Wait, Absolute Exclusions CAN Make Coverage Illusory?!?!
A true Cinderella story of one policyholder who fought against an absolute exclusion and won
“Based upon or arising out of”, this innocuous sounding phrase has caught many a policyholder by surprise. If a claim arises, and somewhere in the policy there’s an absolute exclusion, a “based upon or arising out of…” and your claim contains that named exposure, you’re out of luck. No coverage, claim denied. Do not pass go. Do not collect $200.
Let’s say you’re an environmental contractor who carries an Errors & Omissions policy, but your policy contains absolute exclusions for pollution, bodily injury and property damage? No coverage.
No Coverage, Period
I previously wrote about the absolute pollution exclusion problem in environmental contractor errors & omissions policies. In that piece, I explored how carriers can issue policies marketed for environmental consultants, only to exclude claims arising from pollution… you know, the contractor’s main exposure?
Maybe you’re a life coach, and you carry E&O coverage in case a distressed client decides you gave them bad advice. You think that’s covered?
Designed to Deny: The Cruelest Clause in Professional Liability
I recently reviewed another policy with the “absolute exclusion” language. As I’ve written about here and here, absolute exclusions within insurance policies are very, very problematic for the policyholder. These exclusions carve out coverage the insured often assumes is there. Unfortunately the policyholder doesn’t find out they’re not covered until th…
Or you’re a title agent where a large part of your job is to transfer your client’s funds. Think your E&O policy covers this professional exposure? Think again.
Running Bare
Imagine running a business where you’re responsible for transferring your client’s funds. Maybe you’re a lawyer, an accountant, a title company or some other profession where you have to coordinate the transfer of funds to finish the transactions. You would want a professional liability policy that covers this exposure. You purchase a policy designed fo…
As a professional liability broker I get so frustrated when I look across the E&O landscape and see insurance products riddled with potholes and trap doors. Policyholders think they’ll have coverage for anything arising from their professional services, and are shocked and appalled when the claim gets denied. What’s more frustrating; these absolute exclusions seemingly carve out the main exposure, the very area the insured is expecting coverage for. Imagine having a hot dog stand, and you buy hot dog stand insurance only to realize that buried in the fine print is an exclusion that carves out any claims “based upon or arising out of the sale of hot dogs”. You’d rightly be incensed. “How can an insurance company write hot dog stand insurance and simultaneously exclude claims arising from hot dog sales. That’s what my business is!”
What if you decided to pursue your grievance against the insurance company in a court of law? As I noted in the aforementioned articles, that almost never works out. If the exclusion clearly and unambiguously excludes a particular exposure, than the carrier is off the hook.
“But your honor, how can they sell me hot dog stand insurance and exclude claims arising from the sale of hot dogs?!?!?!”
“The policy was clear and unambiguous. If you wanted hot dog stand coverage, than you shouldn’t have bought a policy that excludes hot dog stand claims.”
A Court Disagrees
You can imagine my surprise when I found a case that went the OTHER way. A court agreed with the insured, that the absolute exclusion carved out all meaningful coverage.
Check out Crum & Forster Specialty Insurance Co. v. DVO, Inc. where this exact situation occurred. DVO created an anaerobic digester for a client under contract. This anaerobic digester was designed to generate electricity from cow manure, which would then be sold to the electric power utility. Apparently the client was not happy with the final product, and sued DVO for breach of contract. DVO tenders the claim to their carrier, Crum & Forster, where, you guessed it, the claim was denied.
What absolute exclusion did Crum & Forster deploy to deny the claim? See for yourself:
This Policy does not apply to “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 [sic], regardless of whether “bodily in‐ jury”, “property damage”, “personal and advertising injury” or a “wrongful act” is alleged.
This is an absolute contract exclusion. If anything arises from a contract dispute, then there’s no coverage.
On the surface this exclusion seems absolutely nefarious and despicable. How could any carrier exclude claims arising from contracts? This is actually a common exclusion, and the reason is simple; carriers do not want to get roped into every single petty contract dispute. Without a contract exclusion carriers would inadvertently create a moral hazard whereby the insureds are not properly incentivized to handle contract disputes at the lowest level.
