Policy Could Cover Contract Case: Court
December 16, 2008
The U.S. District Court for the Northern District of Illinois recently held that an insurance policy providing management liability coverage could cover claims against the insured for breach of contract. Sigma Chi Corporation v. Westchester Fire Insurance Co., 2008 WL 4722295 (N.D. Ill. Oct. 22).
The insured, Sigma Chi, was represented by Blake T. Hannafan and Eric J. Malnar of Hannafan & Hannafan Ltd. Michael P. Tone, Kimberly E. Rients Blair, Ryan T. Brown and Tyler S. Mertes of Gordon & Rees LLP, Chicago, represented the insurer, Westchester.
A former employee of Sigma Chi executed various purchase orders, financing agreements and service agreements with IBM Credit Corporation and Incentra Solutions of Illinois for hardware, software and consulting services. After the employee resigned from Sigma Chi, the company notified IBM and Incentra that various of the contractual obligations were not valid because the employee had no authority to execute them.
IBM and Incentra subsequently claimed that Sigma Chi was in breach of its various contract obligations in a total amount of over $1.5 million. Sigma Chi submitted the claims to Westchester, which ultimately denied coverage.
Westchester's policy to Sigma Chi, which was issued on a claims made basis, provided management liability coverage. Specifically, Westchester agreed to pay any ''loss'' for which the company became ''legally obligated to pay'' for any ''wrongful act'' taking place during the policy period. A ''wrongful act'' was defined to include any ''breach of duty'' committed by the company. A ''loss'' was defined to include damages.
Sigma Chi filed this action against Westchester in February of 2008 for breach of contract and for sanctions under section 155 of the Illinois Insurance Code. Westchester counterclaimed seeking a declaration that it had no duty to defend or indemnify. It also filed a motion for judgment on the pleadings claiming, among other things, that its policy provided no coverage for breach of contract.
In an opinion by Judge Ruben Castillo, the court denied Westchester's motion. He first addressed Westchester's argument that Illinois law generally prohibits coverage for breach of contract. He noted that many cases do, in fact, deny coverage for breach of contract, but said that they do so based upon the language of the policies involved, and not based upon any blanket prohibition of Illinois law.
In support, Castillo cited Krueger Int'l, Inc. v. Royal Indem. Co., 481 F.3d 993 (7th Cir. 2007), where the 7th U.S. Circuit Court of Appeals observed that coverage was not excluded under a policy just because a contract had allegedly been breached, at least so long as the insured's conduct was also allegedly negligent and tortious. On these grounds, Castillo found that the breach of contract claims against Sigma Chi were not necessarily excluded from coverage based simply on the dictates of Illinois law.
Westchester next argued that the language ''legally obligated to pay'' in its policy is ''universally'' interpreted to refer only to tort liability and not to damages for breach of contract. Castillo disagreed, observing that one of the California cases relied on by Westchester had actually been overruled by Vandenburg v. Superior Court, 88 Cal. Rptr. 2d 366, 982 P.2d 229 (Cal. 1999).
In that case the California Supreme Court held that the language ''legally obligated to pay'' could refer to any obligation that is binding and enforceable under the law, whether in contract or tort. Castillo therefore concluded that the language could refer to contract obligations, and at the very least it was ambiguous and would be construed in favor of coverage.
Westchester further argued that contractual obligations did not constitute ''wrongful acts'' or ''losses'' as defined in the policy. In support it relied upon other California cases where the courts found there were no wrongful acts or losses under the applicable policies because the contractual obligations were debts of the insureds voluntarily accepted. Castillo distinguished those cases, however, on the ground that Sigma Chi here claimed that its employee had no authority to enter into the contracts with IBM and Incentra. If these allegations were true, said Castillo, then Sigma Chi did not enter into the contractual obligations voluntarily.
Castillo also relied again on the Krueger case, in which the 7th Circuit found that, even though the underlying claim was based on breach of contract, a ''wrongful act'' by the insured might nevertheless have occurred because the contract was allegedly entered into on the basis of a misrepresentation by the insured. Although the court in Krueger ultimately found that there was no coverage, Castillo concluded that questions regarding the authority of Sigma Chi's employee created fact issues requiring denial of Westchester's motion at the present time.
Finally, Westchester argued that coverage was excluded by an exclusion applicable to breach of contract liability. Relying on the specific language of the exclusion, however, Castillo found that it was limited in application to the Directors and Officers' Liability part of the policy and did not apply to the Company Liability section, which both Westchester and Sigma Chi agreed was the applicable section.
While Westchester claimed that Castillo's proposed limitation of the exclusion was based on a typographical error, Castillo said that the error, at most, created a factual dispute, which made resolution of coverage in favor of Westchester inappropriate at the present time.
With respect to Sigma Chi's argument that it was entitled to remedies under section 155 of the Illinois Insurance Code, 215 ILCS 5/155, Castillo found that those remedies applied only when an insurer acts vexatiously and unreasonably in denying coverage, and that the insurer does not do so when the insurer takes a reasonable legal position.
Here, said Castillo, there was a genuine factual issue regarding coverage, and even if Westchester did not ultimately prevail with respect to coverage, its actions in denying coverage could not be considered vexatious or unreasonable.
For these reasons, the court denied Westchester's motion for judgment on the pleadings and dismissed the count of Sigma Chi's complaint based on section 155.
