Misdirection: The (Rising?) Use of Unstated Exclusions to Deny Coverage

Misdirection: The (Rising?) Use of Unstated Exclusions to Deny Coverage

In magic it is called misdirection. “Look at the floating bikini-clad lass seeming to defy gravity,” the magician suggests, “and look at the hoop passed around her to prove there are no wires; but ignore the fact that the hoop has gaps in it to pass over the wires.”
 
Misdirection is practiced by insurance companies with what I perceive to be increasing frequency when denying claims. It may take several forms, but one of the most common is the fabrication of an implied policy exclusion or forfeiture clause notwithstanding the fact that a claim otherwise falls within the basic insuring agreement. Policyholders should be careful to identify such misdirection when it occurs. Once the fallacy is revealed, the courts generally find the misdirection unacceptable and hold in favor of the insureds.
 
This situation arises most commonly when an insurance company or its counsel makes the argument that a claim is not covered, based upon an unstated exclusion the insurer reads into the policy based upon an interpretation of policy language, the policy “taken as a whole,” or even public policy -- despite the fact that an express grant of coverage in the policy addresses the precise issue. That grant of coverage may appear in an insuring agreement, a specific endorsement, or a carve-out from an exclusion. Such insurer arguments may violate several general rules of insurance contract interpretation, including the rule that a court must give meaning to all contract terms, and not render a provision (such as a coverage grant) surplusage;1 the rule that exclusions, exceptions or limitations to coverage “are strictly construed against the insurer . . . [and therefore a] risk that comes naturally within the terms of a policy is not deemed to be excluded unless the intent of the parties to exclude it appears clearly, so that it cannot be misconstrued,” 2 or the rule that insurance policies “must not be so construed as to work a forfeiture, unless by clear and unambiguous language, readily understandable . . . by businessmen of average intelligence . . . “.3 On the other hand, in some circumstances, an exception to a policy exclusion cannot, by itself, create coverage where the coverage is not otherwise provided by the policy.4
 
Insurers attempt to argue the existence of unstated, implied (or to call a spade a spade, fabricated) exclusions across all lines of coverage, from CGL to D&O. Here are a few notable examples from the caselaw.
 
In Hotel des Artistes, Inc. v. General Acc. Ins. Co. of America, 9 A.D.3d 181, 775 N.Y.S.2d 262 (N.Y. A.D. 2004), a hotel restaurant that was damaged in a fire sued the hotel operator for loss of income due to the hotel’s failure to meet its lease obligations to complete repairs in a timely fashion. The hotel tendered the claim to its CGL insurer under a standard policy covering amounts the insured is “legally obligated to pay as damages because of bodily injury and property damage to which the insurance applies.” The policy also contained a standard contractual liability exclusion that excepted from its scope any “insured contract,” including any lease. The insurer denied the claim on the ground that the CGL policy generally does not provide coverage for losses caused by the insured’s failure to perform its contractual obligations. The appellate court made short shrift of this argument. The underlying claim by the restaurant for breach of the lease following a fire fell squarely within the insuring agreement, the court held, and, the insurer conceded that the contract exclusion did not apply. Id. at 188-189.   The court rejected the theory that the policy contains an implicit exclusion for “contractual obligations” as contrary to the general rule that “the 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. [citations omitted] Further, ‘policy exclusions are not to be extended by interpretation or implication, but are to be accorded a strict and narrow construction.’” Id. at 189.
 
In simpler terms, the express contractual liability exclusion set forth the bargain struck by the insured and the insurer as to which contractual claims were covered and which were not. Any other policy terms should be construed to give meaning to the expressly delineated provision, and not to render it meaningless.
 
