Management Liability Insurance: Amounts Due Based on "Pre-Existing Duty" Not Covered Loss

Management Liability Insurance: Amounts Due Based on "Pre-Existing Duty" Not Covered Loss

An employer's management liability insurance policy does not provide coverage for employees' claims that - contrary to statutory requirements -- the employer collected and failed to remit gratuities, because amounts owing due to a preexisting statutory duty do not represent covered loss, according to a recent decision of a Massachusetts federal court applying Massachusetts law. The September 10, 2012 decision can be found here. The decision is the subject of a November 26, 2012 post on the blog, here.


The Kittansett Club is a golf club in Marion, Massachusetts. According to the allegations in the underlying complaint, the club typically adds an 18% gratuity to food and beverage bills. A lawsuit filed on behalf of servers and bartenders at the club alleged that the club did not remit the gratuities to the servers at the club, but rather retained the gratuities or distributed them to management, in violation of a Massachusetts statute requiring employers imposing service charge or tip to remit the amounts to the service staff. The claimants also alleged breach of an implied contract, interference with contractual relations and unjust enrichment. The claimants sought restitution, injunctive relief, liquidated damages and attorneys' fees. The club ultimately settled the servers' claims.

The club submitted the servers' complaint as a claim under its management liability insurance policy. The policy included both a directors and officers liability coverage part and an employment practices liability part. The club's insurer denied coverage for the claim, arguing that the damages the claimants sought to recover did not arise from an alleged wrongful act but rather from a pre-existing statutory duty. When the insurer denied coverage for the claim, the club initiated a coverage action against the insurer in Massachusetts state court. The insurer removed the action to federal court, and the parties cross moved for summary judgment.

The September 10 Ruling

In her September 10, 2012 Memorandum and Order, Judge Denise J. Casper granted the insurer's motion for summary judgment. In considering the insurer's position, Judge Casper reviewed a number of cases -- including in particular the Fourth Circuit's February 2012 opinion in Republic Franklin Insurance Co. v. Albemarle County School Board -- standing for the proposition that amounts owing as a result of a statutory obligation do not represent covered "loss" under a liability insurance policy. Judge Casper quoted the Fourth Circuit's decision as saying that the case authorities on which it relied stand for the proposition that a judgment ordering an insured to pay money that the insured was already obligated to pay, either by contract or statue, is not a 'loss' covered under an insurance policy that requires that the loss be caused by a 'wrongful act.' The alleged 'loss' in such cases arises from the contract or the statute itself, not from the failure to abide by it.

Judge Casper held that the right of restitution for gratuities the club's servers asserted "arose not from the wrongful act, but the Insureds' pre-existing duty" under the Massachusetts statute requiring employers collecting tips or service fees to remit those amounts to the service staff.

The claimants in the underlying claim sought not only payment of the unpaid gratuities but also statutory treble damages, attorneys' fees and costs. The insurer argued that these amounts were also outside the definition of loss because they represented penalties for which the policy did not provide coverage. Judge Casper concluded that these other amounts were compensatory in nature, and therefore not excluded as penalties that could be covered under the policy - "if no exclusion applied."

The insurer further argued that the policy's Earned Wages exclusion operated to preclude these other amounts, and Judge Casper agreed. The exclusion provides that there is no coverage under the policy "for any Claim related to, arising out of, based upon, or attributable to the refusal, failure or inability of any Insured(s) to pay Earned Wages." The policy defines "Earned Wages" to mean "wages or overtime pay for services rendered." Judge Casper concluded that "the usual and ordinary meaning of wages in this context would include gratuities." Therefore, she concluded, "the Exclusions excluding coverage for any claims arising out of an insured's failure to pay Earned Wages unambiguously applies in this case and the Insureds are not entitled to coverage under the Policy."


At one level, Judge Casper's decision is no surprise. As Judge Casper herself noted, after concluding that the alleged misconduct in the underlying complaint constituted a "wrongful act" within the meaning of the policy, that fact does not, she said, "allow the Insureds to ignore their statutory obligations by shifting costs to their insurer." Insured companies cannot, Judge Casper seems to be saying, withhold compensation from their employees and then shift the bill for the unpaid amounts to their insurer.

The "no loss" argument on which the insurer relied is based on increasingly well-established case authority; as the blog notes, Judge Casper's decision "joins a series of cases" including the Fourth Circuit's decision in the Republic Franklin case) holding that "when an Insured is only being forced to return that which it never had a legal right either to receive or retain, insurance is not available."

The more troublesome aspect of this decision relates to the fact that the claimants in the underlying claim sought further relief beyond just the remittance of the unpaid gratuities; they sought amounts that Judge Casper expressly found to be compensatory in nature. In addition, the golf club itself incurred expenses defending against the claimants' claims, yet all of these amounts were found to be precluded from coverage under the policy's Earned Wages exclusion.

This latter part of Judge Casper's opinion illustrates how broadly these types of wage claim exclusions can sweep. If nothing else, Judge Casper's ruling in this case is a reminder to insurance practitioners to review these exclusions to determine whether or not they would apply more broadly than intended. The exclusionary language of the type on which the insurer relied in this case typically is found in an exclusion referred to as the FLSA exclusion or the wage and hour exclusion, designed to preclude coverage primarily for alleged overtime and minimum wage violations. As this case shows, these exclusions can be worded so as to sweep far beyond just overtime and minimum wage claims.

Finally, it is worth noting that at least some contemporary management liability policies include some sublimited defense cost coverage for FLSA and wage and hour claims. From the face of Judge Casper's opinion it does not appear that this policy provided this type of sublimited defense cost protection. This case does however provide a reminder that the sublimited defense cost protection afforded in these types of coverage extensions should be worded broadly enough to extend defense cost protection, for example, to all of the "Earned Wage" violations otherwise precluded from coverage under this policy. subscribers can access a Lexis enhanced version of the Republic Franklin Ins. Co. v. Albemarle County Sch. Bd., 670 F.3d 563 (4th Cir. Va. 2012) decision with summary, headnotes, and Shepard's.

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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