HNRK Coverage Corner

On April 9, 2021, the Second Circuit issued a decision in Fabrique Innovations, Inc. v. Federal Insurance Company, 20-1396-cv, holding that a policy’s “willful acts” exclusions were not triggered by a “simple breach of contract.” (N.B. HRNK insurance recovery partner Joshua Blosveren successfully represented the Appellee in this appeal.) The insured (“Fabrique”) made a claim under a cargo insurance policy that covered damage to fabric and plush merchandise temporarily in storage at specified locations.  The goods at issue were lost “after Hancock Fabrics, Inc. (“Hancock”), the company that owned and operated the storage warehouse, petitioned for bankruptcy and received authorization from the bankruptcy court to liquidate its holdings—including Fabrique’s merchandise—through closing sales.”  The insurer (“Federal”) denied the claim, arguing that Hancock’s actions triggered policy exclusions for:  (1) “loss, damage or expense caused by or resulting from willful misconduct, fraud or deceit . . . by other parties involved in the sale or purchase of merchandise . . . “; and (2) “any dishonest or fraudulent act or acts committed . . . by any proprietor, partner, director, trustee or elected officer of any organization . . . engaged by you to provide services in connection with the storage of the merchandise.”

The District Court granted summary judgment to the insured, and the Second Circuit affirmed, explaining:

Under New York law, to negate coverage by virtue of an exclusion, an insurer must establish that the exclusion applies in the particular case and that its interpretation of the exclusion is the only construction that could fairly be placed thereon. . . .

Neither exclusion applied to Hancock’s sale of Fabrique’s goods because that conduct did not involve willful misconduct, fraud deceit, or a dishonest act. The New York Court of Appeals has defined “willful acts” provisions in negotiated contracts to require “conduct which is tortious in nature, i.e., wrongful conduct in which defendant willfully intends to inflict harm on plaintiff at least in part through the means of breaching the contract between the parties. Metro. Life Ins. Co. v. Noble Lowndes Int’l, Inc., 84 N.Y.2d 430, 438 (1994). To constitute willful misconduct, therefore, the breaching party’s conduct must have extended well beyond a simple breach of contract. Here, Hancock’s liquidation of its holdings in breach of its third-party logistics agreement with Fabrique was not “truly culpable, harmful conduct,” but “merely intentional nonperformance . . . motivated by financial self-interest.” Metro. Life Ins. Co., 84 N.Y.2d at 438.  On advice of counsel, Hancock candidly informed Fabrique it would not return the goods, then sought and received authorization from the bankruptcy court for conducting closing sales. We are hard pressed to find tortious misconduct or dishonesty where a party openly sought and obtained leave from a court before engaging in the conduct at issue, and where the opposing party had an opportunity to object. In light of this and the parties’ representations to the district court that there was no genuine issue of material fact concerning the underlying dispute between Fabrique and Hancock, summary judgment in favor of Fabrique was appropriate.

The issue of insurance coverage for “intentional” conduct arises in a number of contexts.  As a matter of public policy, D&O and other liability policies do not provide indemnity coverage for fraudulent or other intentional wrongdoing—although typically, the exclusion is not triggered until there is a final judgment against the insured in the underlying lawsuit.  Effectively, this means that the policy provides defense coverage for alleged fraud, but no indemnity coverage if the fraud is proven.  (See a previous post on D&O coverage for alleged criminal conduct here. CGL policies are triggered by an “occurrence” (defined as an “accident”), not intentional conduct.  Importantly, however, the courts recognize that “[a]ccidental results can flow from intentional acts.”  Or, stated otherwise, “[t]he damages in question may be unintended” (and therefore covered) “even though the original act or acts leading to the damage were intentional.” Salimbene v. Merchants Mut. Ins. Co., 217 A.D.2d 991, 994 (4th Dep’t 1995). See our previous posts on the occurrence/accident issue.