Businesses have responsibilities; they buy liability insurance to cover losses that arise if they fail to perform them all. Businesses also “assume” responsibilities under contracts; those responsibilities are typically excluded from coverage. Sometimes the two kinds of responsibility overlap. Last month, in Payroll Management, Inc. v. Lexington Ins. Co., No. 15-10314 (11th Cir. March 1, 2016), the U.S. Court of Appeals rejected an insured’s attempt to exploit that common territory, but it also suggested that policy language will sometimes turn out to be ambiguous there.

How Did We Get Here?

Payroll Management, Inc. (PMI) is an employee leasing company. That means it offers other businesses services such as “writing and posting job descriptions,” “processing payroll” and “putting together a benefits package that will make your jobs competitive.”In the course of putting that benefits package together, PMI entered into an agreement for healthcare coverage with Blue Cross Blue Shield of Florida.

Putting a package together is one thing; paying for it is another. After PMI failed to make premium payments for five consecutive months, Blue Cross canceled the policy and sued to recover the missed payments.

Together with a related company, Payroll Management, Inc. of Delaware (PMI Delaware), PMI sought coverage for the suit under an Employment Practices Liability Insurance policy issued by Lexington Insurance Company. The insurer denied the claim, and the two PMI companies filed an action for breach of contract and declaratory judgment in the Florida Circuit Court for Okaloosa County. The removal of the case to federal court led to some jurisdictional skirmishing that will be described below, but, eventually, the U.S. District Court for the Northern District of Florida granted the insurer’s motion for summary judgment. PMI appealed.

What Business Is It Of Yours?

The EPLI policy PMI had purchased covered “all sums” the company became legally obligated to pay for a “Wrongful Professional Act.” The policy defined “Wrongful Professional Act” to include

any breach of duty, neglect, error, … or omission in performing or failing to perform services for others … in the administration of Leased Employees assumed from the Client.

The policy also expressly excluded coverage for any claim “arising out of liability the Insured assumed under any contract or agreement.” But the exclusion contained an exception for liability “which would arise against the Insured [even] in the absence of the contract or agreement.”

The district court found that the contractual liability exclusion did not apply in this case, but it nevertheless upheld the denial of the claim, on the ground that the underlying suit against PMI did not arise out of a “Wrongful Professional Act.” The court reached that conclusion by applying Florida law governing coverage for breach-of-contract claims.

On appeal, PMI argued that it was not seeking coverage for a breach of contract at all. It contended that the “Wrongful Professional Act” for which it was seeking coverage was a “wrongful diversion of funds” by PMI’s former president, rather than a failure to discharge contractual obligations to Blue Cross. According to PMI, it was that officer’s “inexperience, lack of education, incompetence, and negligence” which had given rise to the claim, by rendering PMI unable to pay Blue Cross and other creditors.

The Eleventh Circuit was not convinced. It observed that the complaint in the Blue Cross lawsuit “[sought]damages for missed payments,” and did not “seek damages for the wrongful diversion of funds, even if that wrongful diversion directly resulted in the missed payments.” More fundamentally, the court found it unreasonable to hold an insurer responsible for the insured’s mismanagement of its own finances:

If [PMI’s] proposed understanding of the policy’s scope were correct, Lexington would … be obligated to cover [PMI’s] failure to pay any of its contractually obligated debts—including its rent and utilities bills. It is hard to see how the policy, given the language quoted above, could be read faithfully to include such coverage.

The Court of Appeals also disagreed with the district court and found that the contractual liability exclusion “squarely applie[d] to bar coverage for the Blue Cross suit.”

Though the parties could have allocated the risk so that Lexington would have been on the hook for [PMI’s] failure to pay Blue Cross in theory, the contractual-liability exclusion makes clear that they did not do so in fact.

Things might be different, the court noted, if the underlying suit alleged breach of a contract with the insured’s own clients or employees. In that case, the language of the contract liability exclusion might conflict with the insuring clause, which (by incorporating the definition of “Wrongful Professional Act”) states that the policy covers “any… omission … in the administration of Leased Employees.” The opinion went so far as to say the exclusion “may be ambiguous” in those circumstances. But it found no such problem in a claim for payment by a third-party vendor of services, even if those services were ones that the insured was independently obligated to provide.

That Jurisdiction Problem …

The district court actually granted the insurer’s summary judgment motion twice. When PMI appealed from the first order, the Eleventh Circuit observed that the presence of PMI Delaware as a party to the case defeated complete diversity and deprived the court of subject matter jurisdiction. Without ruling on the merits, the Court of Appeals remanded the case for additional fact-finding on the question of whether jurisdiction could be preserved by dismissing the claims of PMI Delaware.

On remand, the district court concluded that PMI Delaware was a nominal, non-essential party, not a real party in interest. The court dismissed it from the case, pursuant to Fed. R. Civ. P. 21, and it entered summary judgment on the merits for the second time.

On appeal, PMI argued that PMI Delaware was entitled to share in any judgment against the insurer, because some of its employees were covered by the Blue Cross contract, and because it was eventually joined as a defendant in the Blue Cross lawsuit. The Court of Appeals pointed out, however, that PMI Delaware was not a party to the suit at the time when Lexington denied the insurance claim that was at issue in the coverage action. Nor did PMI Delaware ever make an independent demand for coverage. Consequently,

Lexington … did not owe any duty to defend or indemnify PMI Delaware in the Blue Cross suit that would be implicated in the present proceedings.

The Yoohoo Claim

The Payroll Management case presented one more issue. At the time PMI filed its claim for the Blue Cross suit, a company called Yoohoo Capital, LLC, was considering whether to buy stock in PMI and PMI Delaware. A consultant for Yoohoo contacted a Lexington claims examiner, to inquire whether PMI’s losses would be covered. The examiner responded by email, stating:

As we discussed, there appears to be coverage for this matter … but, as we also discussed, I must review with my supervisor.

Yoohoo acquired PMI Florida and PMI Delaware that same day. It later joined PMI’s suit against the insurer, asserting a claim for negligent misrepresentation.

The district court granted summary judgment on this claim, as well, and the Eleventh Circuit affirmed. In the opinion of the Court of Appeals, no reasonable jury could find that the examiner’s “inherently equivocal statement” was “both false and capable of being justifiably relied on.”

Final Thoughts

Payroll Management appears to create a useful rule of thumb for cases in which insured companies conduct their business by entering into contracts. Breach-of-contract claims by third-party vendors are not covered as part of the normal operation of the insured’s business. But breach-of-contract claims by the insured’s own employees or clients might be problematic. Carriers that want to exclude coverage for employee or client contracts in Florida have been given timely warning.