Broad Contract Exclusion Did Not Render Errors & Omissions Coverage “Illusory”

Applying Wisconsin law, the United States District Court for the Eastern District of Wisconsin has held that a contract exclusion in a multi-line liability policy barred coverage for an action solely alleging breach of contract.  Crum & Forster Specialty Ins. Co. v. GHD Inc., 2018 WL 3304631 (E.D. Wisc. Jul. 5, 2018).  The court also held that the broad language in the exclusion did not render coverage “illusory” such that the reformation of the policy would be warranted.

The insured, a designer and builder of anaerobic digest systems, was sued for breach of contract based on its alleged failure to properly design substantial portions of the systems.  The relevant E&O coverage part provided that the insurer would pay “‘damages’ or ‘cleanup costs’ because of a wrongful act.’”  “Wrongful act” was defined as “an act, error or omission in the rendering or failure to render ‘professional services’ by any insured.”  The policy also contained a contract exclusion precluding coverage for damages, defense expenses, cleanup costs, or any loss, cost or expense, or any claim or suit “[b]ased upon or arising out of” a breach of contract.

The insured tendered the claim to its insurer for coverage under the E&O coverage part.  The insurer then sought a declaratory judgment that it had no obligation to defend or indemnify because coverage was eliminated by the contract exclusion.  In response, the insured stipulated that coverage was barred by the exclusion but argued that the broad “arising out of” language effectively eliminated any possible coverage, thus rendering coverage “illusory.”  Because every contract contains a common-law duty to perform “with care, skill, reasonable expedience and faithfulness,” the insured reasoned that every failure to perform a contract in conformance with that duty is, in essence, a “professional error or omission.”  So, according to the insured, any professional errors or omissions claim must “arise out of” a breach of contract, and coverage could never exist.  Since illusory coverage is contrary to Wisconsin public policy, the insured argued that the court should reform the contract by removing the contract exclusion.

Granting summary judgment for the insurer, the court rejected the insured’s broad reading of the contract exclusion.  According to the court, there were several professional duties beyond strictly contractual obligations, including duties to third parties with no contractual relation to the insured, or duties to the “world at large.”  The court concluded that the insurer agreed to provide coverage for liability incurred to third parties for negligent errors and omissions, but it chose not to provide coverage for liability incurred based on failures to meet contractual obligations.  The court also noted that, even if the contract exclusion did render coverage illusory, the exclusion would not be eliminated altogether.  Instead, “the policy may be reformed to meet an insured’s reasonable expectations of coverage.”  Here, “that liability for breach of contract would be excluded, but not liability to third parties who were not parties to the contract.”  Accordingly, the court held that the insurer had no duty to defend or indemnify the insured.