Introduction

By Greg Johnson. Having worked in the consumer finance and insurance coverage arenas for over twenty years, I have frequently been asked whether an auto dealer’s “intentional” or “wilful” violation of a statutory disclosure law, such as the federal Truth in Lending Act (TILA), Consumer Leasing Act (CLA) or similar state credit sale disclosure law, is covered by the dealer’s policy.  The suit papers, often styled as a class action, often assert the dealer engaged in some type of intentional scheme to deceive consumers.  As noted in previous articles on this blog, auto dealer insurers have offered statutory errors and omissions coverage to dealers for several decades.  Since 2013, ISO has offered “acts, errors and omissions” coverage under the Auto Dealer Coverage Form.

The answer, of course, is: it depends. This answer is confusing to most (and upsetting to some) as the issue is, in most people’s estimation, rather simple and straightforward. However, the answer to the question in the context of an auto dealer policy involves a host of issues not encountered under typical liability policies. This article addresses those issues and explains why the examination of an auto dealer insurer’s obligation to defend should not be based solely on a consumer’s assertions of wrongful intent in suits under statutory disclosure laws. Unlike typical tort-based bodily injury or property damage claims, disclosure statutes often impose liability based on a strict liability basis without any proof of wrongful intent.  Virtually all jurisdictions recognize that a liability insurer is obligated to defend an insured when there is any “possible” or “conceivable” way the plaintiff could obtain a judgment on the alleged cause of action that would be covered by the policy. Because statutory disclosure laws typically do not require any level of intent – thereby giving rise to a judgment not based on wrongful intent — an auto dealer insurer should defend the dealer despite the consumer’s assertions of wrongful intent. This is particularly so under policies which specifically describe the involved statute as one covered by the policy.

The auto dealer purchases statutory errors and omissions coverage for TILA and CLA to protect itself against liability under the TILA and CLA and cannot control whether the consumer attaches superfluous assertions of wrongful intent to those claims.  The auto dealer insurer is, by offering the coverage, specifically opting to underwrite that liability.  While insurers should be required to defend or indemnify an auto dealer who has engaged in conduct with the intent to evade the law or cause consumer harm, the determination should not be based on the consumer’s allegations. Rather, it should be based on an examination of actual facts compared to the policy.

This is not an insignificant issue from the perspective of the auto dealer insurer.  Many bad faith claims against liability insurers are attributable to the denial of coverage based on an insured’s alleged, as opposed to actual, intent. Most claims professionals are used to analyzing coverage under bodily injury or property damage policy forms where the insurer can rely on the plaintiff’s allegations of intent in analyzing coverage.  The insurer can do so in such claims because the insured’s intent is a required element of the plaintiff’s cause of action itself and determines whether the cause of action is one sounding in negligence or is based on an intentional tort.  That same type of analysis cannot be applied to statutory disclosure claims.  Relying on the consumer’s allegations of wrongful intent, when the statute does not require intent or would allow the plaintiff to prevail based on lesser levels of culpability, is a mistake and can potentially lead to extra-contractual liability against the insurer.

The “Negligence” Requirement

The “Acts, Errors or Omissions” coverage of the Auto Dealers Coverage Form limits insurance coverage to “negligent acts, errors or omissions” committed in the course of auto dealer operations which relate to certain described statutes and activities. The “negligence” requirement was lifted from professional liability and directors and officer’s liability policies. While there is case law to the contrary, the majority of courts have interpreted the term “negligent” to modify all the words that follow it such that the policies containing this language will only apply to negligent acts, negligent errors and negligent omissions. See e.g., Forest Meadows Owners Ass’n v. State Farm Gen. Ins. Co., 2012 WL 1205204 (E.D. Cal. Apr. 11, 2012) aff’d, 2014 WL 1425299 (9th Cir. Apr. 15, 2014); Oak Park Calabasas Condominium Assn. v. State Farm, 137 Cal. App. 4th 557, 40 Cal.Rptr.3d 263 (2006); TIG Ins. Co. v. Joe Rizza Lincoln–Mercury, Inc., 2002 WL 406982 (N.D. Ill. 2002) (“[i]t would be illogical for an endorsement to limit coverage to negligent acts, but to provide coverage for intentional omissions or errors”); Golf Course Superintendents Ass’n of America v. Underwriters at Lloyd’s, London, 761 F. Supp. 1485, 1490 (D.Kan.1991) (“It would be self-defeating to limit the definition of ‘wrongful act’ to negligent acts, but at the same time cover intentional errors or omissions”).

