Why it matters: In a victory for the policyholders, a federal court judge in Illinois held that an insurer owed a duty to defend under a claims-made employment practices liability insurance policy to a company and individual defendant for a False Claims Act (FCA) lawsuit initiated by a former employee. In a ruling that highlights the need to read all policy terms carefully and measure them against all allegations in the underlying litigation, particularly in the context of the broad duty to defend, the court ruled that although the gist of the FCA claim concerned allegations of fraudulent contracting, the lawsuit also contained allegations concerning “harassment, wrongful termination, retaliation or discrimination,” which triggered coverage under the policy. 

Detailed discussion: Lawrence McCarthy filed a six-count complaint pursuant to the FCA in Illinois federal court against Marathon Technologies, Sigmatek, Inc., and their mutual owner, Jerry Kozlowski. McCarthy formerly was an employee of both Marathon and Sigmatek, both arms manufacturers that had contracts with the United States Army. Both entities, as required, certified that their products satisfied contract terms and design specifications, and could be used safely in military combat and exercises. 

Relator McCarthy alleged that the certifications were false and fraudulent because the products did not pass the quality assurance program, a fact that the defendants fraudulently conspired to conceal from the U.S. government. 

McCarthy claimed that, while still employed, he reported the false certification to Kozlowski, who advised him to violate the government specifications and falsify documents. McCarthy further alleged that he “was forced to terminate his employment” because of Kozlowski’s behavior toward him. 

The defendants tendered the suit to United States Liability Insurance Company (USLI) under an employment practices liability insurance (EPLI) policy. The insurer denied coverage, filed a declaratory action and moved for judgment on the pleadings, arguing that the suit was a qui tam action based in fraud and the policy issued to the defendants was for employment practices liability. 

The court denied the insurer’s motion, ruling that the complaint alleged not just fraud against the government but wrongful employment practices as well, including harassment, wrongful termination, retaliation, and discrimination. Such allegations were covered. 

“USLI correctly notes that McCarthy does not assert a separate claim for wrongful employment practices. However, when considering whether an insurance company has a duty to defend, a court ‘should not simply look to the particular legal theories pursued by the claimant [in the underlying action], but must focus on the allegedly tortious conduct on which the lawsuit is based,’ ” Judge Castillo wrote. “Thus, McCarthy’s failure to assert a separate count for wrongful employment practices is not dispositive to this coverage dispute.” 

The court emphasized that McCarthy requested a broad prayer for “all relief, both in law and equity, to which … [h]e may reasonably appear entitled,” while realleging all prior paragraphs in the complaint, including the employment-related allegations. 

The FCA provides employees with “all relief necessary to make that employee … whole,” including “reinstatement with the same seniority status that employee … would have had but for the discrimination,” as well as back pay, interest on the back pay, and compensation for any special damages sustained as a result of the discrimination. 

“Because the Court is required to view the complaint in the light most favorable to the insured, the Court finds that incorporating Section 3730(h) in each count, along with his broad prayer for all relief to which he may reasonably appear entitled to, is sufficient to assert a claim for relief for wrongful employment practices,” Judge Castillo wrote. 

The court therefore held that USLI has a duty to defend Sigmatek, Marathon Technologies, and Kozlowski in the McCarthy lawsuit. Because the underlying suit remained pending, however, the court dismissed without prejudice the policyholders’ request for indemnification. 

To read the opinion in United States Liability Insurance Co. v. Sigmatek, Inc., click here.