Lender Liability Coverage: Contractual Liability Exclusion Does Not Preclude Coverage for Interrelated Claim

Lender Liability Coverage: Contractual Liability Exclusion Does Not Preclude Coverage for Interrelated Claim

 In a March 20, 2014 decision involving interpretation of the interrelated wrongful acts provision and of the contractual liability exclusion in a bank professional liability insurance policy, District of Idaho Magistrate Judge Ronald E. Bush entered summary judgment on behalf of the policyholder, ruling that the underlying dispute was covered under the policy’s lender liability coverage section.

The Magistrate Judge’s interpretation of the interrelatedness issue is interesting because he found that an earlier and a subsequent claim were interrelated despite deposition testimony of the policyholder’s designated representative that the two claims were “not connected” and “independent.”

The Magistrate Judge’s noteworthy ruling that the contract exclusion did not apply to preclude coverage here depended on his finding that if applied here the exclusion “would serve to eliminate promised coverage” under the policy’s lender liability coverage section.

A copy of the March 20, 2014 opinion can be found here [an enhanced version of this opinion is available to lexis.com subscribers]. Hat tip to the Jones Lemon & Graham law firm’s D&O Digest blog for the link to the opinion. The law firm’s May 1, 2014 blog post about the opinion can be found here.

Background 

In August 2009, Inland Storage filed a third-party complaint against Idaho Trust Bank over the bank’s alleged refusal to extend promised financing for Inland Storage’s planned 2008 construction of an RV and boat storage facility. Inland Storage’s third-party complaint (referred to in the subsequent coverage opinion as the “2008 claim”) asserted four separate causes of action: breach of contract; breach of the implied covenant of good faith and fair dealing; estoppel; and detrimental reliance.

In February 2010, Inland Storage and the bank settled their dispute based on the bank’s agreement to provide Inland Storage with future loans which, if completed, would result in a mutual release of claims. A disagreement later arose regarding the bank’s funding of a loan for Inland Storage to purchase steel for the proposed RV storage facility.

In July 2010, Inland Storage filed a second amended third-party complaint against the bank, alleging that the bank breached the settlement agreement by failing to extend the 2010 steel loan. Inland Steel added two counts (counts 5 and 6) to its third-party complaint against the bank, alleging breach of contract and breach of the implied covenant of good faith and fair dealing. (In the subsequent insurance coverage lawsuit, Inland Storage’s claims based on the alleged breach of the settlement agreement were referred to as “the 2010 claim.”)

In November 2010, the court in the underlying action granted summary judgment for the bank on Counts 1-4 of the third-party complaint. The court denied summary judgment on counts 5-6 relating to Inland Storage’s claims that the bank had breached the 2010 settlement agreement. A subsequent jury trial resulted in a verdict in favor of the bank.

At the time Inland Storage first made its claim against the bank, the bank was insured under an Extended Professional Liability Insurance Policy, which included a lender liability coverage section. This section of the policy provides coverage for a “lending wrongful act,” which the policy defines, in relevant part, as “any actual or alleged error, misstatement, misleading statement, act or omission, or neglect or breach of duty by the company concerning an extension of credit, an actual or alleged failure or refusal by the company to extend credit or an actual or alleged agreement by the company to extend credit.”

The policy provided that claims based on interrelated wrongful acts are deemed first made when the earliest claim was made. The policy defined “interrelated wrongful acts” as “wrongful acts that have as a common nexus any fact, circumstance, situation, event, transaction, or series of facts, circumstances, situations, events or transactions.’

The policy contained a contractual liability exclusion providing that the insurer is not liable to make any payment for loss for any claims “based upon, arising out of, relating to, in consequence of, or in any way involving … any assumption by the company or an insured person of any liability or obligation under any contract or agreement, or the failure to perform any contract or agreement, unless such company or insured person would have been liable even in the absence of such contract or agreement.”

When the bank first submitted the Inland Storage claim to the insurer, the insurer agreed to reimburse the bank for its costs of defense, subject to a reservation of rights under the policy. However, after the November 2010 ruling in the underling lawsuit in which the state court granted summary judgment in favor of the bank with regard to counts 1-4 of Inland Storage’s third-party complaint, the insurer advised the bank that its policy would not cover damages relating to the remaining counts 5 and 6 and specifically that the policy’s contract exclusion precluded coverage for the two remaining claims. The insurer refused to continue funding the bank’s defense in the underlying litigation.

