Most of the business community is generally familiar with the standard types of liability insurance coverage available to protect against claims of wrongdoing. In their most basic forms, these coverages include general liability insurance, directors and officers liability insurance, as well as some form of professional liability/errors and omissions coverage.

One of the key features of these policies is the insurer’s duty to provide the policyholder with a defense against lawsuits. This duty is generally very broad: Under many states’ laws, an insurer will be required to defend the policyholder against any suit that alleges even a single claim potentially covered under the policy—even if some or all the other claims are clearly not covered.  

Many suits arising from the commission of so-called “business torts”—claims such as breach of fiduciary duty, improper use of trade secrets, various forms of advertising and intellectual property infringement and so on—often include a combination of covered and non-covered claims. The cost to defend against one of these suits can easily exceed six figures or more, even for claims without merit. Accordingly, the fact that a single covered claim – even one that is arguably a very minor piece of the overall lawsuit – entitles the insured to a defense against that entire suit is a very valuable asset to policyholders. 

A recent Delaware Superior Court case demonstrates how the “in for a penny, in for a pound” conception of defense costs discussed above works in the policyholder’s favor. Woodspring Hotels v. National Union Fire Ins. Co., C.A. No. N17C-09-274 (Del. Supr. May 2, 2018). In this case, a high-ranking employee left her company for a competitor, allegedly taking confidential/proprietary information with her when she left.  The former employer sued the employee and her new employer, alleging 11 separate causes of action –  including not limited to trade secret violations, breach of fiduciary duty, tortious interference and computer fraud.

The employee and new employer tendered the defense of the matter to their D&O carrier, which denied any obligation to provide coverage or a defense based on a policy exclusion barring coverage for “any actual or alleged misappropriation or infringement of trade secret or any other intellectual property rights.”

The employee and new employer sued the insurer, seeking to compel it to provide a defense against the claims. The insurer resisted, offering the common-sense argument that the gravamen (main complaint) of the entire lawsuit was the alleged misappropriation of trade secrets, and any defense obligation was therefore barred by the policy exclusion for infringement of trade secrets. Although that argument perhaps has some intuitive appeal, the court nonetheless rejected it and found that proof of certain claims would not necessarily require the misappropriation of a trade secret to establish liability. Thus, even though the potential for actual coverage under the policy was “remote,” the insurer was ordered to provide a defense against the entire lawsuit.

In response to rulings like Woodspring, insurers have begun to develop new policy exclusions or other limitations intended to pare back their defense obligations where the gist of the lawsuit arises from an excluded claim. 

For example, in recent years there have been a number of cases resulting from intellectual property violations – which are presumptively not covered under most general liability policies – that also include a single/limited potential covered claim (e.g., defamation) that in turn triggers the insurer’s defense obligation for the entire lawsuit.  In response to cases like this, insurers have crafted exclusions that bar coverage for “any injury or damage alleged in any claim or suit that also alleges an infringement or violation of intellectual property rights . . . regardless of whether such allegation is made against you or some other party in the suit and regardless of whether this insurance would otherwise apply.”

In other words, the inclusion of any intellectual property claim, even if asserted against another party, will bar coverage in its entirety—therefore leaving the policyholder to pay its own defense costs. See, e.g.Comprehensive Microfilm & Scanning Services, Inc. v. Main St. Am. Grp., 2012 WL 1339435, *7 (M.D. Pa. 2012) (“As the underlying suit arises ‘in part’ from copyright infringement, we find that the entire suit is excluded from the coverage under the policy.”).

Similarly, some directors and officers liability insurers have limited their defense obligation on hybrid covered/non-covered claims through “Allocation” provisions. These provisions require that where both covered and non-covered matters are asserted, the insurer and policyholder “shall use their best efforts to fairly and reasonably allocate payment of defense costs based on the relative legal exposures of the parties.” If the parties cannot reach such an agreement, the policy allows for resort to a judicial determination that will be applied retroactively.

As one court noted, “these provisions attempt to limit, though not eliminate, the typically-broad duty to defend included within most general liability policies.” Housing Auth. of N.O. v. Landmark Ins. Co., No. 15-1080, 2016 WL 772649 (E.D. La. 2/29/16). The HANO court enforced the allocation provision, relying on a federal district court case from California in 2006 that had likewise upheld a similar provision. Id. at *6, citing Commercial Capital Bankcorp, Inc. v. St. Paul Mercury Ins. Co., 419 F. Supp. 2d 1173 (C.D. Cal. 2006) 

The application of provisions like those discussed above is hotly contested. However, these limiting provisions are often found to be applicable, leaving the policyholder on the hook to pay its own defense costs. Commercial liability policies are very expensive, and no one wants to find themselves in a position of having paid tens, if not hundreds, of thousands of dollars for a policy that on its face provides no possibility of coverage for foreseeable risks that may be unique to a business. Policyholders are legally presumed to have read and understood the terms of their policies prior to accepting them.  

It is therefore imperative that policyholders review their coverage accordingly to minimize surprises if and when a suit is filed. Simply assuming full protection against lawsuits because one has insurance is not commercially reasonable, though it is a surprisingly common view expressed by many sophisticated businesspeople. Steps to take on the frontend include engaging a broker or other representative to help you negotiate proper coverage, and, as a business evolves, it is important to revisit needs each renewal period. In the event of a claim, promptly consult an attorney who is well-versed in coverage issues to have a realistic sense of one’s rights under the policy.  

From our New Orleans headquarters, Dan Centner has experience defending individuals and entities in a wide variety of commercial disputes, including oil and gas matters, insurance coverage issues, contractual claims, trademark and copyright claims, various real estate disputes and construction matters. To learn more about his experience and areas of practice, view his profile.

The content of this article is not intended to serve as an exhaustive review of the laws and statutes, and it is not intended to provide legal advice. The opinions expressed through this article may not reflect the opinions of the firm, individual attorneys or clients.