Contract-Related Breach and Negligence Damages Constitute “Loss;” Coverage Precluded by Warranty Exclusion

A federal district court in Oregon has held that damages awarded against an insured for breach of contract and negligence in connection with its performance under a software development contract constituted “loss” under an E&O policy but were excluded from coverage by the policy’s warranty exclusion.  Travelers Prop. Cas. Co. of Am. v. ServerLogic Corp., 2015 WL 920419 (D. Or. Mar. 3, 2015).

The insured software developer contracted with a customer to create a custom point-of-sale software system.  After multiple failed attempts to resolve problems with the software, the customer terminated the agreement and initiated arbitration against the insured, alleging breach of contract and negligence in failing to perform under the contract.  The arbitration panel ultimately found for the customer.  The insured sought coverage for the arbitration award under its E&O policy, which provided coverage for “loss” that “arises out of ‘[the insured’s] product’ provided to others or ‘[the insured’s] work’ provided or performed for others.”  The policy also contained a warranty exclusion precluding coverage for “any cost or expense incurred . . . to perform or complete ‘[the insured’s] work.’”

In the coverage litigation that followed, the court held that the damages awarded in the arbitration constituted “loss” within the scope of coverage under the policy because they “ar[ose] out of” the policyholder’s product or work as required under the policy.  In this regard, the court recognized that under Oregon law, “arising out of” means “originat[ing] from, [] incident to or hav[ing] a connection with,” and found that the loss at issue “at the very least” had a connection to the insured’s work or product.

The court also held, however, the loss was barred from coverage by the policy’s warranty exclusion, which applied to “any cost or expense” incurred “to perform or complete ‘[the insured’s] work.’”  In this regard, the court found that the damages awarded were the result of the insured’s failure to perform or complete the contracted for software development and implantation work and as such, fell squarely within the ambit of the exclusion.  Pointing to other exclusions in the policy, such  as those related to defects in the insured’s own work, compliance with warranties and cost overruns, the court further found that the policy evidenced an intent by the parties to exclude damages of the type at issue here.  And, according to the court, the negligence claim did not alter this result because the arbitration panel had concluded that the negligence and breach of contract awards were duplicative, and not cumulative, and because the phrase “any cost or expense” indicated that the applicability of the exclusion did not turn on the type of underlying claim or cause of action.

Additionally, the court held that the policy did not cover costs taxed against the insured in the arbitration.  In this regard, the court pointed out that while the policy provided that it covered “costs taxed against the insured,” it was only with respect to “that part of the judgment we pay.”  Because the insurer had no duty to pay any part of the judgment, it was not obligated to pay for any interest or attorney fees under the supplementary payments provision.

Wiley Executive Summary

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