The Superior Court of Georgia for Fulton County has ruled in favor of a BatesCarey LLP client, holding that a contract exclusion in a D&O Policy unambiguously excluded coverage for Subscription Agreements valued at $1.7 million.

An insurer issued a duty-to-defend, Private Company Management Liability Insurance Policy to the insured.  The policy contained a Directors, Officers, and Corporate Liability Insurance Coverage Part, which included a contract exclusion barring coverage for:  “‘Loss’ on account of any ‘Claim’ made against any ‘Insured’ directly or indirectly based upon, arising out of, or attributable to any actual or alleged liability under a written or oral contract or agreement. However, this exclusion does not apply to your liability that would have attached in the absence of such contract or agreement.”

Three investors sued the insured for failing to return their investment of $1.7 million in a hotel venture that never came to fruition.  In exchange for their investment, the investors executed Subscription Agreements for the purchase of Preferred Units of Membership Interest in an affiliate of the insured at the cost of $250,000 per Unit.  According to the Subscription Agreements, the Units were being purchased in accordance with the terms of a Private Placement Memorandum (the “PPM”).  Under the Subscription Agreements and PPM, the investors were supposed to receive a complete refund of their investment funds if all 11 Units in the insured’s affiliate were not sold by a certain date, or if other conditions were not met. Instead, the insured directed its attorneys to take the invested funds out of an escrow account and transfer the funds to another prospective investor, who absconded with the funds.

The investors sued the insured and others. The investors’ complaint contained a cause of action for breach of contract and 19 additional causes of action, including counts for breach of fiduciary duties, fraud, negligent misrepresentation, and unjust enrichment.  The insured tendered the suit to the insurer, which denied coverage, asserting that coverage was barred by the contract exclusion.  The insurer explained that the investors’ claims were inextricably intertwined with the obligations under the Subscription Agreements and PPM, and, therefore, the investors’ complaint would not exist in the absence of these agreements.  Accordingly, the insurer asserted, the contract exclusion applied because there could be no claims or liability except that arising exclusively form the insured’s alleged breach of the Subscription Agreements.

In examining the insurer’s position, the court first noted that the underlying facts and circumstances of the claims determined whether or not the exclusion applied.  The court further noted that, under Georgia law, “arising out of” exclusionary provisions focus on the “genesis” of the claims and apply a “but for” test.  In applying this test, the court found that none of the investors’ claims would have existed but for the investors’ relationship with the insured based on the Subscription Agreements and the incorporated PPM.  Therefore, the court held that the contract exclusion unambiguously barred coverage for the investors’ complaint in its entirety.

Notably, the court rejected the insured’s argument that the exception to the exclusion (“this exclusion does not apply to your liability that would have attached in the absence of such contract or agreement”) applied.  First, the insured argued that several of investors’ claims, such as unjust enrichment and money had and received, could only be brought in the absence of a contract.  The court rejected this argument, finding that the underlying facts and circumstances alleged controlled, not the theory of the claims asserted.  According to the court, all 20 counts in the investors’ complaint relied on the same set of alleged facts – the insured had an agreement with the investors regarding their investment as memorialized in the Subscription Agreements and PPM, and the insured disregarded that agreement by transferring money out of the escrow account and negotiating a conflicting deal with the party which absconded with the funds.  As such, the court found, no liability would attach absent the Subscription Agreements and, thus, the contract exclusion applied.

Second, the insured argued that the investors’ claim for breach of fiduciary duties against the insured could arise from outside the contract.  The court pointed out, however, that the insured did not cite to any source which gave rise to fiduciary duties in the case at bar.  To the contrary, the allegations in the investors’ complaint cited to duties arising directly from the Subscription Agreements and PPM, such as the duty to refund money if 11 subscriptions were not sold and the duty to hold money in escrow.  Likewise, the insured argued that the investors brought several tort claims, such as fraud and negligent misrepresentation, that were wholly independent of the existence of a contractual relationship. The court rejected this argument, too, finding that these counts relied on the same set of alleged facts that would not arise but for the Subscription Agreements. The court emphasized that the Subscription Agreements were the genesis of all of the individuals’ claims and, thus, the contract exclusion applied.

Finally, the insured argued that only its affiliate was a party to the contract, and, thus, the claims against the other insured entities and individuals could not have arisen “but for” the Subscription Agreements and the PPM.  But the court pointed out that the insured defendants were jointly and severally liable for breach of contract, and thus any duties held by the insureds who were not parties to the contract would be as a result of the duties arising under the Subscription Agreements.  According to the court, the individuals simply did not allege any alternative source of a duty held by any of the insureds outside of the Subscription Agreements that were relevant to the investors’ claims. Ommid C. Farashahi, Jason P. Minkin, Michael S. Skoglund, and Adrian T. Rohrer defended the insurer.