The ability to build and maintain strong relationships with business partners and vendors is an essential requirement for any business seeking long-term success. This is especially true in the fast-paced technology sector, where a company’s ability to put its innovative ideas to work often depends on its access to outside capital and its skill in turning connections into contractually-bound partners, vendors, clients, and customers. The unfortunate corollary to the need for technology firms to build and maintain relationships with outside partners is, of course, that no relationship is perfect. Not all partnerships are built to last. That reality raises an all-important question: how do you prepare your firm for the inevitable day when one of its business relationships sours?

As my colleague Linda Powell discussed recently, firms that provide technology services and products can manage their relationship-based risk by purchasing Technology Errors and Omissions (Tech E&O) insurance. Alternately known as Technology Professional Liability Insurance, Tech E&O insurance is likely to respond to demand letters, claims, or lawsuits brought against your firm by dissatisfied business partners, vendors, or customers who believe that your firm has committed an error or made an omission that caused financial harm. Tech E&O policies help to manage the risks of a business partnership gone bad by focusing on third-party claims that do not allege any physical bodily injury, property damage, or advertising-related injury. This is valuable coverage as such claims are generally not covered by the run-of-the-mill commercial general liability insurance that most firms carry. Importantly, Tech E&O policies also typically include a “duty to defend,” whereby insurers are obligated to defend any claim made against their insured (including demand letters, claims, or lawsuits) regardless of the merits of the claim so long as a single allegation against the firm has even the mere potential of being covered under the policy’s indemnification requirement.

Though Tech E&O policies are a valuable tool to reduce business-relationship-based risk, insurers have sought to limit these policies’ effectiveness by excluding coverage for claims based on or arising out of any actual or alleged breach of contract. This so-called “contract exclusion” is typically worded broadly and seeks to preclude Tech E&O coverage for any contract-based claim by a third party against the insured, regardless of whether the actual or alleged contract was express, oral, or implied by law or fact. Though the contract exclusion theoretically seeks to ensure that a Tech E&O policy protects firms from the downside risk of truly negligent conduct and not contractually-manufactured liability, the practical effect of the contract exclusion is to gut a significant amount of the Tech E&O policy’s value: the protection it offers technology firms from claims arising out of business relationships gone bad.

Tech E&O insurers have increasingly relied on the broadly-worded contract exclusion to deny coverage for demands, claims, and lawsuits brought against technology firms by contractually-bound business partners, vendors, clients, and/or customers. Courts, however, have taken notice of this practice and have begun to push back.

In a resounding victory for technology firms, the U.S. Court of Appeals for the Seventh Circuit recently ruled in Crum & Forster Specialty Insurance Company v. DVO, Inc., 939 F.3d 852 (7th Cir. 2019) that a contract exclusion in an E&O policy was so broad that it made the policy’s professional liability coverage illusory. In that case, the insured—a renewable energy technology firm that designs and builds anaerobic digesters which turn biodegradable materials into bio-gas—was sued by a business partner who alleged that the insured breached its agreement by failing to properly design substantial portions of the anaerobic digester that the insured had agreed to provide to that business partner. The insured sought coverage for the lawsuit from its E&O insurer. The insurer initially agreed to honor its duty to defend the lawsuit, but did so pursuant to a reservation of rights to later contest coverage. Months later, the insurer withdrew from its defense of the lawsuit and itself brought suit against its insured seeking judicial confirmation that the E&O policy’s contract exclusion barred coverage for the lawsuit.

The contract exclusion at issue stated:

This Policy does not apply to “damages,” “defense expenses,” “cleanup costs,” or any loss, cost or expense, or any “claim” or “suit”:

Based upon or arising out of:

a. breach of contract, whether express or oral, nor any “claim” for breach of an implied in law or an implied in fact contracts [sic], regardless of whether “bodily injury,” “property damage,” “personal and advertising injury” or a “wrongful act” is alleged.

The insured argued that this language was so broad that it effectively nullified the policy’s professional liability coverage. Though the trial court sided with the insurer and rejected this argument, the Seventh Circuit did not—rather, it determined that the contract exclusion’s language barring claims “arising out of” a contract was “extremely broad” and encompassed “a class of claims more expansive than those based upon the contract.” The court noted that, based on the broad “arising out of” language, the contract exclusion would bar tort claims brought by third parties against firms where the third party never had a contract with the firm, but was injured in connection with some product or service the firm was providing to a business partner under a contract. In the court’s view, this was a bridge too far. As such, the court determined that the provision was not enforceable as written and sent the case back to the trial court for the trial court to consider how the E&O policy should be modified to meet the insured’s reasonable expectations of coverage.

This case provides strong guidance for technology firms in building an insurance program that will protect against the inevitable business relationships gone bad. For one, it is important that technology firms reduce their risk of facing costly litigation alone and being solely responsible for paying a large settlement or judgment by purchasing Tech E&O policies. Additionally, in purchasing such policies, technology firms should be diligent to partner with brokers and outside policyholder counsel that will negotiate the policy terms of that policy to eliminate the contract exclusion or, at a minimum, limit the exclusion’s scope. Though insurance may be its own unique market, technology firms benefit from approaching their insurance procurement like any other deal and fighting for the best possible terms. While having insurance will not prevent demands or lawsuits from business partners, vendors, clients, or customers, having a strong Tech E&O policy can help to mitigate the negative financial impact of such demands on the business.