The negligence requirement serves a valuable purpose in the context of professional liability and directors and officer’s liability policies. Similar to the “accident” requirement in commercial liability policies, the negligence limitation is intended to restrict coverage to certain types of conduct, primarily tortious, which generally only produce fortuitous harm or losses – i.e., harm or losses beyond the effective control of the insured.

The limitation is not difficult to apply when addressing the insurer’s obligation to defend in the typical tort- based case of action. There, the cause of action identifies the elements of the cause of action including the insured’s relative degree of culpability (intent) when committing the tortious act. A tortfeasor’s level of culpability lies on a continuum: it may be negligent, reckless or intentional, or something in between. The “negligent act, error or omission” requirement thus serves to limit coverage to claims where the insured’s culpability is something less than intentional — where the probability of harm is something less than substantially certain to occur. An allegation pertaining to the insured’s intent is not superfluous to the tort claim — it is an essential element of the cause of action. If, for example, the insured is sued for an intentional tort, the liability insurer will generally have no obligation to defend the insured because it will never be obligated to pay: the plaintiff will either prevail on the claim (in which case coverage is invariably excluded under the policy) or the plaintiff will fail to prove the elements of the cause of action in which case there will be no judgment. Further, an insurer is generally not required to defend a complaint alleging an intentional tort on the basis that the complaint may later be amended to allege a claim based on lesser culpability, such as one sounding in negligence. The insurer is not required to do so because the plaintiff will never obtain a judgment on a cause of action not before the court.  A plaintiff can only recover a judgment on a cause of action set forth in the complaint. Thus, it is appropriate to say that causes of action which could have been alleged to invoke coverage, but which were not, are immaterial to the insurer’s obligation to defend. (Of course, if a complaint alleging an intentional tort is later amended to include a negligence cause of action, the insurer may be required to step in and defend).

The “negligence” requirement is more difficult to apply to non-tort based causes of action, such as those based on breach of contract.  Some courts have held “negligent” acts, errors and omissions only embrace causes of action sounding in tort and, thus, do not insure liability resulting from breach of contractual obligations. See e.g., Baylor Heating & Air Conditioning, Inc. v. Federated Mut. Ins. Co., 987 F.2d 415, 420 (7th Cir.1993) (policy insuring negligent acts, errors or omissions did not apply to breach of contract because “[t]here is a well-recognized line of demarcation between negligent acts and breaches of contract”); Benefit Sys. & Servs., Inc. v. Travelers Cas. & Sur. Co. of Am., 2009 WL 1106948 (N.D. Ill. 2009) (breach of contract cannot be considered an act of negligence and therefore was not covered by policy); First Southern Ins. Co. v. Jim Lynch Enterprises, Inc., 932 F.2d 717, 719 (8th Cir.1991) (holding that policy covering acts of negligence did not extend to a breach of contract).

However, other courts have recognized that a breach of a contractual duty may in some circumstances constitute a “negligent act, error or omission.” These courts then proceed to scour the complaint in search of allegations that sound like negligence. See e.g., Transcon. Ins. Co. v. Caliber One Indem. Co., 367 F. Supp. 2d 994 (E.D. Va. 2005); Richards v. Fireman’s Fund Ins. Co., 417 N.W.2d 663 (Minn. Ct. App. 1988), pet. for review denied (Minn. Mar. 23, 1988); Mgmt. Support Assocs. v. Union Indem. Ins. Co., 129 Ill.App.3d 1089, 85 Ill. Dec. 37, 473 N.E.2d 405, 412 (1984); USM Corp. v. First State Ins. Co., 420 Mass. 865, 652 N.E.2d 613, 614–15 (1995); Touchette Corp. v. Merchants Mut. Ins. Co., 76 A.D.2d 7, 10, 429 N.Y.S.2d 952 (N.Y.App.Div.1980). “The principle that “the nature of the insured’s conduct” should trump the form of action pleaded for purposes of the duty-to-defend analysis is supported by the commonsense proposition that an insured purchases professional liability insurance to protect itself from its own failures and cannot readily control whether it is sued for those failures in tort or contract.” Touchette, 76 A.D.2d at 10–11.

