The United States District Court for the District of New Jersey, applying Delaware law, has held that an exclusion precluding coverage for misappropriation of trade secrets in a directors and officers liability policy barred coverage for a claim brought against the insured by a competitor alleging the negligent failure to supervise an employee.  Sprout Health, LLC v. RSUI Indem. Co., 2020 WL 2507776 (D.N.J. May 15, 2020).  The court determined that the negligence count was “directly contingent” on a showing that the insured’s employee misappropriated the competitor’s trade secrets.

An employee of the insured, an addiction recovery services provider, allegedly conspired with employees of a competitor to purchase “leads” of potential customers interested in the competitor’s services.  The competitor sued the insured, asserting a claim under the California Uniform Trade Secret Act (CUTSA), alleging that its data on leads constituted confidential trade secrets misappropriated by the insured.  The competitor also sued for negligence, alleging that the insured had a duty to supervise and monitor the employee and that the insured breached its duty by allowing the employee to purchase the competitor’s data.

The insured’s directors and officers liability insurer denied coverage for both counts based on an exclusion barring coverage for “actual or alleged plagiarism, misappropriation, infringement or violation of copyright, patent, trademark, secret or any other intellectual property rights” and for claims based on business competition and unfair trade practices.  The insured conceded that the CUTSA count was barred by the exclusion but argued that the insurer owed a duty to defend and indemnify because the exclusion did not apply to the negligence count.

In subsequent coverage litigation, the court held that the exclusion barred coverage for the negligence count.  The court found that a “plain reading” of the complaint made clear that the insured allegedly breached its duty to supervise by allowing its employee to purchase leads in an unlawful manner, “i.e., by misappropriating [ ] trade secrets.”  The court reasoned that, under the applicable substantive law, “when a plaintiff alleges that an employer is liable for negligent supervision based upon an employee’s misappropriation of trade secrets, there must be a showing that the particular harm of trade secret misappropriation actually materialized.”  As such, the court held that the negligence count was “directly contingent” on conduct excluded by the policy, and therefore the insurer had no duty to defend or indemnify.