The bank filed an insurance coverage lawsuit in Idaho state court alleging that the insurer was required to but had failed to defend and indemnify the bank against the Inland Storage lawsuit. The insurer removed the lawsuit to federal court. The bank and the insurer cross-moved for summary judgment.

In its summary judgment motion, the insurer argued that the 2010 claim had been first made after the expiration of the policy period and therefore was not covered under the policy. The insurer also argued that in any event the 2010 claims was precluded from coverage under the policy’s contractual liability provision. The bank argued that the 2010 claim was interrelated with 2008 claim and therefore that the 2010 claim is “deemed” under the policy to have been first made at the time of the 2008 claim. The bank also argued that the contractual liability provision could not be reconciled with the coverage provided in the lender liability coverage section and therefore should not be enforced.

The March 20 Opinion 

In his March 20, 2010 Opinion, Magistrate Judge Bush granted summary judgment in favor of the bank and against the insurer, finding that the 2010 claim was interrelated with the 2008 claim and that the contractual liability exclusion could not be enforced to preclude coverage in these circumstances.

In arguing that the 2010 claim was not interrelated with the 2008 claim, and therefore was not deemed first made at the time of the earlier claim, the insurer had relied on deposition testimony of the bank’s designated representative, based upon which the insurer contended that the representative had made “admissions” that the subsequent claim was “independent” and “completely, logically not connected” to the earlier claim. The insurer also sought to rely on the summary judgment ruling in the underlying lawsuit, in which the judge in that case had referred to the 2008 and the 2010 claims as representing “two categories of claims.”

The Magistrate Judge rejected both of these arguments. The Magistrate Judge reviewed (and reproduced at length in his opinion) the bank’s designated representative’s deposition testimony. The Magistrate Judge agreed that the deposition testimony was “clearly relevant” but “on this record it is not dispositive.” The Magistrate Judge also found that the language from the underlying summary judgment ruling was not determinative, as neither the deposition testimony nor the underlying ruling were addressed to the specific inquiry required by the policy’s definition of interrelated wrongful acts. While the deposition testimony “may offer some piece to be used in that puzzle” and the state court’s opinion may be “useful,” neither is dispositive upon the Court’s interpretation of the insurance policy.

The Magistrate Judge went on to conclude that the policy’s definition of “interrelated wrongful acts” describes “a broad range of relationships that is decidedly satisfied here.” The 2008 and 2010 claims, the Magistrate Judge said “share as a common nexus, facts circumstances and events,” adding that “the 2010 claim would not exist but for the attempts to settle the 2008 claim” and that the two claims “involve the same parties, the same lending relationship between the parties and the same underlying subject matter (the steel for [the] proposed RV facility).” The Magistrate Judge concluded that “reasonable minds could not differ as to the conclusion that these two claims were interrelated and according the 2010 claim falls within [the insurer’s] policy period.”

The Magistrate Judge also concluded that the contractual liability exclusion did not preclude coverage. The Magistrate Judge said that although the two causes of action identified in the 2010 claim were identified as “breach of contract” and “breach of the implied covenant of good faith and fair dealing,” they both “stem from [the] allegation that Idaho Trust promised to extend a loan and subsequently failed to do so,” which he noted, “falls squarely within the definition of a ‘lending wrongful act.’”

Notwithstanding the form in which the 2010 claims were asserted, the contractual liability exclusion is “unenforceable” because it “would eliminate coverage for something otherwise clearly covered under the Policy.” An insurer, the Magistrate Judge said “cannot seek to apply policy limitations and exclusions in a way to defeat the precise purpose for which the insurance is purchased.”

The Magistrate Judge went on to note that “while the Court does not find the contractual liability exclusion to render the Policy completely illusory, the Court will not enforce it against Idaho Trust on the particular facts in this case.” The Magistrate Judge emphasized that an insurer “cannot in one section provide coverage or acts that include ‘an actual or alleged agreement’ and then, in another section, attempt to exclude coverage for claims ‘based upon [or] arising out of’ the failure to perform any contract or agreement.” The Magistrate Judge found that the two provisions “cannot be reconciled,” adding that the contractual liability exclusion “frustrates the purposes for which the insurance was purchased and should be strictly construed in favor of Idaho Trust.”