The Problem

However, there is a fundamental problem with the application of the “negligence” limitation in the context of causes of action under the federal Truth in Lending Act (TILA) and Consumer Leasing Act (CLA) with respect to the insurer’s duty to defend, at least in those states where the term “negligent” also modifies “errors and omissions.” First, causes of action under the TILA and CLA – claims the insurer is specifically opting to underwrite — are not tort-based and, thus, the consumer’s complaint will rarely, if ever, contain allegations of negligent acts, negligent errors or negligent omissions. While the “negligence” requirement is appropriate with respect to the insurance agent and title activities described in the coverage — it is clearly out of place with respect to statutory disclosure claims.  It is a bit like trying to fit the proverbial square peg in a round hole. It suggests that one must comb through a complaint for allegations which “sound like” negligence in order to trigger coverage, when no such allegations will be made. In my 20 years of representing auto dealers in consumer finance litigation and serving as a consultant on major losses, I have never encountered a complaint alleging a negligent violation of the TILA or CLA. The reason is obvious – proof of negligence is not required to recover on such claims.

Second, an auto dealer’s intent – whether expressed as an intent to violate the law or cause consumer harm — is not a required element of a cause of action under the TILA or CLA. Whether the auto dealer knew, should have known or did not know the disclosure requirements of the statutes when it arranged financing and completed the credit sale or lease agreement is immaterial. See e.g., Smith v. Fid. Consumer Disc. Co., 898 F.2d 896, 898 (3d Cir. 1990) (citing 15 U.S.C. § 1640(a)) (“[a] creditor who fails to comply with TILA in any respect is liable to the consumer under the statute regardless of the nature of the violation or the creditor’s intent”); Thomka v. A.Z. Chevrolet Inc., 619 F.2d 246, 249–50 (3d Cir.1980) (“[e]nforcement is achieved in part by a system of strict liability in favor of consumers who have secured financing when this standard is not met”); Grant v. Imperial Motors, 539 F.2d 506, 510 (5th Cir.1976) (“once the court finds a violation, no matter how technical, it has no discretion with respect to liability”). Thus, unlike a tort-based cause of action, allegations of intent made in the context of causes of action which do not require intent are conclusory — indeed superfluous — to the claimant’s right of recovery. Stated another way, it doesn’t matter whether the auto dealer acted negligently, recklessly or intentionally in failing to comply with the law.  Further, since the TILA and CLA do not authorize punitive damages in addition to the relief proscribed under the statutes, the issue of “intent” will rarely, if ever, be examined in the litigation.

As noted above, the “negligence” limitation is intended to restrict coverage to tortious conduct which produces fortuitous losses – losses beyond the effective control of the insured.  Intentional conduct which produces “substantially certain” losses are thus not covered. Despite the fact that TILA and the CLA not require “intent,” required consumers invariably allege — particularly in class action styled complaints – the auto dealer engaged in an intentional and illegal scheme to deceive and harm consumers by not disclosing statutorily required information on credit sale and/or lease agreements. The determination of whether an auto dealer insurer is obligated to defend the dealer against a TILA or CLA claim should not be based on conclusory and superfluous assertions of wrongful intent. In this regard, the comments of the California Supreme Court in Gray v. Zurich Ins. Co., 65 Cal.2d 263, 54 Cal.Rptr. 104, 419 P.2d 168 (1966), deserve repeating: “To restrict the defense obligation of the insurer to the precise language of the pleading would . . . create an anomaly for the insured.” Gray, 419 P.2d at 177. “[T]he complainant in the third party action drafts his complaint in the broadest terms; he may very well stretch the action which lies in only non-intentional conduct to the dramatic complaint that alleges intentional misconduct. In light of the likely overstatement of the complaint and of the plasticity of modern pleading, we should hardly designate the third party as the arbiter of the policy’s coverage.” Id.

