Why it matters: A breach of contract policy exclusion precludes coverage for a cross-claim against a policyholder alleging fraud and breach of contract, according to a California federal court. Claiming that Biotab Nutraceuticals failed to pay for advertising services, Inter/Media Time Buying Corp. filed suit seeking reimbursement based on contracts between the parties. Biotab cross-claimed that Inter/Media breached the parties’ contracts and committed fraud. Inter/Media turned to Axis Insurance Co. for a defense pursuant to a multimedia liability policy that included an errors and omissions endorsement for advertising services. Axis rejected the request, arguing that the policy’s exclusion for breach of contract applied. The court agreed, finding that all of the allegations in the counterclaim were contract-based, which nullified the applicability of the endorsement.

Detailed discussion: Inter/Media Time Buying and Biotab Nutraceuticals entered multiple contracts that required Inter/Media to provide various advertising services in return for payment. The most recent agreement, from November 2010, included a guarantee on Biotab’s part to pay previously accrued debts as well as provisions regarding the exclusivity of the advertising relationship and the disclosure of media costs.

Two years later, Inter/Media filed suit against Biotab to collect debts owed. Biotab responded with a cross-complaint against Inter/Media and related entities alleging breach of contract with respect to the exclusivity requirement and the full disclosure of media costs as well as fraud and other claims.

Specifically, Biotab claimed that it contracted to use Inter/Media exclusively for its advertising needs but that Inter/Media used other entities to perform media buying and other ad services, adding an additional commission or markup. Inter/Media also failed to provide Biotab with proof of the specific ads and their prices, the cross-claim alleged.

Inter/Media tendered defense of the suit to Axis Insurance Company pursuant to a series of Multimedia Liability Policies. As relevant to the dispute, the policies contained an “Advertising Services Errors & Omissions Endorsement” as well as an exclusion for breach of contract.

Axis denied the tender, taking the position that no potential for coverage existed under the policy; alternatively, the insurer said the breach of contract exclusion precluded coverage.

U.S. District Court Judge Dolly M. Gee first determined that the E&O endorsement applied because some of the claims arose out of the insured’s conduct “in connection with the performance of Advertising Services” as covered by the provision.

Biotab’s fraud in the inducement of the contract with Inter/Media was not covered by the endorsement because the performance of the contract was irrelevant to that claim, she explained. However, Biotab also alleged that Inter/Media misrepresented that it had provided accurate information regarding the actual costs incurred in placing ads—allegations that concerned services rendered in the performance of advertising services, the court said.

In addition, the complaint’s contractual claims also fell under the scope of the E&O endorsement, Judge Gee said, such as allegations that Inter/Media used brokers to place advertisements rather than performing the service itself.

“Because all of Biotab’s allegations—except for the allegation that Inter/Media made misrepresentations in inducing the contract—concern Inter/Media’s performance of Advertising Services, and Axis does not dispute the other elements required for coverage, the Court finds that the Policy covers the claims in Biotab’s cross-complaint against Inter/Media,” the court wrote.

The insured’s victory was short-lived as the court then held the contract exclusion applied to preclude coverage for the Biotab cross-complaint. California courts may construe exclusions narrowly but they also interpret the term “arising out of” broadly, the judge said.

The breach of contract exclusion stated that Axis “will not be obligated to pay Damages or Claim Expense for Claims for or arising out of any actual or alleged: breach of contract … except that this exclusion shall not apply to: a. Liability which the Insured would have incurred in the absence of such contract, warranty, guarantee or fiduciary relationship.”

“Here, all of the allegations in the underlying action that are covered under the agreement’s E&O Endorsement ‘flow from’ Inter/Media’s alleged contractual obligations to purchase the advertising time slots itself and to make full disclosures of all media costs to Biotab,” Judge Gee wrote. “The exclusion applies because Biotab’s claim that Inter/Media’s representations about doing the work itself and fully disclosing actual media costs were misrepresentations only insofar as the contract allegedly created the expectation that Inter/Media would not use brokers and would fully disclose actual media costs.”

The “inextricable linkage” between the insured’s contractual obligations and the allegations in the cross-complaint, coupled with the broad “arising out of” language in the contract exclusion, “militates toward a finding that the breach of contract exclusion applies, thus precluding coverage.”

Inter/Media’s attempt to dodge the exclusion relied upon Biotab’s other allegations grounded in fraud. “This argument falters because … Defendants did not establish that the allegations related to fraud in the inducement fall within the scope of the Policy’s coverage, which encompasses only claims in connection with the performance of Advertising Services,” the court said. “Misrepresentations made to induce Biotab to enter into a contractual relationship, before any contract existed, cannot be construed to be connected with the performance of Advertising Services.”

Because Axis had no duty to defend on the basis of the contract exclusion, Judge Gee denied Inter/Media’s motion for summary judgment and instead granted summary judgment for the insurer sua sponte.

To read the order in Axis Insurance Company v. Inter/Media Time Buying Corp., click here.