Appeals Court Confirms Contract Exclusion Bars Coverage for Statutory Claims Related to Alleged Contract Breach

January 31, 2013 | Insurance Coverage

A Minnesota appeals court has ruled that an insurance policy that expressly excluded coverage for claims arising from an alleged contract breach by the insured also excluded coverage for other statutory claims related to the alleged breach – and that the insurer was entitled to recover the defense costs it had previously advanced.  

The Case 

Beginning in 2001, Northstar Education Finance, Inc., a Minnesota-based nonprofit corporation in the business of providing student loans to college and graduate students, began offering a bonus program to its customers. Under the program, borrowers who were fewer than 59 days delinquent on their student loan payments were eligible for a credit on their loans equivalent to an annualized interest rate reduction of 0.75 percent. In February 2008, however, Northstar notified its customers that it was suspending the bonus program because of “ongoing disruption in the global markets.” 

Thereafter, four putative class actions were filed in federal court against Northstar claiming, in essence, that Northstar had violated its obligations under the loans by shutting down the bonus program. Two of the cases – the Guidos and Staul actions – were filed in the District of Minnesota claiming between them breach of contract, violation of the Minnesota Uniform Deceptive Trade Practices Act (DTPA), violation of the Minnesota Prevention of Consumer Fraud Act (CFA), and seeking equitable relief. Another action – the So action – was filed in the Central District of California claiming breach of contract and seeking equitable relief. The fourth action, Pintar, was filed in the Eastern District of Michigan, also claiming breach of contract and seeking equitable relief. The four cases were consolidated by the U.S. Judicial Panel on Multidistrict Litigation and referred to the District of Minnesota for pretrial proceedings. 

Northstar’s directors and officers (“D&O) insurer, St. Paul Mercury Ins. Co, notified Northstar that, with respect to the So and Pintar actions, there was no possibility of coverage under the policy because of its contract exclusion. With respect to the Guidos and Staul actions, St. Paul advised that there was no possibility of coverage for those parts of the actions seeking to recover for a breach of contract, or seeking declaratory or injunctive relief. St. Paul advised that it would pay for Northstar’s defense costs for the Minnesota statutory claims, but reserved its right to deny coverage in the future, and to demand repayment of the costs it was advancing. St. Paul began paying the defense costs and, during the course of the underlying litigation, spent nearly $270,000. 

Northstar and the class action plaintiffs reached a settlement that reinstated the bonus program as a guaranteed benefit by establishing a trust account funded annually by Northstar. Northstar was required under the settlement to make five annual payments of at least $1.25 million to the trust account on top of an initial payment of $3.5 million. The settlement also called for Northstar to make payments to the class representatives and to pay class counsel at least $1 million initially and an additional $250,000 annually for another four years. 

Before Northstar accepted the settlement, St. Paul notified it that the settlement costs were not covered under the policy because they reflected an attempt by Northstar to satisfy its contractual obligations to its customers, a loss that the insurer claimed was expressly excluded under the policy. 

Northstar sued St. Paul and its excess insurer, claiming that they had breached their contractual obligations and that Northstar was entitled to a declaratory judgment that it was owed defense and settlement costs. The trial court entered judgment against Northstar, and the case reached a Minnesota state appellate court. 

The Appellate Court’s Decision 

The appellate court reasoned that the essential nature of the class action plaintiffs’ complaints was that they were “bamboozled into taking out a student loan with Northstar by the promise of a discount.” They signed a promissory note with Northstar, and when Northstar cancelled the bonus program, the class action plaintiffs had to pay more on their student loans. As the appellate court pointed out, none of Northstar’s actions posed a problem for people who had no contractual relationship with the company, and the class action plaintiffs only were plaintiffs because they had a contract with Northstar. Accordingly, it ruled, the class action plaintiffs’ complaints all arose from and were causally connected with their contracts, and it held that the exclusion in the St. Paul policy for “liability . . . under any contract or agreement” (emphasis added) barred coverage of the claims against Northstar. 

The appellate court then affirmed the trial court’s decision ordering Northstar to return nearly $270,000 in defense costs that had been paid by St. Paul under the policy, finding that the D&O policy unambiguously provided for repayment of the defense costs. The appellate court also ruled that St. Paul was entitled to interest accrued between judgment and entry of judgment but not to pre-award interest on advanced defense costs, which was not provided for in the policy. 

The case is Northstar Education Finance, Inc. v. St. Paul Mercury Ins. Co., No. A12-0959 (Ct. App. Minn. Jan. 14, 2013).

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