Second Circuit: ERISA Claims Raise Reasonable Possibility of Negligence, Trigger Duty to Defend Under EBL Coverage

The plaintiff’s complaint in the underlying action alleged that she had been sexually harassed by a senior executive of the insured and that, when she confronted him about his conduct, she had been wrongfully terminated and coerced into accepting an independent contractor position that disqualified her from receiving certain employee benefits. The insured tendered the defense of the underlying action to the CGL carrier who disclaimed coverage. The underlying action was subsequently settled and the insured then filed a declaratory judgment action seeking defense and indemnification.

On cross-motions for summary judgment in the declaratory judgment action, the district court ruled that the insurer had no duty to defend because the CGL policy excluded the intentional conduct alleged in the amended complaint. The underlying plaintiff’s claims were based on Employee Retirement Income Security Act and claimed that the plaintiff had been deprived of pension benefits through the insured’s improper classification of her as an independent contractor rather than as an employee. The insured appealed to the Second Circuit.

The policy excluded coverage for employment-related practices, but contained an Employee Benefits Liability (EBL) endorsement which provided coverage for “those sums that the insured becomes legally obligated to pay as ‘damages’ because of ‘employee benefits injury’ to which this insurance applies.” Under the EBL endorsement, “Employee benefits injury” was defined as “injury that arises out of any negligent act, error or omission in the ‘administration’ of your ‘employee benefit programs.’” The policy defined “administration” as “giving counsel to your employees or their dependents and beneficiaries, with respect to interpreting the scope of your ‘employee benefits program’ or their eligibility to participate in such programs” and “handling records” in connection with your “employee benefits program.” The policy also contained an exclusion that barred coverage for civil or criminal liability arising out of “Any dishonest, fraudulent, criminal or malicious act.”

First, the Second Circuit concluded that the exclusion wrongful conduct did not bar coverage as the amended complaint alleged, with respect to the ERISA classification, that it was done only “improperly and unlawfully,” which the Court found were legal conclusions, not allegations of fact.

Second, the court stated that the decisive issue was whether there was a reasonable possibility that the underlying plaintiff’s ERISA claims arose from negligence in administering the plan. The Court found that determining eligibility may reasonably be considered part of the program’s recordkeeping function. The insurer argued that the EBL coverage extends only to “ministerial actions” not “deliberate, discretionary activity.” In response, the Court stated that classification of someone either as an independent contractor or as an employee for purposes of program eligibility is not a matter of discretion. Because the Court found there was a reasonable possibility of coverage under the EBL endorsement, the insurer had a duty to defend. The case was remanded for a determination on the duty to indemnify.