(Article from Insurance Law Alert, February 2015)
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A New York federal district court ruled that a Failure to Conform exclusion precluded coverage for various common law and statutory claims asserted in class action suits against an energy supplement manufacturer. General Star Indem. Co. v. Driven Sports, Inc., 2015 WL 307017 (E.D.N.Y. Jan. 23, 2015).
The suits alleged that Driven Sports, Inc. marketed an energy supplement (“Craze”) as containing natural ingredients, when in fact, it contained an illegal and potentially-dangerous methamphetamine analog. The complaints alleged a variety of statutory and common law causes of action, including false advertising, unfair competition, deceptive practices and consumer protection violations. General Star agreed to provide a defense subject to a reservation of rights, including the right to recoup defense costs in the event it was determined that the policy did not provide coverage. General Star sought a declaration as to its coverage obligations, and both parties moved for summary judgment. The court ruled in General Star’s favor, finding that the policy’s Failure to Conform exclusion barred coverage for all claims.
The Failure to Conform exclusion precludes coverage for “personal and advertising injury arising out of the failure of goods, products or services to conform with any statement of quality or performance made in [the policyholder’s] advertisement.” The court concluded that all of the injuries alleged in the underlying suits “arose out of” Craze’s failure to conform with advertised statements about it. The court reasoned that all underlying claims stemmed from allegations that Craze failed to meet its advertised quality.
The court rejected Driven Sports’ assertion that the underlying complaints alleged both covered and uncovered claims, such that General Star was obligated to defend the suits in their entirety. In doing so, the court held that under New York law, “the question is whether the plaintiffs in the underlying action would be able to prove the allegedly covered claim without proving the uncovered claim.” Here, the court found that none of the underlying claims could be proven without proving that Craze failed to conform with advertisements about its quality. The court likewise rejected Driven Sports’ argument that statements on its website gave rise to separate and independent disparagement claims (outside the scope of the Failure to Conform exclusion), explaining that website statements were not referenced in the underlying complaints and therefore not the basis of any underlying claims. Finally, the court rejected the notion that phrase “quality or performance” in the exclusion was vague and/or did not encompass allegations relating to the ingredients of a product.
The court also addressed General Star’s claim for recoupment of defense costs. Indicating that New York law is “unclear” on this issue, the court concluded that recoupment was not appropriate because the policy was silent on the issue and the policyholder expressly refused to consent to recoupment. However, the court ruled that policy language established that the policy was “self-liquidating,” such that defense costs expended by General Star counted against the limits of liability.