Discussion 

With respect to the Magistrate Judge’s determination of the interrelatedness issue, it is on one level not surprising that a court might conclude on this record that the 2008 and 2010 claims are interrelated. However, it is noteworthy that the determination of this issue was so clear – at least to the Magistrate Judge — that the policyholder was entitled to entry of summary judgment in its favor, notwithstanding the arguable contradictory testimony of the bank’s designated representative.  In that regard, the bank’s designated representative’s testimony may not, as the Magistrate Judge said, be dispositive, but it is, as the Magistrate Judge also said, “useful” and a relevant piece in the puzzle.

Notwithstanding the potentially relevant and arguably contradictory testimony, the Court nevertheless found no material issue of disputed fact that might otherwise have precluded summary judgment. (I will say based on my own reading of the deposition testimony reproduced in the court’s opinion that it is just about impossible to follow the colloquy between the attorney’s questions and the witness’s testimony, and I am not sure what the witness said or didn’t say).

In the end, the Magistrate Judge’s determination of the interrelatedness issue simply corroborates my long-standing view about interrelatedness disputes generally, which is that courts generally approach the analysis of interrelatedness issues with an unconscious bias in favor of whatever outcome will maximize the amount of insurance available.

The Magistrate Judge’s ruling on the contractual liability exclusion is more interesting and arguably troublesome. The Magistrate Judge found the contractual liability provision’s preclusive effect to be objectionable and therefore unenforceable because it would “eliminate coverage for something otherwise clearly covered under the Policy.” I have to say that I find this observation just plain odd. Of course the exclusion precludes coverage for something that is otherwise covered under the policy, that is the very purpose of an exclusion from coverage. If the claim were not otherwise covered, there would be no need for an exclusion. Simply put, every exclusion in every insurance policy eliminates coverage for something otherwise clearly covered under the policy. If that alone were sufficient to vitiate policy exclusions, no exclusion in any insurance policy would be enforceable.

The Magistrate Judge did say that while the contractual liability provision is unenforceable in this case, the exclusion does not render coverage under the lender liability section “completely illusory;” indeed, in a footnote, he specifically recognized circumstances in which the section could provide coverage that would not be precluded by the exclusion.

As the Jones, Lemon & Graham firm noted in its blog post about the case, courts typically will refuse to enforce exclusions on this basis “only when it leaves nothing material covered.” Citing an insurance coverage hornbook stating that “the correct rule … is that an insurance policy does not afford illusory coverage if some material coverage is afforded,” the blog post’s authors note that “there’s nothing illusory about insurance if it provides material coverage, even if an exclusion narrows the coverage grant. The point of an exclusion after all is to narrow coverage.”

Regular readers of this blog know that a frequent gripe of mine is the (in my view) overly broad interpretation courts will sometimes give contractual liability exclusions having broad “based upon or arising out of” preambles. (Refer here for an example of a case illustrating this concern.) Notwithstanding my long-standing concern that the exclusion can sometimes be applied overly broadly, I have never thought that the exclusion ought to be unenforceable. Insurers understandably do not feel they should be liable for their policyholder’s voluntary contractual obligation.

Significantly the Magistrate Judge did not say the contractual liability provision would be unenforceable in any circumstance, but only “on the particular facts of this case.” In particular, it was the interaction between the definition of “lending wrongful acts” – which definition includes “an actual or alleged agreement by the company to extend credit” – and the contractual liability provision, which precludes coverage for loss based upon or arising out of “the failure to perform any contract or agreement” that is at the heart of the Magistrate’s refusal to enforce the exclusion here. It is the two provisions’ specific references to an “agreement” that troubled the Magistrate Judge.

Whether or not the Magistrate Judge’s interpretation of the exclusion will withstand appeal (if any is pursued) remains to be seen. But the Magistrate Judge’s interpretation of the contract exclusion cannot be understood as and was not intended as a comprehensive rejection of the contractual liability exclusion. His unwillingness to enforce the exclusion is specifically relevant only in the context of the lender liability insuring provision and then only in a context in which both the coverage grant and the policy exclusion refer to refer to an “agreement.” For that reason, as interesting as the Magistrate Judge’s ruling is, it is unlikely to prove useful to policyholders seeking to limit the preclusive effect of a contractual liability provision in most other circumstances.  

 Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.

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