An appellate court violated these principles in CNL Hotels & Resorts, Inc. v. Twin City Fire Insur. Co., 291 Fed. Appx. 220 (11th Cir. 2008). There, the court accepted an insurer’s argument under a directors and officers liability policy that public policy concerns trump these principles of construction. CNL had been sued by its shareholders under Section 11 of the Securities Act of 1933 for damages as a result of a stock offering that allegedly overvalued the stock price by $8 per share. The class action was settled for $35 million and CNL sought coverage under the D&O policies. The insurers denied the claim, arguing that the settlement amount constituted disgorgement of “ill-gotten” gains that did not constitute a “loss” within the meaning of the policy, citing Level 3 Communications, Inc. v. Fed. Ins. Co., 272 F.3d 908, 910 (7th Cir. 2001) (another anti-policyholder decision by Judge Richard Posner). The court agreed, concluding that the return of money obtained by the insured through violation of law, even if the insured was innocent in committing the violation, is not a “loss.” Id. at 223. Yet the panel (and the district court below) rejected CNL’s argument that the insuring agreement explicitly covered claims under the Securities Act of 1933, of which Section 11 is a part. Thus ignoring the express grant of coverage for the exact claim at issue, the court chose to fabricate an exclusion based upon a public policy-driven interpretation of “loss.” Again, by misdirection, the insurer was able to keep the court’s eyes deflected from the parties’ understanding, as reflected in the stated wording of the coverage grant.
 
Finally, in a recent case, Dyncorp. v. Certain Underwriters at Lloyd’s, London, C.A. No. 08C-09-218 (D. Del. Nov. 9, 2009), the court addressed a claim for coverage under aviation liability policies for lawsuits brought by landowners allegedly damaged by Dyncorp’s aerial spraying to eradicate drug crops in Columbia. The insurer denied coverage, in relevant part, under the policy’s pollution exclusion. However, the insured pointed out that the policy included a separate exclusion for aerial spraying, which excepted from its scope spraying that was declared to the insurers, which the insured had done. In granting summary judgment for the insured on the duty to defend, the court relied on the more specific provision, which afforded coverage for the “spraying” claims, concluding that “if the spraying operations of Plaintiffs were intended to fall under the Pollution Exclusion, there would not be a need to have a separate exclusion for undeclared “crop dusting” and “spraying.” (Slip Op. at 16).
 
These cases illustrate the variety of contexts in which an insurer may deny coverage by misdirecting attention away from an express grant of coverage to an unstated exclusion, or from an exclusion’s express carve-out to a less specific exclusion. And they show the divergence in the approaches the courts will take in response. I have seen no reliable data to support the hypothesis that the reliance on such unstated exclusions is on the rise, but from a sampling of the claims that our practice group has been asked to handle, that appears to be the case. I would be grateful to receive other examples or data on this point.
 
 
Peter M. Gillon
Pillsbury Winthrop Shaw Pittman
Washington, D.C.
 
                                                     l
 
[1] See, e.g., King v. Dallas Fire Ins. Co., 85 S.W. 3d 185, 192-193 (“[T]he construction given to the word ‘occurrence’ by Dallas Fire renders the exclusion for intended injury surplusage. [O]ur duty is to give effect to all contract provisions, and render none meaningless. Finally, to read ‘occurrence’ as narrowly as Dallas Fire suggests obviates the need for many other standard exclusions. . . “); Raymond Corp. v. Nat’l Union Fire Ins. Co., 5 N.Y.3d 157 (N.Y. 2005) (“We construe the policy in a way that affords a fair meaning to all of the language employed by the parties in the contract and leaves no provision without force and effect.”); U.S. Fire Ins. Co. v. J.S.U.B. Inc., 979 So.2d 871 (Fla. 2007)(rejecting interpretation of insuring agreement that would render language in exclusion meaningless).
[2] Couch on Insur. 3d § 22.31 (citations omitted).
[3] Couch on Insur. 3d § 22.35, citing Zivitz v. Maryland Casualty Co., 192 A.D. 83, 182 N.Y.S. 321 (1920).
[4] Continental Casualty Co. v. Pittsburgh Corning Corp., 917 F.2d 297 (7th Cir. 1990), reh’g. denied, en banc, 1990 U.S. App. Lexis 21758 (7th Cir. Dec. 17, 1990) (in coverage action seeking defense costs for asbestos products liability claims, court held that where excess policy excluded “legal expenses” from covered “loss,” and the definition of “legal expenses” excepted “retained counsel,” there was no coverage for outside counsel, as exception was properly interpreted to mean “in-house counsel.” The Court went on to observe that when the policy excludes coverage for defense costs, but the definition of defense costs does not include in-house counsel, that exception does not create coverage for in-house counsel, it being a principle of contract interpretation that “an exclusion from insurance coverage cannot create coverage.”).