnati Ins. Co., 260 F.3d at 745 (applying Illinois law) (“Nor is the insurer allowed to escape from his duties of defense and indemnity by reference to the core or dominant character of the plaintiff’s allegations.”); Pension Trust Fund v. Fed. Ins. Co., 307 F.3d 944, 951 (9th Cir. (Cal.) 2002) (“The duty to defend does not usually turn on whether facts supporting a covered claim predominate or generate the claim. . . . [R]emote facts buried within causes of action that may potentially give rise to coverage are sufficient to invoke the defense duty . . . [and the] law does not require that the insured’s conduct proximately cause the third party claim in order to trigger the defense duty.”) (emphasis added).

[3] Atlantic Mut. Ins. Co. v. J. Lamb, Inc., 100 Cal. App. 4th 1017, 1039 (2002) (“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.”)

[4] No. 21-cv-06204-HSG, 2022 U.S. Dist. LEXIS 152325, *10 (N.D. Cal. Aug. 24, 2022).

[5] Id.

[6] No. 2:20-CV-0318-TOR, 2021 U.S. Dist. LEXIS 155029, *22 (E.D. Wash. Aug. 17, 2021) (“[T]o the extent any allegations in the Underlying Complaint are premised on a breach of contract, the breach of contract theory was disputed in the underlying litigation. . . . Therefore, Defendant had a duty to defend until it obtained a declaratory judgment releasing it from its duty.”) 

[7] See, e.g., Basic Research, LLC v. Admiral Ins. Co., 297 P.3d 578, 582 (Utah 2013) (“[E]ach of the underlying claims is premised on Akävar's failure to perform as advertised. . . . The underlying claims assert injury and damages resulting from Akävar's failure to live up to the promises of quality and performance expressed by the slogans.”)

[8] 22 F.4th 386, 396 (3d Cir. (Pa.) 2022).

[9] Id. (“[A]s discussed above, it is Vitamin Energy's alleged misrepresentation of the ingredients in 5-hour Energy's products, not Vitamin Energy's own products, that creates the possibility of coverage. . . . Accordingly, the exclusions do not affect Evanston's duty to defend the lawsuit.”)

[10] See, e.g., Great Am. Ins. Co. v. Beyond Gravity Media, Inc., 560 F. Supp. 3d 1024, 1036 (S.D. Tex. 2021) (Improperly finding no coverage despite acknowledging the exclusion did not apply to the entirety of the underlying complaint based on a narrow construction of the “eight-corner” rule subsequently abandoned by the Texas Supreme Court: “The ‘knowing violation’ exclusion thus excuses Great American from the duty to defend for the bulk of Code Ninjas's claims—for breach of the non-competition and confidentiality covenants, intentional misappropriation of trade secrets, fraudulent rescission of the contract, knowing/malicious/willful/intentional unfair competition, and breach of the agreements and the resulting breach of the personal guaranties.”) (emphasis added).

[11] Vitamin Energy, 22 F.4th at 396 (“Vitamin Energy's alleged knowledge of trademark infringement does not eliminate coverage for a disparagement claim, and so does not eliminate the duty to defend.”)

[12] Civil Action No. 4:21-CV-00617-ALM, 2022 U.S. Dist. LEXIS 148232, *31 (E.D. Tex. Aug. 18, 2022) (Following Monroe Guar. Ins. Co. v. BITCO Gen. Ins. Corp., 640 S.W.3d 195 (Tex. 2022), “Here, the Court is not persuaded that the Knowing Violation of Rights exclusion would relieve Allied's duty to defend all of the underlying claims brought against Armadillo. First, even if Armadillo had knowledge that it was infringing some of Gibson's trademarks, the record does not show that Armadillo had knowledge that it was infringing all of the trademarks Gibson alleged were violated.”)

[13] No. 5:20-cv-07655-EJD, 2022 U.S. Dist. LEXIS 54289 (N.D. Cal. Mar. 25, 2022).

[14] Id. at *6–7.

[15] Id. at *15–16. (“[T]his Court must read each exclusion's ‘arising out of’ language broadly and because all claims flow from Huang's employment with Acrisure and involve the misappropriation of trade secrets, the Court concludes that Defendant has no duty to defend or indemnify Plaintiff in the Acrisure action.”)

[16] David A. Gauntlett, Three 2020 Coverage Cases Clarify Coverage Availability, https://www.gauntlettlaw.com/news/three-2020-coverage-cases-clarify-coverage-availability (Feb. 17, 2021).

[17] 627 S.W.3d 96, 112–13 (Mo. Ct. App. 2021) (“Union's argument under this point is based on its characterization that all of Porters's allegations in the Underlying Suit centered on and sought damages for the wrongful and unlawful misappropriation and disclosure of confidential information and trade secrets. That characterization, however, is far too sweeping. As discussed in point one, the Underlying Suit also involved the wrongful solicitation of its customers through the disparagement of Porters.”)