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HNRK Coverage Corner

E&O Policy May Cover Amounts Employer Was Required to Pay Because of Executive Director’s Negligent Administration of Retirement Accounts

On November 30, 2018, Judge Kahn of the NDNY issued a decision in Young Men’s Christian Assn v. Philadelphia Indem. Ins. Co., Case No. 18-cv-0565 (KEK/DJS), denying an E&O insurer's motion to dismiss the insured's claim for amounts it was required to contribute to employee retirement accounts because of the insured's negligent failure to withdraw contributions from the employees’ paychecks.

Plaintiff YMCA made a claim under an errors and omissions policy after discovering that its executive director had negligently failed to make both employer and employee contributions to the YMCA Retirement Fund.  The policy covered “those sums that you become legally obligated to pay as damages because of a negligent act, error or omission in the administration of your employee benefits program.”  The insurer argued that coverage would be limited to any “lost profits” the employees would have earned on the omitted contributions, but would not include “any principal amounts Plaintiff may be found liable to pay into its employee benefit program, including contributions that the impacted employees would have made but for the error.”

On the insurer’s motion to dismiss, Judge Kahn agreed that the policy did not cover the employer contributions that the YMCA negligently failed to make.  This liability “did not arise ‘because of a negligent act, error or omission in the administration of [Plaintiff’s] employee benefits program’”; YMCA had a pre-existing contractual obligation to make the contributions.  However, the Court denied the motion to dismiss the claim with respect to the employee contributions, explaining:

Plaintiff has plausibly alleged that, in the absence of the executive director’s errors, it would not have “become legally obligated” to pay from its own funds the Employee Contribution.

. . . 

[T]hat legal obligation arose only “because” of the Executive Director’s “negligent act, error or omission in the administration of [Plaintiff’s] employee benefits program,” and not because of a pre-existing contractual obligation.  Defendant counters that Plaintiff is not, in fact, “legally obligated to pay as damages” the Employee Contribution, because Plaintiff is entitled to reimbursement of this amount from the employees themselves in a claim for unjust enrichment.

. . .

Whether Plaintiff has a viable unjust enrichment suit against current and former employees does not change whether or not Plaintiff is “legally obligated” to pay the Employee Contribution to the Retirement Fund. By Defendant’s logic, if a party were insured for a tort, and had insurance to cover that tort, the party would not be deemed to have any legal obligation to pay the victim for damages resulting from that tort. Obviously, though, if Plaintiff does recover Employee Contributions from employees, Plaintiff’s potential claim against Defendant would decrease correspondingly.

. . .

Defendant also argues for dismissal of the Employee Contribution claim because the Employee Contribution liability is “contractual in nature,” and under New York law,   liability policies do not provide coverage where the complaint sounds in contract and not in negligence.” Defendant points to a number of cases, though none from the New York Court of Appeals, for the proposition that liability coverage does not cover damages stemming from a breach of contract.  But in those cases, the insured plaintiffs had pre-existing contractual obligations independent of any wrongful act.  With regard to the Employee Contribution, however, Plaintiff seeks coverage not for pre-existing contractual obligations, but for damages that it did not owe until negligent benefits administration caused them. Defendant also argues for dismissal on public policy grounds, in that an “undeserved gain” would accrue to Plaintiff, and the contract would present a moral hazard if the Employee Benefits Insurance covers the damages at issue here.  But at least with regard to the Employee Contribution, there is no gain or windfall to Plaintiff directly. The Plaintiff is now obliged to pay the Employee Contribution to the Retirement Fund directly, rather from employees’ paychecks; it would not have been required to do so but for the wrongful act. Therefore, insurance coverage will simply make Plaintiff whole. As for moral hazard, the Court is confident that sophisticated insurance companies are capable of drafting contracts and conducting due diligence regarding an insured’s pension policies to avoid such pitfalls.

With certain exceptions (see, e.g., our previous post on "insured contract" coverage), insurance policies do not provide coverage for contractual liabilities.  Thus, in this case, there was no coverage for amounts the insured was contractually obligated to pay independent of its executive director's negligence.

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