Fifth Circuit Reaffirm Acceptance of Reasonable Constructions

The Fifth Circuit’s most recent coverage decision reversed the district court and reaffirmed the principle of Texas coverage law that any reasonable construction of an exclusion advanced by the insured must be accepted. In Paloma Res., L.L.C. v. Axis Ins. Co., No. 22-20228, 2025 WL 1864957, at 2 (5th Cir. (Tex.) July 7, 2025), an employee of the insured entity allegedly colluded with employees of a competitor to steal and transfer confidential information.

Axis denied any duty to defend based on its IP exclusion. The exclusion precluded potential coverage for any claims arising out of: any actual or alleged infringement of copyright, patent, trademark, trade name, trade dress, or service mark or the misappropriation of ideas or trade secrets, or the unauthorized disclosure of or access to confidential information . . . .

Axis argued that the allegations clearly fell within the exclusion’s trade secret and confidential information provisions. Paloma argued that allegations were insufficient as the phrase “actual or alleged” only applied to the first portion of the exclusion (“infringement of . . . service mark”).

The Fifth Circuit panel (Judges Carl Steward, James Dennis, and Priscilla Richman) agreed with Paloma. It noted the grammatical inconsistency created by the word “the” before “misappropriation” in Axis’s construction. Id. at 2. The court deemed Paloma’s construction to be reasonable, thereby rendering the exclusion inapplicable for the duty to defend stage where an adjudication had not yet occurred.

The panel noted that the merits of Axis's construction were ultimately irrelevant since it was bound to accept any reasonable construction of the insured. Id. at 3 (“Texas courts ‘must adopt the construction of an exclusionary clause urged by the insured as long as that construction is not itself unreasonable, even if the construction urged by the insurer appears to be more reasonable or a more accurate reflection of the parties' intent.’”); see also SXSW, L.L.C. v. Fed. Ins. Co., No. 22-50933, 2024 WL 1216560, at 4 (5th Cir. (Tex.) Mar. 21, 2024) (“We need not consider Federal's understanding of the exclusion because SXSW's reading of it is plainly reasonable.”)

A Ninth Circuit panel facing analogous facts refused to accept this inconvenient truth and rejected a construction of a “Knowing Violation” exclusion that would similarly limit it to indemnity. Aram Logistics v. United States Liab. Ins. Co., No. 24-1046, 2025 WL 470888, *1 (9th Cir. (Cal.) Feb. 12, 2025). This despite ample precedent reaching that exact conclusion. Zurich Ins. Co. v. Killer Music, Inc., 998 F.2d 674, 678 (9th Cir. (Cal.) 1993) (“While Zurich characterizes Killer Music's infringement as ‘knowing,’ Killer Music's president Hicklin, by sworn affidavit, indicated that he did not know that any of Pfeifer's work was being used in the music library and that he ‘never intended to engage in any unauthorized use of any work owned in whole or in part by Pfeifer.’”)