Why it matters: Two policy exclusions—one for violations of deceptive practices laws and another for predetermined level of fitness failures—operated to preclude coverage for a False Claims Act (FCA) suit against a shipbuilder, the Fifth Circuit Court of Appeals recently determined. The shipbuilder worked on a project to convert U.S. Coast Guard boats into larger vessels. When one of the ships demonstrated structural problems, a government investigation revealed all of the boats were unsound and the shipbuilder made misrepresentations about the strength of their hulls. The government filed suit alleging violations of the FCA as well as fraud, negligent misrepresentation, and unjust enrichment. The shipbuilders denied coverage and the Fifth Circuit agreed, holding that two exclusions barred coverage for the government's lawsuit: one for predetermined level of fitness failures (which took care of the unjust enrichment and negligent misrepresentation claims), while the violation of deceptive practices law exclusion eliminated coverage for the FCA and common-law fraud claims, the court said.

Detailed discussion: Bollinger Shipyards won a multimillion-dollar contract to upgrade eight U.S. Coast Guard 110-foot cutters to 123-foot craft as part of the Coast Guard's modernization program. In 2004, one of the vessels refitted by Bollinger suffered a structural casualty. An investigation by the Coast Guard found that all eight vessels were similarly deficient and unusable, despite efforts to remedy the hull strength.

The government filed an FCA suit against Bollinger. According to the complaint, when the Coast Guard expressed concern during the bidding and development stages about the ability of the boats' hulls to accommodate the extensions, the shipbuilder submitted a longitudinal strength analysis demonstrating that the boats would have more than the required strength. Bollinger did not disclose that revised calculations indicated the hull strength was not sufficient for the conversion, the government said.

Four claims were included in the lawsuit: two violations of the FCA, as well as counts alleging common-law fraud, negligent misrepresentation, and unjust enrichment. Trial is currently scheduled for April 2016.

Bollinger requested coverage for the government's lawsuit from its general maritime liability insurer XL Specialty Insurance Company and excess insurer Continental Insurance Company. XL responded with a reservation of rights letter and Bollinger continued to fund its own defense.

The policyholder then filed suit against both insurers alleging bad faith and breach of contract. A federal court judge in Louisiana granted summary judgment in favor of the insurers, and Bollinger appealed to the Fifth Circuit Court of Appeals.

XL proffered several exclusions that it argued applied to preclude coverage for the government's suit against Bollinger. The federal appellate panel found two of the exclusions prevented coverage: one for failures of predetermined level of fitness and a second prohibiting coverage for unfair or deceptive trade practices.

Exclusion 28 of the policy stated that coverage "shall not apply to … [t]he failure of your products to meet any predetermined level of fitness or performance and/or guarantee of such fitness or level of performance and/or any consequential loss arising therefrom."

Bollinger told the court that the exclusion was inapplicable because the government was seeking damages for the entire value of the vessels and not just the work product for which the shipbuilder was responsible. "This argument cannot succeed," the three-judge panel wrote. "Exclusion 28, by its own terms, exempts claims for damage not only to the insured's work product but also to things other than the insured's product."

The shipbuilder also contended that the underlying suit did not actually allege a failure to meet a predetermined level of fitness. Again, the court rejected the insured's argument. The underlying complaint pled that "Bollinger … was responsible for the … performance requirements" of the modified boats, the Fifth Circuit said, and referenced specific requirements such as "the required section modulus," a requirement to comply with American Bureau of Shipping standards, and a requirement to provide a hull strength analysis.

"[T]he complaint lays out straightforwardly that Bollinger failed to meet a requirement that the parties together determined in advance," the court said. "The [contract] required the vendor to submit a hull strength analysis, which states the required longitudinal strength that Bollinger's work failed to meet."

Exclusion 28 foreclosed coverage for the unjust enrichment and fraudulent misrepresentation claims, the court said. Turning to Exclusion 32, the panel found it precluded coverage for the remaining counts under the FCA and common-law fraud.

Absolving XL from coverage, Exclusion 32 stated: "e. Actual or alleged liability arising out of or incidental to any alleged violation(s) of any federal or state law regulating, controlling, and governing antitrust or the prohibition of monopolies, activities in restraint of trade, unfair methods of competition or deceptive acts and practices in trade and commerce, including, without limitation, the Sherman Act, the Clayton Act, the Robinson-Patman Act, the Federal Trade Commission Act and the Hart-Scott-Rodino Antitrust Improvements Act; or f. Actual or alleged liability arising out of or contributed by [Bollinger's] dishonesty or infidelity."

Although the shipbuilder conceded at the district court level that Exclusion 32 eliminated coverage, it changed position to qualify that provision "may" exempt the underlying claims. "Of course it does," the panel wrote. "[T]he FCA claims clearly fall under Exclusion 32.e. It is irrelevant that the FCA is not listed among the statutes excluded, since the FCA is a 'federal law … regulating … deceptive acts and practices in trade and commerce[.]'" Further, "the alleged FCA violation need not itself be 'deceptive.' The plain language of Exclusion 32.e embraces laws that regulate deceptive acts, not allegations of deceptive acts."

As for Continental, the panel affirmed summary judgment in the excess carrier's favor, as the policy provided coverage only for property damage and personal injury—not payment for false claims made to the government, as requested in the underlying FCA suit.

To read the decision in XL Specialty Insurance Co. v. Bollinger Shipyards, click here.