The United States District Court for the Southern District of Ohio has held that a breach of an employment contract by a failure to transfer stock was not a covered securities claim under a D&O policy and that professional liability policies do not cover damages from a breach of contract. Newman v. XL Specialty Ins. Co., No. C-1-06-781 (S.D. Ohio Sept. 24, 2007). Wiley Rein LLP represented the insurer in the case.
A former employee had entered into an employment contract with the insured company, pursuant to which he was to receive shares of the company's stock. The company later fired him without transferring the stock. The former employee arbitrated his claims based on alleged violations of the employment contract, but the company did not defend the arbitration hearing. The arbitration hearing resulted in an award in favor of the former employee. A federal district court then entered a default judgment against the company that confirmed the arbitration award after the company failed to pay the judgment. The company did not respond to the former employee's demand for payment, and the former employee then filed suit against the insurer to collect the damages.
The former employee alleged that his claim against the insured was a "securities claim" under the D&O policy because "the failure to transfer stock as agreed in [the] employment contract can be construed as an act or omission in connection with the purchase or sale of securities." The court rejected the argument, holding that the "claim, while involving securities, is not one that involves either the purchase or sale of said securities."
The court next considered whether the D&O policy covered breach of contract claims. The court, following other federal courts, examined the definition of loss in the policy, which stated that loss was "damages, judgments, settlements or other amounts . . . that the Insured is legally obligated to pay." The court noted that the company had a "contractual duty to pay [the former employee] what he is owed under the contract, not a legal one." The amount of damages owed therefore did not fall into the definition of loss as an amount the insured was "legally obligated to pay."
The court also endorsed the view that a breach of contract is not a "wrongful act" under the policy because a breach of contract claim arises from "the legal and voluntary action of creating a contract." In addition, the court stated that a strong public policy rationale exists for distinguishing between wrongful acts and voluntary conduct. The court stated that "[t]o interpret a liability insurance policy that makes no mention of breach of contract as covering breach of contract would have the effect of encouraging such irresponsible voluntary behavior. Companies could then use their liability insurance policy to make deals that they do not intend to honor, break them after having gained the benefits and rest assured that their insurance company will cover it. This is not the type of irresponsible and dishonest behavior the judicial system should encourage." It therefore held that an insurance policy should not be interpreted to cover breach of contract claims unless the policy expressly provides that it will do so.