Contract Exclusion Does Not Bar Coverage for Intentional Misrepresentations During Pre-Contract Negotiations

The United States District Court for the District of Rhode Island, applying Rhode Island law, has held that a contract exclusion did not bar coverage for a jury verdict holding in part that the insured’s intentional misrepresentations had induced the claimant to enter into a disputed contract.  TranSched Sys. Ltd. v. Fed. Ins. Co., 2014 WL 7251184 (D.R.I. Dec. 22, 2014).

The claimant entered into an agreement with the insured to purchase certain transportation software assets.  The software assets were not delivered as expected, and the claimant later learned that two of the insured’s vice presidents had made material misrepresentations about the time frame and viability of the software during the negotiation and execution of the agreement.

The claimant obtained a jury verdict against the insured in the underlying action in which the jury found against the insured on three grounds: (1) intentional misrepresentation, (2) breach of contract, and (3) breach of the covenant of good faith and fair dealing.  The jury awarded the claimant $500,000 but did not allocate the damages among the three counts.

The claimant brought suit against the insurer seeking satisfaction of the underlying judgment.  The insurer argued that two exclusions in the policy—the contract exclusion and the fraud exclusion—barred coverage for any damages awarded for the insured’s intentional misrepresentations.

Ruling on the parties’ cross-motions for summary judgment, the court considered the policy’s contract exclusion, which barred coverage for claims arising from the insured’s liability under a contract.  The court found that the evidence at the underlying trial supported the claimant’s assertion that the misrepresentation claims concerned only pre-transaction conduct.  The court therefore held that the intentional misrepresentation claims were not excluded from coverage because the misrepresentations were made before the agreement was executed, and the agreement therefore was not the cause of the intentional misrepresentation claim but the result of it.  Because the insured’s tortious conduct preceded the agreement, it was independent of the terms of the contract itself.

The court also looked to the policy’s fraud exclusion, which barred coverage based upon, arising from, or in consequence of any deliberate fraudulent act or omission by the insured if established by a final and non-appealable judgment.  The policy also contained a severability provision, which provided that only the facts pertaining to and knowledge possessed by certain specified officers would be imputed to the insured organization for purposes of the fraud exclusion.  The court determined that the fraudulent conduct was not perpetrated by any of the specified officers, and therefore it could not be imputed to the insured company.

The court then considered whether the damages could be allocated between the intentional misrepresentation count and two uncovered counts.  Although the court observed that, under Rhode Island law, the insured bears the burden to allocate, the court held that the insurer has a duty to inform its insured that allocation through a special jury verdict is advisable where a suit contains the potential for both covered and uncovered counts.  Since the insurer had failed to propose an allocated verdict form, the court held that the insurer could not now impose an unreasonable burden on the claimant to request allocation.  In order to avoid re-litigating the underlying facts, however, the court ordered the parties to mediate how the damages should be allocated.

Finally, the court held that the claimant could not recover under Rhode Island’s “rejected settlement offer” statute, which allows for the recovery of interest on an underlying judgment, even if it exceeds the applicable policy limits, where the insurer rejected a pre-trial settlement demand within the policy limits.  Although the claimant had filed the coverage action in Rhode Island and the court was deciding the coverage issues under Rhode Island law, the court held that the Rhode Island statute did not apply because the underlying suit was litigated in Delaware, the underlying settlement discussions took place in Delaware, and the Delaware court had already awarded pre-judgment interest.  The court observed that the determination of the scope of coverage under the policy had nothing to do with whether the insurer should be liable for the consequences of a rejected settlement demand.

Wiley Executive Summary

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