D&O Coverage for Contract Claims?

By Brit Weimer

Associations frequently seek D&O coverage for tort lawsuits by owners. Insurers often try to deny D&O coverage for these claims based upon broadly-worded contractual-liability exclusions. These exclusions often bar coverage for liability "under" or "arising out of" a contract.

In the context of lawsuits against associations, the D&O insurers’ position can lead to absurd results, since most board conduct indirectly stems from its powers under the governing documents, which are for most purposes contracts between the association and its members. Three basic arguments are helpful here:

First, courts narrowly construe exclusions against the insurers who draft them, avoiding technical interpretations that undermine the insured’s reasonable coverage expectations. See Bohrer v. Church Mut. Ins. Co., 965 P.2d 1258, 1262 (Colo. 1998) (where insurer seeks to limit coverage through an exclusionary provision, the exclusion "must be written in clear and specific language"); Bailey v. Lincoln Gen. Ins. Co., 255 P.3d 1039, 1054 (Colo. 2011) (“honoring the reasonable expectations of insureds over exclusionary contract language may be appropriate even in the absence of contract ambiguity”). Associations reasonably expect coverage for their boards in tort suits by members, and that should not be undermined with the technicality that the parties’ underlying relationship is contractual, subjecting all claims to the contractual-liability exclusion.

Second, courts will not construe an insurance contract in a manner that creates an "absurd result" or that would be "inconsistent with the purpose of the contract.” Depositors Insurance Co. v. Murphy, 629 F.Supp.3d 1050, 1061 (D. Colo. 2022). The principal purpose of D&O contractual exclusions is to avoid the moral hazard of shifting contractual duties to insurance companies. See Domokos v. Scottsdale Ins. Co., 2020 WL 4016811 (N.D. Cal. 2020) (the general purpose behind a D&O contract exclusion is to “ensure that the insured does not breach its contracts with impunity with the expectation to pass the cost off to the insurer"). The purpose is not to eliminate all coverage for claims by members, some of the most common claims against associations and their boards.

Third, not all claims that have contractual components are in substance contract claims. See Town of Alma v. AZCO Constr., Inc., 10 P.3d 1256, 1263 (Colo. 2000) (some special relationships by their nature automatically trigger an independent duty of care that “supports a tort action even when the parties have entered into a contractual relationship”); Union Ins. Co. v. Kjeldgaard, 775 P.2d 55, 56 (Colo. App. 1988) ("contractual liability exclusion" did not apply to defendants' claims against the insured because those claims were “based, in part, on tort liability”). Instead, coverage is determined by the source of the duty giving rise to the claim in the lawsuit. Thus, claims against associations based upon negligence, breach of fiduciary duty or other common-law claims should not be excluded by a contractual-liability exclusion.

In conclusion, D&O contract exclusions must be read in a common-sense way, not artificially eliminating all coverage for owner tort claims. And, since there are no standard-form D&O policies, it is important to analyze the language of the particular policy, in light of state law.

If you would like help evaluating the pros and cons of submitting a D&O insurance claim on behalf of the association, the experienced lawyers at Moeller Graf are available to assist. This information should be viewed as informational and not direct legal advice.