No Right to Rescind a Contract that Does Not Exist
Liability insurance is designed to provide defense and indemnity to persons insured who are sued as a result of events covered by the insurance policy. It does not, nor can it, provide defense to a person not insured. Further, a liability policy will not defend if a clear and unambiguous exclusion applies.
In Robert Mau; Eagle Well Services, Inc. v. Twin City Fire Insurance Co., No. 17-3392, United States Court of Appeals For the Eighth Circuit (December 6, 2018) Robert Mau and Eagle Well Services, Inc. (“EWS”) failed in its efforts to get defense and indemnity from Twin City. They then appealed the district court’s grant of Twin City Fire Insurance Company’s (“Twin City”) cross-motion for summary judgment.
THE AVAILABLE COVERAGE
Twin City insured Eagle Operating, Inc. and its subsidiaries. Endorsement No. 2 of the policy defined Eagle Operating’s subsidiaries to include EWS and MW Industries, Inc. During the relevant period, Mau was president of Eagle Operating, shareholder and president of EWS, director and president of MW, and an owner of American Well Services (“AWS”).
In February 2012, EWS sold its assets to a predecessor of Sun Well Services (“Sun Well”) through an Asset Purchase Agreement (“Agreement”). EWS and Mau were parties to the Agreement, which included a noncompetition covenant.
BREACH OF A NONCOMPETITION CONTRACT
After the Agreement was signed, MW sold equipment to AWS. Claiming that the sale violated the noncompetition covenant, Sun Well sued Mau for breach of contract, fraud, and civil conspiracy, and it sued EWS for breach of contract and fraud. Twin City refused to defend the suit.
THE DECLARATORY RELIEF ACTION
Mau and EWS sued Twin City, seeking a declaration that they were insured under the policy. They also sued Twin City for breach of contract and breach of the implied covenant of good faith and fair dealing. Mau filed a motion for partial summary judgment. Twin City filed a response in opposition and a cross-motion for summary judgment, asking the court to find that Twin City had no duty to defend Mau or EWS. The district court denied Mau’s motion for partial summary judgment, and it granted Twin City’s cross-motion for summary judgment.
North Dakota law applies in this case. An insurer has no duty to defend an action if there is no possibility of coverage under the policy. Any doubt about whether a duty to defend exists must be resolved in favor of the insured.
Mau argued before the district court that Twin City owed him a duty to defend because Sun Well sued him in his capacity as a director and officer of MW, an insured subsidiary of Eagle Operating. The district court rejected his argument. Sun Well’s claims do not depend on any actions Mau took as president of MW. This is evidenced by the fact that Sun Well did not sue MW. While Sun Well’s complaint mentions MW contextually, MW is not a party to the suit. There is no need for an insurer to defend a party who was not sued.
Instead, Sun Well’s claims depend on the alleged breach of the noncompetition covenant in the Agreement between EWS and Sun Well, an agreement to which MW was not a party. Sun Well would have no claim for breach of contract, fraud, or civil conspiracy against Mau were it not for the Agreement, which he signed as president of EWS, not as a director and officer of MW. Thus, Sun Well sued Mau in his capacity as president of EWS. Because Sun Well’s complaint contains no claims based on any actions Mau took as a director and officer of MW, Twin City owes him no duty to defend on that basis.
Eagle Operating’s insurance policy with Twin City includes an exclusion that applies to Mau in his capacity as president of EWS. The dual service exclusion provides as follows: “The Insurer shall not pay Loss: . . . of an Insured Person based upon, arising from, or in any way related to such Insured Person’s service, at any time, as a director, officer, trustee, regent, governor or equivalent executive or as an employee of any entity other than an Insured Entity even if such service is at the direction or request of such Insured Entity….”
Because the allegations of the complaint govern the duty to defend, the appellate court looks to Sun Well’s complaint when applying the dual service exclusion. The complaint says that Mau “participated in the formation and subsequent operation” of AWS. And it says that AWS is an “affiliate” of Mau “as that term is defined in Section 7.13 of the [Agreement].” Any loss Mau suffers from the Sun Well litigation certainly “arises from” and is “related to” his service in one of the exclusion’s stipulated roles for AWS, an uninsured entity. Thus, the dual service exclusion applies to Mau.
Because Mau was not sued in his capacity as director and officer of MW and because the dual service exclusion applies, there is no possibility of coverage for Mau under Twin City’s policy.
Similarly, Twin City has no duty to defend EWS in this suit. The insurance policy includes another exclusion that reads as follows: “The Insurer shall not pay Loss under Insuring Agreement (C) in connection with any Claim based upon, arising from, or in any way related to any actual or alleged: ¶ (1) liability under any contract or agreement, provided that this exclusion shall not apply to the extent that liability would have been incurred in the absence of such contract or agreement . . . .”
In other words, the contract exclusion applies to claims arising from the insured’s contracts or agreements unless liability otherwise would exist in the absence of the contract or agreement. This exclusion applies to EWS because Sun Well’s claims against EWS for breach of contract and fraud are based upon, arise from, or are related to the Agreement, and liability could not have been incurred in the absence of the Agreement.
EWS does not contest that Sun Well’s claims are based upon, arise from, or are related to the Agreement. EWS argues that Sun Well’s fraud claim created the possibility that the Agreement would be rescinded. If the Agreement were to be rescinded, EWS claims, liability would exist in the absence of the Agreement.
In either case, even if EWS’s arguments had some validity, the contract exclusion would apply to any resulting liability. Sun Well’s fraud claim would not exist in the absence of the Agreement. The fraud claim alleged that Mau and EWS “concealed” material facts about their plan to breach the noncompetition covenant that they had a duty to disclose. And a contract that does not exist cannot be rescinded.
There is no possibility of coverage for EWS under Twin City’s policy because the contract exclusion applies.
Applying North Dakota law, the court held that Twin City owed no duty to defend Mau in his capacity as director and officer of MW because no claims were brought against him in that capacity and, in any event, the dual service exclusion applied. The court also held that Twin City did not owe a duty to defend EWS where the claims against it for breach of contract and fraud are based upon the Asset Purchase Agreement and liability could not have been incurred in absence of the Agreement. Furthermore, even if EWS’s arguments had some validity, the contract exclusion would apply to any resulting liability.
Liability insurance is not designed to protect against breaches of contracts which, by definition, must be neither contingent nor unknown losses and are, therefore, not insurable. Breaching a non-competition clause is, by definition, an intentional act. Since fortuity is required for coverage under a liability policy an intentional breach of contract can never be the subject of insurance. Finally, there can never be an obligation of an insurer to do the impossible – defend an insured who was not sued.
© 2018 – Barry Zalma
This article, and all of the blog posts on this site, digest and summarize cases published by courts of the various states and the United States. The court decisions have been modified from the actual language of the court decisions, were condensed for ease of reading, and convey the opinions of the author regarding each case.
Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 50 years in the insurance business. He is available at http://www.zalma.com and firstname.lastname@example.org.
Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.
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