By having a contract exclusion in place, carriers clarify that their policyholders need to handle any contract disputes themselves.
Now you might be thinking, rightly, that a business that works under contract won’t ever have coverage under a policy like this. And you would be correct! This is why MOST contract exclusions have a carveback that states “this exclusion will not apply to the extent that an Insured Organization would have been liable in the absence of the contract or agreement.” While the contract exclusion might still seem overreaching, this carveback at least clarifies that the intent is NOT to get out of a claim every time a contract issue comes up somewhere in the claim.
Question: does this carveback exist in the Crum & Forster policy?
This Policy does not apply to “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 [sic], regardless of whether “bodily in‐ jury”, “property damage”, “personal and advertising injury” or a “wrongful act” is alleged.
No, it does not.
The way Crum & Forster’s policy reads, should anything arise from a breach of contract dispute then C&F is off the hook. And that’s exactly what they argued in court.
Neither C&F or DVO disputed that the claim arose from a contract exclusion. As the court put it:
The sole issue, then, is whether the language in that breach of contract exclusion renders the exclusion broader than the grant of coverage, and therefore renders the coverage illusory.
Arguing that a policy is illusory is an extremely difficult, uphill battle for an insured to take. I’ve written before about how policyholders have tried and failed to prove coverage was illusory, as have others. There’s a legal precedence in the United States that more or less states:
If the exclusion is clear and unambiguous then the policyholder should have read and understood the exclusion
And since policies are all written at an 8th grade level, policyholders have no excuse for not reading and understanding the exclusion
“Illusory coverage” is often an irrelevant argument. If you wanted that coverage than you shouldn’t have bought a policy that excludes it, dummy.
I’m not sure how or why in America we have this sort of uber-libertarian “the contract is the contract” type of mentality, where reasonable expectations of the consumer are irrelevant.
Which is what makes this case so interesting. I feel like I’ve already teased out the spoiler, but DVO prevailed!
But not initially. The district court rejected the illusory coverage argument, stating that in spite of the absolute contract exclusion, “third parties could still bring tort claims against DVO that would not fall within the exclusion and would trigger the duty to defend in the E&O provision of the policy.”
The 7th Circuit Appeals Court disagreed:
“…the term “arising out of” has been interpreted broadly to reach any conduct that has at least some causal relationship between the injury and the event not covered, which sweeps in third‐party claims as well when so related.”
The court further argued that “the overlap between claims of professional malpractice and breach of contract is complete, because the professional malpractice necessarily involves the contractual relationship.” THIS IS ABSOLUTE GOLD! How can you write professional liability and exclude claims arising from contracts, the very exposure from which arises professional liability?
Because the coverage was found illusory, “the policy may be reformed to meet an insured’s reasonable expectation of coverage.” The court remanded the case back to the district court in order to consider DVO’s reasonable expectations in securing the coverage they thought they were purchasing.
Let Reasonable Expectations Reign.
DVO’s success is genuinely worth celebrating. But let’s be honest about what DVO is and what it’s not. It’s one favorable circuit court opinion applying Wisconsin law in a jurisdiction that was already relatively receptive to reasonable expectations arguments.
It is NOT a landmark case overturning a mountain of legal precedent that stretches from Florida to California.
For every DVO there’s dozens of cases going against insureds, against reasonable expectations, and not overly concerned about whether or not coverage was illusory.
This is why I always advise my clients to find and flag absolute exclusions. Push back where you can. And if you purchase a policy that contains absolute exclusions, assume that any claim that may arise in the future and that claim so much as TOUCHES an absolute exclusion, assume that claim will be denied. If you’re ok self insuring with those types of claims, then by all means, buy the policy.
Until next time agents, stay bindin and grindin 🫡
This article references publicly available court documents in James River Insurance Company v. Ground Down Engineering, Inc., 540 F.3d 1270 (11th Cir. 2008) and Crum & Forster Specialty Insurance Co. v. DVO, Inc., No. 18-2571 (7th Cir. Sept. 23, 2019). All analysis is for educational purposes only and does not constitute legal or coverage advice. Readers with questions about their specific policy language or coverage obligations should consult qualified coverage counsel.