Medill v. Westport Ins. Corp.

No Duty to Defend Directors and Officers against Claims of Negligence and Breach of Fiduciary Duty Where Loss Arises Out of Breach of Contract

Submitted by Brian J. Colombana

In Medill v. Westport Ins. Corp., 06 C.D.O.S. 9358 (2^nd Dist. Oct. 4, 2006), the Court of Appeal affirmed summary judgment in favor of the insurer, holding that an insurer whose liability insurance policy precludes coverage for contract claims has no duty to defend directors and officers against claims of negligence and breach of fiduciary duty where the loss arises out of a breach of contract.

This action arose from damages sustained by Plaintiffs in Heritage’s municipal bond offerings, which raised money for the acquisition and renovation of healthcare facilities. However, due to the wrongful disbursements of bond proceeds and improper commingling of funds, many renovations were not completed. The facilities went into foreclosure shortly thereafter.

The bondholders filed a class action against Heritage and its officers and directors for negligence and breach of fiduciary duty. Heritage tendered the claims to Westport, its directors and officers liability insurer. Westport denied coverage on three grounds: (1) The policy’s definition of “loss” excludes coverage for claims arising out of breach of contract; (2) the policy excludes coverage for claims arising out of the issuance or endorsement of bonds; and (3) the policy excludes coverage for claims arising out of the failure to pay on financial instruments. Westport successfully moved for summary judgment on these grounds and Heritage appealed.

The Court of Appeal affirmed finding that there was no potential for coverage for any of the claims asserted against Heritage. First, the court held that Heritage failed to satisfy their initial burden of proving the claim falls within the scope of coverage. “Loss” is defined by the policy to exclude “damages arising out of breach of any contract.” The Court recognized that in essence, ”the underlying bond litigation…seek[s] to recover damages for the failure of [Heritage]…to perform their contractual obligations to repay the bonds. The bond litigation in its entirety ‘arises out of’ breach of contract, even if not alleged.”

Secondly, the policy excludes coverage for any ‘loss’ ‘arising out of’ the issuance of bonds. The Court found that Heritage, as the obligor on the bonds, is considered to be the issuer of the securities under SEC Rule 131. Thus, Heritage engaged in the excluded activity of issuing bonds.

The Court of Appeal lastly held that the exclusion for any loss arising out of “the failure to honor or pay on any financial instrument” precludes coverage. Any ambiguity in the term “financial instrument” is resolved by construing the phrase in the context of the policy as a whole. “There is nothing in the policy to suggest that Westport intended to act as a guarantor for hundreds of millions of dollars of unpaid contractual obligations in connection with the issuance of bonds. “The bond litigation clearly arises out of th[e] failure to pay on the bonds.”

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