Management liability insurer had no duty to defend hospital and trustees against IRS claim for unpaid employment taxes and related penalties

by Christopher Graham and Joseph Kelly

New Jersey

William B. Kessler Memorial Hospital, Case No. A-2201-12T3 (Sup. Ct. N.J. Nov. 15, 2013)

Does a management liability policy require an insurer to defend an IRS claim for alleged failure to pay employment taxes, where “taxes,” “fines,” and “penalties” are exceptions from the definition of “Loss”? Not this one, according to this court.

The IRS claimed the insured hospital failed to pay what was owed for employment taxes for withholding and otherwise under the hospital’s quarterly Form 941. It demanded payment from the hospital and its trustees personally.

The policy included a duty to defend, providing: “The Insurer shall have the right and the duty to defend any Claim regardless of whether any of the allegations are groundless, false, or fraudulent.” Claim included “… any Insured Person Claim . . . .” “Insured Person Claim” included certain written demands, civil and criminal proceedings, and administrative and regulatory proceedings. “Loss” wasn’t incorporated into the “Insured Person Claim” definition, but it was used within the policy’s insuring agreement.

The insureds argued in essence that the “duty to defend any Claim” meant even a Claim for unpaid taxes and related penalties, for which the insurer had no indemnity obligation. In rejecting the insureds’ arguments, the court explained:

Plaintiffs’ main argument is that because North River’s definition of “Insured Person Claim” does not specifically refer to its definition of “Loss,” North River’s promise to “defend any Claim” must be honored notwithstanding that taxes and penalties are policy exclusions. In other words, even though North River might not be obliged to indemnify plaintiffs if they were ultimately made responsible for the section 941 taxes, plaintiffs were, nonetheless, entitled to have their defense costs paid for under the policy because the Internal Revenue Service was asserting an “Insured Person Claim.”

We are not persuaded by this overly-simplistic and literal interpretation of the policy. The notion advanced by plaintiffs would require North River to provide a defense against any and all claims lodged against its insureds, regardless of whether the claim embraced a covered risk. This novel interpretation is contrary to our settled jurisprudence with respect to liability policies, and not supported by principles of interpretation applied to insurance policies in general.

Plaintiffs’ potential exposure to the Internal Revenue Service’s effort to impose responsibility for section 941 liabilities is undoubtedly either a tax or a penalty. It is also clear that the policy excludes coverage for fines, penalties, or taxes. Nevertheless, plaintiffs argue that an Insured Person Claim and a Loss are two separate terms and provisions in the policy. They point to Section VI “General Conditions” as creating an independent duty to defend, regardless of whether the loss is contemplated by the policy. This fragmentary approach stands in contradistinction to our obligation to “interpret the policy as written and avoid writing a better policy for the insured.”

Tags: Duty to defend, loss, fines, penalties, taxes

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