Case Review: Seventh Circuit Repudiates Insurer’s Attempt to Sell Illusory Coverage to Policyholder

Shareen Sarwar

Last week, the Seventh Circuit had occasion to consider the scope of a contractual liability exclusion in the context of professional liability coverage. In Crum & Forster Specialty Ins. Co. v. DVO, Inc., No. 18-2571, 2019 WL 4594229 (7th Cir. Sept. 23, 2019), an insurer insisted that its contractual liability exclusion did not render the professional liability coverage it sold illusory. The Court disagreed, however, holding that the exclusion was overbroad and would, if applied, defeat the fundamental purpose of the insurance. The Court further concluded that the policy must be reformed to meet the policyholder’s “reasonable expectations” of coverage.

The insurer had sold both primary and excess insurance policies to its policyholder, DVO, a company which designs and constructs anaerobic digesters. Pursuant to the coverage grant, the insurer agreed to pay DVO’s liabilities for, among other things, “damages or cleanup costs because of a wrongful act” arising out of “a failure to render professional services.” The Court opined that the essential purpose of this insurance was to provide coverage for professional malpractice. However, the insurance also contained a contractual liability exclusion that purported to preclude coverage for any:

“‘damages,’ ‘defense expenses,’ ‘cleanup costs,’ or any loss, cost or expense, or any ‘claim’ or ‘suit’: based upon or arising out of…a breach of contract, whether express or oral, nor any ‘claim’ for breach of an implied in law or an implied in fact contracts… regardless of whether ‘bodily injury’, ‘property damage’, ‘personal and advertising injury’ or a ‘wrongful act’ is alleged.”

Id. at *2. DVO argued that the language contained in the breach of contract exclusion was “so broad as to render the E&O professional liability coverage illusory…”. Id. at *1.

The district court originally held for the insurer, concluding that the provision was not overbroad because although all professional malpractice coverage would likely fall within the scope of the exclusion, at least theoretically “third parties could still bring tort claims against DVO that would not fall within the exclusion and would trigger the duty to defend ….” Id. at *2. DVO appealed the decision as erroneous and contrary to the reasonable expectations of a policyholder. The Seventh Circuit ultimately agreed and reversed the decision of the district court, highlighting that the district court had erroneously failed to consider the exclusion in light of the nature and purpose of the insurance.

The sole issue before the appellate court was whether the contractual liability exclusion and the interpretation advanced by the insurer rendered the insurance illusory. The Court rejected the insurer’s argument that the exclusion was valid on the theoretical basis that it might possibility provide coverage in limited situations. Instead, the Court highlighted that it was unreasonable to conclude that any policyholder would purchase professional liability insurance with an exclusion that could be construed as eliminating coverage for all losses relating to a contract:

“The overlap between claims of professional malpractice and breach of contract is complete, because the professional malpractice necessarily involves the contractual relationship….

There is, after all, no reason to believe that DVO in purchasing Errors and Omissions coverage to provide insurance against professional malpractice claims had a reasonable expectation that it was obtaining insurance only for claims of professional malpractice brought by third parties.”

Id. at *4. Such an interpretation of the exclusion would preclude coverage for the very types of claims the policy was purchased to protect against.

Where an insurance policy is rendered illusory, the policy may be reformed to “meet an insured’s reasonable expectation” or “intended role” of coverage. Id. at *5. The court reviewed relevant case law in determining that the insured’s “reasonable expectations” are dictated by the type of policy purchased and the nature and purpose of such policy. Id. Therefore, the court reversed and remanded “for further proceedings consistent with this opinion.” Id.

This case joins other decisions that have rejected insurer attempts to render a policyholder’s coverage illusory. While such decisions reinforce a court’s role in protecting policyholders from such abuses, they also serve as an important reminder of the value (and potential litigation cost savings) that additional insurance due diligence can provide. As the old adage goes, “an ounce of prevention is worth a pound of cure.” Accordingly, policyholders would be well served to carefully evaluate the exclusionary language in their policies during each renewal to ensure that the coverage clearly aligns with the expectations of the business.