Hunton Insurance Recovery Blog

The Seventh Circuit held last week that a manufacturer’s insurer must cover its insured, a designer and builder of anaerobic digesters, under its errors and omissions policy for claims alleging breach of contract, despite an exclusion in the policy for claims arising out of the breach of an express or oral contract. The decision in Crum & Forster Specialty Insurance Company v. DVO, Inc., No. 18-2571 (7th Cir. Sept. 23, 2019), illustrates the practical application of policy construction to avoid what would otherwise amount to an illusory promise of coverage.

The coverage action arises from a 2013 lawsuit filed against DVO in Wisconsin state court by WTE-S&S AG Enterprises LLC, alleging that DVO breached a contract based on its failure to properly design and build an anaerobic digester, a tank that converts cow manure into electricity. In addition, WTE alleged that DVO engaged in an unethical kickback scheme.

Crum initially defended DVO under a reservation of rights for the underlying action but withdrew from the case in 2015, relying on the breach of contract exclusion. Thereafter, in 2016, Crum brought the coverage action in Wisconsin federal court, seeking a declaration that it had no duty to defend or indemnify DVO in the underlying action. Following a trial, and while the coverage action was pending, a bankruptcy court in Illinois ordered DVO to pay WTE $65,000 in 2017.

In July 2018, the Wisconsin federal court overseeing the coverage action agreed with Crum and held that the breach of contract exclusion precluded coverage for the underlying state court action. The Seventh Circuit disagreed. Specifically, the court took issue with the “arising out of” language in the breach of contract exclusion. The court found that Wisconsin law, as in many states, interprets the language at issue broadly, and that applying it to a breach of contract exclusion would effectively preclude coverage for almost any action related to work performed under a contract. Accordingly, the court took into account the insured’s reasonable expectations and held that the breach of contract exclusion at issue rendered the professional liability coverage in the E&O policy illusory.

Professional liability policies typically contain breach of contract exclusions like the one before the court here. Policyholders must be wary of an insurer’s attempt to rely on a breach of contract exclusion (or any exclusion) in seeking to preclude coverage to ensure that the exclusion is not being used in a manner that swallows up all of the coverage purportedly provided or is contrary to the policyholder’s reasonable expectations for coverage. For this reason, among others, policyholders should consider engaging experienced coverage counsel early in the claim process and certainly after an insurer has asserted or reserved its right to assert a purportedly applicable exclusion.