Contract Exclusion Bars Coverage for Suit Alleging Breach of Special Relationship and Conversion

The United States Court of Appeals for the Ninth Circuit, applying Washington law, has held that a contract exclusion precluded defense or indemnity coverage for a suit alleging breach of special relationship and conversion torts that were predicated on premature termination of a contract. X2 Biosystems, Inc. v. Federal Ins. Co., 2016 WL 4120694 (9th Cir. Aug. 3, 2016).

A technology company licensed some of its technology to a manufacturer pursuant to a license agreement. After receiving the monetary consideration due under the contract, the technology company terminated the contract. The manufacturer brought a suit against the technology company alleging various business torts. Two of the torts were “breach of special relationship” and conversion. The breach of special relationship cause of action asserted that, due to a “special relationship” between the two companies, the technology company owed a duty to disclose its intent to terminate the agreement after receiving the monetary payments. The conversion cause of action asserted that the technology company wrongfully retained the monetary payments made under the contract.

The technology company tendered the suit to its E&O insurer, which denied defense and indemnity coverage, citing the contract exclusion. That exclusion precluded coverage for claims “based upon, arising from, or in consequence of any actual or alleged liability of an Insured Organization under any written or oral contract or agreement, provided that this Exclusion . . . shall not apply to the extent that an Insured Organization would have been liable in the absence of the contract or agreement.”

In the ensuing coverage litigation, the district court granted the insurer’s motion to dismiss, holding that the contract exclusion operated to preclude coverage. The court of appeals affirmed the judgment of the district court. The insured argued that the “breach of special relationship” and conversion torts were independent of any duties the insured owed under contract. The court of appeals disagreed, holding that both causes of action arose out of or were a consequence of the license agreement. As the court of appeals noted, the two companies would not have had a “special relationship” absent the license agreement, and the breach of special relationship tort thus arose out of the contractual agreement. The court of appeals also held that the conversion claim was “closely tied” to the contract, because the “premature termination of the [agreement] . . . gave rise to the conversion allegation.”