Getting Around Employment Practices Exclusions

April 01, 2002

by Mary E. McCutcheon

As companies continue to experience increasingly serious employment-related claims, insurers continue to draft increasingly onerous "employment practices exclusions." A careful review of these exclusions demonstrates, however, that they are not as ironclad as carriers would have you believe. The policyholder's attorney can exploit loopholes in these exclusions which might raise at least the potential for coverage and thus creates a duty to defend.

As always, the search for coverage begins with a painstaking review of the policy language. For example, some older exclusions refer only to claims arising out of the hiring and termination of an employee. In a case where an employee alleges a pattern of wrongful conduct over a period of time, some of that conduct may be covered under the policy's personal injury coverage (e.g., claims for defamation and invasion of privacy) but not related to the employee's termination.

As another example, most commercial general liability policies contain four coverage parts - bodily injury, property damage, personal injury and advertising injury liability. One insurer has issued an extensive employment practices exclusion, encompassing nearly every conceivable injury to a past, current or future employee. The exclusion, however, explicitly applies to "bodily injury, personal injury or property damage" suffered by an employee. So, it does not extend to any advertising injury committed against an employee.

Now, you might assume that an employer cannot commit advertising injury against an employee. Several advertising injury offenses, however, simply are personal injury offenses committed "in the course of" the insured's advertising activities. Depending on the policy's definition of "advertising injury" (or lack thereof), potentially defamatory statements about employees made in press releases, sales meetings or communications to customers may in fact constitute covered "advertising injury."

In the past, employers argued that post-termination defamation did not fall within the scope of an employment practices exclusion because it was committed against someone who was no longer an employee. California courts eliminated that argument in Loyola Marymount University v. Hartford Accident and Indemnity Co. (1990) 219 Cal.App.3d 1217, 1223. The Loyola court found that an exclusion for personal injury "directly or indirectly related to the employment" of an individual encompassed post-employment defamation. The Loyola court explained that the exclusionary language was not limited to personal injury "committed during the employment." Rather, it covered all "personal injuries" "alleged or potentially at issue in the [employees'] actions, because all of them arise from or derive from, and hence are 'related to,' [the former employees'] employment and termination." See also Frank and Freedus v. Allstate Ins. Co. (1996) 45 Cal.App.4th 461, 471 (post-employment defamation is "employment-related").

This argument, however, was revived by two federal cases, which noted that injuries to current or former employees might not necessarily arise out of the employment context. In HS Services, Inc. v. Nationalwide Mutual Ins. Co. (9th Cir. 1997) 109 F.3d 642, 646, the court found that defamatory statements concerning a former employee were not "clearly employment-related" and therefore not subject to the employment practices exclusions contained in that policy. The former employee (Cade) had started a business which competed with his former employer (Cade-Grayson) and was telling Cade-Grayson's vendors that Cade-Grayson was experiencing financial difficulties. Cade-Grayson instructed its sales managers to respond to inquiries regarding the company's financial status by stating, among other things, that Cade had been terminated by Cade-Grayson for acts involving dishonesty. Cade subsequently amended his pending wrongful termination claim to include a claim for defamation. In the ensuing coverage litigation, the court ruled:

The remarks related directly to the competition between Cade and Cade-Grayson in the marketplace and the latter's attempt to protect itself against the remarks made by Cade, not as an ex-employee, but as a present competitor; that was their context. While it may be literally true that the remarks "related" to Cade's employment, that relationship was too indirect and attenuated to qualify under the exclusion.

A second federal case held that an employee's claims of false arrest and imprisonment did not fall within the "catch-all" phrase of "or other employment-related practices, policies, acts or omissions" of an insurer's employment-related practices exclusion. Zurich Ins. Co. v. Smart & Final Inc. (C.D. Cal. 1998) 996 F.Supp. 979, 988. These two cases demonstrate that the policyholder's attorney must scrutinize the complaint, as well as other relevant facts and allegations uncovered through discovery or investigation, for any claim arguably outside of the employment context.

Finally, primary commercial general liability policies are not the only sources of coverage for employment practices claims. The provisions of excess/umbrella policies are not necessarily identical to those of the primary policy. There may be coverage for employment-related torts in an upper layer of coverage even if not available in the primary layer. And directors and officers liability policies often provide at least some limited coverage for employment practices claims if the company's directors and officers are sued as well.

Underwriters may issue broader exclusions to close these and other possible loopholes in employment practices exclusions. Nevertheless, policyholders' attorneys who carefully study the policy and the employee's claims may yet find new loopholes for the policyholder to squeeze through.