The California Court of Appeal has held that a D&O insurer had no duty to defend a homeowner’s association for alleged breach of contractual obligations under a construction contract. (Oak Park Calabasas Condominium Association v. State Farm Fire & Casualty Co. (2006) 2006 WL 391557)
Facts
Oak Park Calabasas Condominium Association (the “HOA”) sustained damages to common area property. The HOA entered into a construction contract with a contractor to repair the damages, but ultimately failed to pay the contractor all sums due under the construction contract. Consequently, the contractor sued the HOA and several unit owners for breach of contract, foreclosure of mechanic’s lien, failure to release retention proceeds and fraud. Several unit owners, in turn, cross-complained against the HOA, alleging negligent handling of the contractor’s claim and breach of various duties to the unit owners.
The HOA tendered the contractor’s complaint and the unit owners’ cross-complaints to State Farm, which had issued a package policy that included D&O coverage. The D&O coverage applied to “wrongful acts,” which the policy defined as “negligent acts, errors, omissions or breach of duty directly related to the operation of the condominium/association.” State Farm refused to defend the HOA against the complaint but agreed to defend the HOA against the cross-complaints.
Meanwhile, the contractor’s action went to trial and the contractor obtained a $7.1 million verdict against the HOA. The contractor’s claims against the individual unit owners ultimately were dismissed and, therefore, the unit owners’ cross-complaints against the HOA also were dismissed.
The HOA then filed a lawsuit against State Farm. In a bench trial on the coverage issues, the trial court concluded that State Farm’s D&O coverage only applied to “negligent breach of duty” and not “breaches of contractual duties.” Thus, the trial court determined that State Farm had no duty to defend or indemnify the HOA.
Holding
The California Court of Appeal affirmed the trial court’s ruling. The Court focused on the phrase “negligent acts, errors, omissions or breach of duty directly related to the operation of the condominium/association.” The Court reasoned that the term “negligent” applied to all of three subsequent nouns (i.e., “acts, errors [or] omissions”), and that it was illogical to interpret the term “negligent” only to modify the term “act” but not “errors [or] omissions.” Additionally, the Court explained that it would be impossible for an insurer to underwrite the risk of an insured entering into a multi-million dollar construction contract, refusing to pay for the construction work and then trying to pass on the loss on to the insurer.
Finally, the Court also was persuaded by the fact that State Farm had paid a first-party loss the HOA had sustained but that the HOA had decided not to use all of the first-party proceeds to pay the contractor. The Court concluded that the contractor’s claim essentially was a claim for restitution or unjust enrichment, which was not covered.
Comment
This case demonstrates the importance of carefully reviewing the specific definition of “wrongful act” in a D&O policy. Many of the D&O forms on the market at this time do not specifically require that the “acts, errors [or] omissions” be “negligent,” which was one of the factors the Court considered when it determined that a breach of contractual obligation was not a “wrongful act.”