Coverage exclusions are a key risk management tool for transactional liability insurers. But they can also be traps for the unwary. In the event of a claims dispute, the insurer will likely bear the burden of proving that an exclusion applies, and a judge or arbitrator may (depending on the circumstances) be tasked with interpreting the exclusion based solely on its terms, without external evidence of what the underwriter intended. Exclusions therefore must be carefully drafted with potential disputes over their meaning in mind.
This article provides guidance for transactional insurers drafting coverage exclusions based on our extensive practice advising on insured transactions and handling claims for our clients.
The Legal Landscape
While a full discussion of the law surrounding exclusions is beyond the scope of this article, we first highlight several legal issues that may arise in the context of a coverage dispute. Each of these issues informs the drafting of exclusions.
First, a well-established principle about the burden of proof: the insured generally bears the burden of "establish[ing] coverage in the first instance," while the insurer has the burden of "proving that an exclusion applies."1 Case law in the transactional liability context is limited, but in coverage disputes in this field, the insureds typically urge that the general principle should be applied.
A second issue is how exclusions will be interpreted. In our experience, insureds often cite case law that they argue imposes a strict standard on insurers seeking to invoke an exclusion. This includes cases that say, for example, that the exclusion must contain "clear and unmistakable language"; be "accorded a strict and narrow construction"; and be subject to "no other reasonable interpretation."2
In that regard, at least one case suggests that courts may be inclined to reflexively apply such rules from other contexts to representations and warranties insurance (RWI) policies. In WPP Group USA, Inc. v. RB/TDM Investors, LLC, the court denied an RWI insurer's motion to dismiss that had invoked an exclusion that excluded the portion of loss relating to certain indemnities in the underlying purchase agreement. And the court observed, among other things, that "[a]mbiguities in exclusions must be strictly construed and are ordinarily resolved in favor of the insured," citing to a New York Court of Appeals case involving a homeowner's insurance policy.3
Exclusions should be written with this case law in mind, but subject to the law governing any particular insurance policy...
