The California Court of Appeal has held that an insurer that issued a Directors and Officers liability policy had no duty to pay for a loss arising out of an insured’s failure to make payment under a contract. ( August Entertainment, Inc. v. Philadelphia Indemnity Insurance Co. (2007) 146 Cal.App.4th 565)
Facts
Philadelphia Indemnity Insurance Company issued a Directors and Officers (D&O) policy to InternetStudios.com, Inc. The policy provided that Philadelphia Indemnity would pay for “loss” caused by a “wrongful act” of an insured, based on a claim made within the policy period. The D&O policy defined “wrongful act” as any “actual or alleged error, misstatement, misleading statement, act, omission, neglect or breach of duty committed by an Insured, individually or otherwise, in his or her capacity as a director or officer.”
During the policy period, August Entertainment, Inc. filed a suit alleging that InternetStudios and MacLean (one of InternetStudios’ officers) had contracted to purchase film rights from August for $2 million, but then failed to make payment. After Philadelphia Indemnity denied coverage for the suit, InternetStudios and MacLean assigned to August all rights under the policy and entered into a stipulated judgment. August then sued Philadelphia Indemnity for breach of contract and bad faith.
In its complaint, August alleged that the stipulated judgment was covered because the loss resulted from a “wrongful act” by MacLean, who mistakenly signed the contract without stating he was an agent for InternetStudios. The trial court disagreed and dismissed the case on demurrer, ruling that the complaint improperly attempted to force an insurer to pay for a corporate breach of contract.
Holding
The Court of Appeal affirmed the trial court ruling in favor of the insurer. Despite MacLean’s alleged mistake in failing to disclose his status as agent of InternetStudios, there was no question the corporation voluntarily accepted the $2 million contract debt. The insureds’ failure to pay the contract price was not a loss caused by a “wrongful act,” since the policy definition of that term did not include “breach of contract.”
While the D&O policy also contained a breach of contract exclusion, the court held that the presence of that exclusion did not serve to broaden the scope of liability coverage provided under the policy. The Court also cited public policy reasons for its ruling, noting that allowing liability coverage in this instance would encourage corporations to breach their contractual obligations.
Comment
This case confirms that liability insurers are not guarantors for the contractual obligations of their insureds. However, that the labels attached to a plaintiff’s causes of action are not dispositive. Depending on the facts in some cases an insurer may have a duty to defend and indemnify a cause of action entitled “breach of contract.” ( Vandenberg v. Superior Court(1999) 21 Cal.4th 815.) Hence, to determine its coverage obligation, a carrier must carefully evaluate the facts relating to a liability claim together with the provisions of its policy.