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Court rules E&O exclusion makes coverage illusory

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E&O

In a policyholder victory, a federal appeals court has overturned a lower court ruling and held a contract liability exclusion for professional liability in an errors and omissions policy was so broad it made coverage illusory, and the policy must be “reformed.”

Chilton, Wisconsin-based DVO Inc., which was formerly known as GHD Inc., designs and builds anaerobic digesters, which uses microorganisms to break down biodegradable materials to create biogas, according to Monday’s ruling by the 7th U.S. Circuit Court of Appeals in Chicago in Crum & Forster Specialty Insurance Co. v. DVO Inc., formerly known as GHD Inc.

Algoma, Wisconsin-based WTE-S&S Ag Enterprise LLC, which later filed for bankruptcy, had a contract with DVO under which DVO was to design and build an anaerobic digester for WTE, according to the ruling.  The digester was to be used to generate electricity from cow manure, which would then be sold to an electric power utility, according to the ruling.

WTE sued DVO for breach of contract, alleging DVO had failed to fulfill its obligations under the contract by not properly designing substantial portions of the digester’s systems, resulting in substantial damages.

A court found in WTE’s favor and ordered DVO to pay more than $65,000 in damages and $198,000 in attorneys’ fees, according to the ruling.

New York-based Crum & Forster had issued primary and excess E&O policies to DVO that included a breach of contract exclusion for professional liability that was added as an endorsement, which provided the policy did not apply to claims or damages based upon, or arising out of, breach of contract.

C&F initially defended DVO under a reservation of rights, but then advised DVO it would no longer provide a defense.

In the ensuing lawsuit, DVO argued that the breach of contract exclusion “was so broad as to render the E&O professional liability coverage illusory, and therefore could not be enforced to preclude the duty to defend.”

The U.S. District Court in Green Bay, Wisconsin, ruled in C&F’s favor, but was overturned by a unanimous three-judge appeals court panel.

The “language in the exclusion at issue here is extremely broad,” said the panel’s ruling. Based on Wisconsin case law, “we hold that the breach of contract exclusion in this case rendered the professional liability coverage in the E&O policy illusory,” it said.

“When a policy’s purported coverage is illusory, the policy may be reformed to meet an insured’s reasonable expectation of coverage,” said the ruling.

“In determining the reasonable expectation of the insured consider the intended role of the coverage,” it said.

“Accordingly, because the breach of contract exclusion renders the professional liability coverage illusory, the contract should be reformed so as to meet the reasonable expectation of DVO as to the E&O policy’s coverage for liability arising out of negligence, omission, mistakes and errors inherent in the practice of the profession,” it said.

The ruling added, “we need not determine precisely what reformation is appropriate here.” On remand, the District Court “may consider DVO’s reasonable expectations in securing the coverage, and can reform the contract so as to give effect to that expectation,” it said.

“The focus, however, must be on that reasonable expectation which was upended by the breach of contract exclusion that rendered it illusory,” said the ruling, in reversing the lower court’s ruling and remanding the case for further proceedings.

Attorneys in the case could not be reached for comment.

 

 

 

 

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