(Article from Insurance Law Alert, October 2019)
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The Seventh Circuit ruled that a breach of contract exclusion rendered errors and omissions coverage illusory and remanded the matter for reformation of the contract so as to meet the reasonable expectations of the insured. Crum & Forster Specialty Ins. Co. v. DVO, Inc., 2019 WL 4594229 (7th Cir. Sept. 23, 2019).
DVO, a mechanical designer and builder, was sued for breach of contract based on its alleged failure to fulfill its mechanical and structural design duties. Crum & Forster initially agreed to defend DVO under a reservation of rights, but later denied coverage. The parties agreed that the policy’s errors and omissions provision, which covers a failure to render professional services, encompassed the allegations against DVO. The parties also agreed that an endorsement that excludes coverage for claims “based upon or arising out of” breach of contract barred coverage for the underlying claims. The sole issue in dispute was whether the exclusionary language rendered coverage illusory.
A Wisconsin federal district court ruled that coverage was not illusory. It reasoned that while the exclusion barred professional claims brought by a party to the underlying contract, it would not exclude coverage for tort claims brought by third-parties based on DVO’s duty of care as a designer and builder. The Seventh Circuit reversed.
The Seventh Circuit explained that under Wisconsin law, “arising out of” is broadly construed to include “any conduct that has at least some causal relationship between the injury and the event not covered, which sweeps in third-party claims as well when so related.” Given the breadth of the exclusion and the “overlap between claims of professional malpractice and breach of contract,” the court concluded that the exclusion rendered errors and omissions coverage illusory. Additionally, the court held that contract reformation must reflect the insured’s reasonable expectations of coverage. The Seventh Circuit remanded the matter to the district court, noting that a possible outcome would be the elimination of the endorsement as to errors and omissions coverage, while allowing it to remain in effect as to other coverages.