The United States District Court for the District of Kansas, applying Kansas law, has held that an exclusion in an employment practices liability insurance policy for claims involving violations of certain labor laws precluded coverage for a suit against the insured company alleging violations of the California Labor Code. Payless Shoesource, Inc. v. Travelers Companies, Inc., No. 07-4075-JAR, 2008 WL 2995553 (D. Kan. Aug. 4, 2008). The court also granted summary judgment to the insurer on a related “bad faith” cause of action, holding that Kansas law does not recognize such a claim by an insured against its insurer.

In 2003, a group of current and former employees of the insured filed a putative class action lawsuit against the insured, alleging that they were required to work off the clock without compensation, in violation of the California Labor Code. The insurer refused to indemnify the insured for any amounts, including defense costs, incurred in connection with the underlying lawsuit on the grounds that the allegations asserted did not constitute wrongful employment practices within the scope of the insuring agreement and, even if they did, coverage was excluded. The insured settled the lawsuit without objection or contribution from the insurer.

The insured later filed suit against the insurer, seeking to recover its settlement and defense costs, as well as damages for bad faith. The parties filed cross-motions for summary judgment. In support of its motion, the insurer argued that the underlying plaintiffs’ claims for unpaid wages and penalties based on violations of the California Labor Code implicated “Exclusion No. 3” in the policy, which precluded coverage for claims against an insured for an actual or alleged violation of several enumerated federal labor laws, including the Fair Labor Standards Action (“FLSA”), as well as “other similar provisions of any federal, state or local statutory or common law or any amendments, rules or regulations promulgated under any of the foregoing . . . .” In response to this argument, and in support of its own motion, the insured argued the exclusion was ambiguous and that under the “last antecedent rule” – a rule of construction which provides that phrases and clauses “are ordinarily confined to . . . the words and phrases immediately preceding” – the phrase “other similar provisions of any federal, state, or local statutory or common law” only applied to the last of seven items in the sequence listed in the exclusion and therefore not to the FLSA, which was listed first. The insured also argued that, in any event, plaintiffs’ claims under the California Labor Code were not similar enough to FLSA claims to implicate Exclusion No. 3.

The court rejected plaintiffs’ arguments. First, the court concluded that Exclusion No. 3 was clear and unambiguous and therefore there was no basis to apply any rule of construction, including the last antecedent rule. Rather, the court recognized its obligation to enforce the policy language as written and, focusing on the “any of the foregoing” phrase, determined that the state law modifier in the exclusion applied to all seven items in the series, including the FLSA. The court further determined that in order to trigger the exclusion, the claims at issue need only be based on state law provisions that are “similar,” and “not identical,” to FLSA provisions. In this connection, the court concluded that the relevant compensation and overtime provisions of the California Labor Code relied upon by the underlying plaintiffs were sufficiently similar to those in the FLSA for the exclusion to apply.

Although the court’s determination as to the applicability of Exclusion No. 3 explicitly “did not hinge” on public policy grounds, the court noted the moral hazard of permitting coverage for violations of certain laws. Specifically, the court recognized to require an insurer to pay for liability resulting violations of overtime laws not only would encourage violations of such laws, but also would create a “financial windfall” for the insured, essentially allowing the insured to enrich itself unjustly with additional work paid for by the insurer.

Turning to the insured’s bad faith claim, the court noted that Kansas law does not recognize an independent tort by an insured based on an insurer’s purported failure to carry out its contractual obligations. According to the court, in the absence of some other legal theory, such as fraud or misrepresentation, an insured’s ability to recover extra-contractual damages from its insurer is limited to a statutory claim for attorneys’ fees. The court therefore rendered judgment in favor of the insurer on all claims asserted.