The vast majority of jurisdictions, if not all, recognize that an insurer’s duty to defend is based on the cause of action(s) alleged in the complaint and the insurer has an obligation to defend whenever an asserted cause of action could give rise to a judgment covered by the policy. Stated another way, if the insurer has a risk of indemnity, the insurer is obligated to defend. Others have recognized that where a complaint alleges an intentional tort, but a judgment on that cause of action may be based on a lower level of culpability at trial, the liability insurer is obligated to defend. The insurer is obligated to defend the insured because it may be required to pay the judgment against the insured. The case of Parker v. Hartford Ins. Co., 222 Va. 33, 278 S.E.2d 803 (1981) is instructive on this point. In Parker, the Virginia Supreme Court required a liability insurer to defend a suit against its insured for intentional trespass even though the policy excluded coverage for property damage caused by intentional acts and the complaint only alleged a claim for intentional trespass, and not a negligent trespass.  The insurer was obligated to defend because under Virginia law, a cause of action for intentional trespass also included the lesser offense of negligent trespass. Because the insured could be found liable at trial for a risk covered by the policy (i.e., negligence), the insurer was required to defend the insured.

These principles are equally true, indeed even more so, in TILA and CLA claims. An auto dealer who has failed to provide the statutorily required information to a consumer can (and actually will) be found liable to the consumer for a judgment without regard to its intent. Because there is a possibility the liability insurer may be required to pay the TILA or CLA judgment (indeed there is a certainty, not possibility), the insurer should be obligated to defend the auto dealer. In short, auto dealer insurers should defend auto dealers on TILA or CLA claims under the “negligent acts, errors or omissions” coverage despite the consumer’s allegations of intentional wrongdoing.

Some courts have stretched the “potentiality” rule further, recognizing an insurer has a duty to defend an intentional tort claim where the insurer had actual knowledge that other, less culpable, claims could be alleged. See e.g., Westport Ins. Corp. v. Napoli, Kaiser & Bern, 746 F.Supp.2d 502, 508 (S.D.N.Y.2010) (holding insurer had duty to defend insured against claim alleging fraudulent scheme where it had “actual knowledge that there are other possible claims” involving lesser culpability that could be brought); Gray v. Zurich Ins. Co., 65 Cal.2d 263, 54 Cal.Rptr. 104, 419 P.2d 168, 177 (1966) (noting in dicta that insurer was required to defend insured despite allegations of intentional and wilful assault because complaint could be amended to allege negligent conduct); Automax Hyundai South, L.L.C. v. Zurich Am. Ins. Co., 720 F.3d 798, 805 (10th Cir.2013) (interpreting Oklahoma law to require an insurer to defend “even when the facts alleged intentional misconduct because at trial the jury could have found the defendant guilty merely of negligence”).

Moreover, while there is room for disagreement on the issue of whether liability resulting from non-tortious conduct should be covered under a professional liability or directors and officer’s policy containing a “negligence” limitation, auto dealer insurers have elected to insure a particular type of liability that is not predicated on negligence. They should not benefit by utilizing policy language that is inconsistent with the specific risks they have opted to insure.  The determination of whether the auto dealer insurer has an obligation to defend should not be based on whether a TILA or CLA complaint contains allegations which sound like negligence, when such allegations are neither required to state a case of action, nor even likely to be made.

