The Fifth Circuit recently affirmed a District Court decision holding that coverage for subsidiary “corporations” does not ordinarily include limited liability companies. American Electric Power Company Inc., et al. v. Affiliated FM Insurance Company, No. 07-31061 (5th Cir. Jan. 21, 2009).

The insurer issued a policy in 2000 covering employee theft or misconduct to the insured, a public utilities conglomerate. The insured then acquired another public utilities company. Subsequently, the insured discovered that, in 1999, employees of a subsidiary of the acquired entity had committed theft. In 1999, the acquired entity had been covered by a policy issued by another insurer and, for the purposes of the appeal, the parties agreed that the 2000 policy provided coverage for “prior losses” that would have been covered under the acquired entity’s predecessor policy.

However, the acquired entity’s predecessor policy only covered “any subsidiary corporation now existing or hereafter created or acquired” (emphasis added). The employees in question had been working for a subsidiary of the acquired entity that was an LLC. The insurer, therefore, argued that there was no coverage. The District Court agreed and granted summary judgment to the insurer on the basis that the term “corporation” unambiguously excluded LLCs.

On appeal, the insured made two arguments: (1) the term “corporation” is ambiguous in this regard and can be reasonably interpreted to include LLC’s; and (2) even if the term “corporation” is unambiguous, in this case the term should have been “reformed” to include LLCs based on evidence that the acquired entity and its insurer had both understood the term to include LLCs.

The Fifth Circuit (applying Louisiana law) rejected the first argument, finding that the “generally prevailing meaning of the term ‘corporation’ does not include LLCs,” which are “defined in part by their contrast to corporate entities.”

As to the second argument, the court noted that, under contract law principles and Louisiana law, an insurance policy “may be reformed if, through mutual error or fraud, the policy as issued does not express the agreement of the parties.” The court further noted, however, that, even in the case of such “mutual error,” reformation may not be appropriate if rights of third parties are affected. The court pointed out that the insurer had “assumed the coverage obligations set forth under the unambiguous terms” of the acquired entity’s policy, and there was no indication that the insurer “knew or should have known of an informal understanding between [the acquired entity and its insurer] regarding the meaning of ‘corporation.’” Therefore, the insurer’s rights would be adversely and unfairly affected by “reformation.” Furthermore, the court observed, “reformation” is typically reserved for obvious clerical errors, whereas the parties here merely had a “broader-than-usual meaning in mind when they purposefully included the word.”

For a copy of the decision, please click here.