The United States Court of Appeals for the Seventh Circuit has affirmed a trial court’s ruling that, under Illinois law, a contract exclusion applied to preclude coverage for a claim stemming from an insured’s failure to pay its contractor because all of the claimant’s causes of action arose from its contract with the insured. Altom Transp., Inc. v. Westchester Fire Ins. Co., 2016 WL 2956834 (7th Cir. May 20, 2016). The appellate court also dismissed the claimant—a dispensable, non-diverse party—in order to preserve diversity jurisdiction.

The case arose when the insured sought coverage for defense costs and a potential settlement in connection with a claim brought by one of the insured’s contractors for failure to pay for his services. The contractor asserted various causes of action against the insured, including violation of statute, breach of contract, and unjust enrichment. The insurer denied coverage for the claim and did not respond to the insured when it requested that the insurer reconsider its denial in light of settlement demands made by the claimant that were within the limits of the management liability policy the insurer had issued to the insured.

The insured filed a declaratory judgment action in Illinois state court, asserting that the insurer wrongfully refused to defend the insured in violation of Illinois statute and that the insurer was therefore estopped from asserting non-coverage. The insured also named the claimant as a defendant because the insured believed it was required to do so pursuant to Illinois case law. The insurer removed the case to federal court and filed a motion to dismiss, arguing that policy’s unpaid wages and contract exclusions applied. The federal district court granted the motion and the insured appealed.

In affirming the district court’s ruling, the appellate court first addressed whether the case fell within the court’s diversity jurisdiction in light of the insured and the claimant both being citizens of the same state. To preserve such jurisdiction, the court dismissed the claimant from the suit since he was a “dispensable, non-diverse party” who had no legal interest in the suit. According to the appellate court, claimants are indispensable under Illinois law when an insurer sues its insured for a declaratory judgment defining coverage, but not when the insured initiates the declaratory judgment action, as the insured can sufficiently represent the claimant’s interest in that scenario.

Next, the court turned to the coverage issues, explaining that the “language of the policy is King,” and, as such, coverage for claims stemming from the insured’s contract with third parties was “unambiguously exclude[d].” According to the court, the claimant’s allegations against the insured, regardless of the legal theory asserted, “rest fundamentally on the lease agreement under which [the claimant] was performing.” As a result, the policy’s exclusion for claims “arising out of, attributable to, directly or indirectly resulting from, in consequence of or in any way involving the actual or alleged breach of any contract” applied. The appellate court further determined that the exception to the exclusion for claims the insured would have been liable for in the absence of a contract did not apply because the claims asserted by the claimant all depended on the content of the agreement.

Finally, the appellate court found that the insurer was not estopped from denying coverage because estoppel applies only when an insurer has breached its duty to defend, which was not the case here.