The Solution

This is not to suggest that auto dealer insurers should be required to defend and indemnify an auto dealer where the dealer engaged in conduct with the intent to evade disclosure requirements or cause consumer harm. Liability policies are only intended to protect insureds against fortuitous harm – not planned or deliberate harm. However, for the reasons discussed above, the determination should not turn on the consumer’s assertions of wrongful intent. The auto dealer insured has no control over whether the consumer attaches superfluous assertions of wrongful intent to the TILA or CLA claim. Allowing the consumer’s allegations to control the issue imposes a burden on auto dealers that could rarely, if ever, be satisfied. See e.g., Sonic Auto., Inc. v. Chrysler Ins. Co., 2014 WL 1382070 (S.D. Ohio Apr. 8, 2014) (auto dealer insurer had no obligation to defend dealerships under policies requiring negligent act or error or omission to trigger coverage: “Sonic does not identify allegations of negligent misconduct or errors or omissions made against it in the . . . pleadings”).  (The decision in Sonic will be the subject of a future article on this blog).

Rather, the analysis should be based on actual facts applied against the wrongful conduct exclusion. The exclusion, which is comprehensive in scope, bars insurance coverage for any damages “arising out of any criminal, fraudulent, malicious, dishonest or intentional ‘act, error or omission’ by an ‘insured’, including the willful or reckless violation of any law or regulation….” Because the coverage determination would turn on the applicability of the exclusion, the burden would rest on the insurer to establish the applicability of the exclusion. Generally, a person acts intentionally when he either “desired to cause the [harmful] consequences of his act” or “acted knowing such [harmful] consequences were substantially certain to result.” Restatement (Second) of Torts § 8A. Consistent with case law interpreting similar “expected or intended” injury exclusions under other forms of commercial liability insurance, the auto dealer insurer would be required to introduce proof the dealer acted with specific intent to evade the disclosure requirements or cause consumer harm or that it was substantially certain, practically certain, highly likely, or highly probable. See e.g., Armstrong World Indus., Inc. v. Aetna Cas. & Sur. Co., 45 Cal. App. 4th 1, 68-74, 52 Cal. Rptr. 2d 690 (1996) (the term “expected” requires proof that insured knew or believed harm was “practically certain to occur”); Ohio Cas. Ins. Co. v. Henderson, 189 Ariz. 184, 939 P.2d 1337 (1997) (“[t]he “term ‘expected’ [should] be given a meaning somewhat broader but akin to ‘intended’ — one that connotes an element of conscious awareness on the insured’s part. The exclusion would apply when the insured acted with an intent to harm and with substantial certainty that some significant injury would result, even if the exact injury that occurred was not intended”); Shell Oil Co. v. Winterthur Swiss Ins. Co., 12 Cal.App.4th 715, 15 Cal.Rptr.2d 815 (1993) (“expected,” as used in the language of insurance policies, means anticipation with a high degree of probability, no matter whether the degree of that probability is expressed as “substantially certain, practically certain, highly likely, or highly probable….”); Brown Foundation v. St. Paul Ins. Co., 814 S.W.2d 273, 278 (Ky.1991) (the insured “subjectively foresaw as a practically certain or expected-to-be result of the conduct”); Indiana Farmers Mut. Ins. Co. v. Graham, 537 N.E.2d 510, 512 (Ind. Ct. App. 1989) (“the insured acted although he was consciously aware that the harm caused by his actions was practically certain to occur”); Farmers Union Oil v. Mutual Service Ins., 422 N.W.2d 530, 533(Minn. Ct. App.1988) (the insured subjectively “knew of the substantial risks involved, proceeded in light of this knowledge, and disregarded the known hazard”); United Services Auto. Ass’n v. Elitzky, 358 Pa.Super. 362, 517 A.2d 982, 991 (1986) (“the insured acted even though he was substantially certain that an injury . . . would result”); United Servs. Auto. Ass’n v. Elitzky, 358 Pa. Super. 362, 517 A.2d 982 (1986) (“[w]e hold that for purposes of an exclusionary clause in an insurance contract, expected injury means that the insured acted even though he was substantially certain that an injury generally similar to the harm which occurred would result”); Bay State Ins. Co. v. Wilson, 96 Ill.2d 487, 451 N.E.2d 880, 883 (1983) (insured was “consciously aware that … injuries were practically certain to be caused by his conduct”); Quincy Mut. Fire Ins. Co. v. Abernathy, 393 Mass. 81, 469 N.E.2d 797, 800 (1983) (the insured “knew to a substantial certainty that the bodily injury would result”); Patrons–Oxford Mut. Ins. Co. v. Dodge, 426 A.2d 888, 891 (Me.1981) (“term ‘expected’ when used in association with ‘intended’ carries the connotation of a high degree of certainty or probability . . . practically [to] equate with ‘intended”); City of Carter Lake v. Aetna Cas. and Sur. Co., 604 F.2d 1052, 1058-59 (8th Cir.1979) (an injury is expected if there was a “substantial probability” harm would result); State Farm Fire & Casualty Company v. Muth, 190 Neb. 248, 207 N.W.2d 364, 366 (1973). See also, Keeton & Widiss, Insurance Law, § 5.4(e)(2) at p. 535 (1988).

Consistent with the fortuity principle and case law, the auto dealer insurer would be entitled to introduce direct evidence of the dealer’s subjective intent (i.e., the dealer desired to evade the disclosure requirements or cause consumer harm) or circumstantial evidence establishing the dealer acted while knowing there was a substantial certainty it would evade the disclosure requirements or cause consumer harm.  (The “expected or intended” exclusion is the subject of another article on this blog).

Fortunately, courts are beginning to recognize the distinction between coverage under professional liability and directors and officer’s liability policies for tort-based causes of action and coverage under policies which insure statutory disclosure violations which impose strict liability and do not require intent as an element of the cause of action.  See e.g., Euchner-USA, Inc. v. Hartford Cas. Ins. Co., 754 F.3d 136 (2d Cir. 2014), reh’g and/or transfer denied (July 28, 2014) (insurer obligated to defend ERISA claims under policy requiring “negligent act, error or omission” despite allegations of intentional misconduct and malice because ERISA does not require showing of intent and the complaint did not specifically allege insured acted with “purpose” of interfering with claimant’s retirement benefits); Pacific Insurance Co. v. Burnet Title, 380 F.3d 1061 (8th Cir.2004) (insurer obligated to defend real estate firm against claims that it failed to disclose material information and overcharged closing costs under RESPA because “proof of intent is not necessarily required to establish a violation of RESPA” and complaint did not allege insured intentionally violated RESPA); Nowacki v. Federated Realty Group, Inc., 36 F.Supp.2d 1099, 1104–05 (E.D.Wis.1999) (holding E & O insurer had duty to defend where complaint against insured alleged a “mixture of intentional and negligent acts” and insured could be found to have violated RESPA through error or omission).

The auto dealer purchases statutory errors and omissions coverage for TILA and CLA to protect itself against liability under the TILA and CLA and cannot control whether the consumer attaches superfluous assertions of wrongful intent to those claims.  The auto dealer insurer is, by offering the coverage, specifically opting to underwrite that liability.  While insurers should be required to defend or indemnify an auto dealer who has engaged in conduct with the intent to evade the law or cause consumer harm, the determination should not be based on the consumer’s allegations.

Representing auto dealers and auto dealer insurers in coverage-related matters is a niche practice area. Among other things, coverage counsel must have extensive, in depth knowledge of the automotive retail industry and risks flowing from auto dealer operations, experience in evaluating and litigating coverage issues under a variety of commercial coverage forms and intimate familiarity with all federal, state and local laws and regulations impacting auto dealership operations, particularly those regulating the auto dealer’s consumer financing activities.

Mr. Johnson grew up in the automobile industry. His father owned an American Motors-Jeep-Chrysler dealership in Rapid City, South Dakota. He has represented auto dealers and auto dealer insurers in insurance coverage disputes and defended consumer finance litigation under the TILA, CLA, ECOA, FCRA, MMWA, FOA, MVRISA, UCC, DTPA and CFA for over 20 years. He defended all 542 Minnesota dealerships in litigation with the Minnesota Attorney General and has served as lead counsel and as a consultant to dealers and insurers on class-action litigation inside and outside of Minnesota.

This blog is for informational purposes only. By reading it, no attorney-client relationship is formed. The law is constantly changing and if you want legal advice, please consult an attorney licensed in your jurisdiction. © All rights reserved. 2010.