Third Circuit Tackles CGL Coverage for IP Claims

The United States Court of Appeals for the Third Circuit recently affirmed a district court’s ruling that applied Pennsylvania law in finding there was no duty to defend trade secret and unfair competition claims under a commercial general liability (“CGL”) policy.  In Tela Bio, Inc. v. Federal Insurance Company, No. 18-1717, 2019 WL 211507 (3^rd Cir. January 16, 2019), the insured, a hernia mesh manufacturer, sought insurance coverage for a suit accusing it of misappropriating confidential trade secrets and “poaching” employees from a competitor.  Before the insurer had even provided its coverage position, the insured filed a declaratory judgment action against it in federal district court in New Jersey.  Thereafter, the coverage action was transferred to the U.S. District Court for the Eastern District of Pennsylvania.  That court subsequently granted the insurer’s motion to dismiss the complaint for failure to state a claim on the basis that the insurer had no duty to defend.  On appeal, the issues were essentially three-fold: (1) whether the substantive laws of New Jersey or Pennsylvania applied to this dispute; (2) whether there was an obligation on the part of the insurer to defend these claims under the CGL policy’s personal and advertising injury coverage for libel and slander; and (3) even if coverage were triggered, whether the policy’s “IP rights” exclusion would apply.   

As to the threshold choice of law issue, there was a “vigorous dispute” between the parties over whether the legal standards applicable to the duty to defend in Pennsylvania or New Jersey law applied.  Pennsylvania is considered a strict “four corners” state, meaning that the allegations in the underlying complaint alone determine whether coverage is potentially triggered for duty to defend purposes.  (See Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co., 908 A.2d 888 (Pa. 2006)).  The insured claimed that in New Jersey, courts were permitted to consider evidence outside of the complaint, and that “extrinsic evidence” of defamatory conduct existed which may trigger coverage.  As an initial matter, the court found that in the context of an insurance coverage dispute, the laws of the place that the parties understood to be the “principal location of the insured risk” control, unless some other state has a more “significant relationship” to the transaction and parties.  The insured argued that New Jersey law should apply because the insurer’s principal place of business was in New Jersey, and the alleged acts triggering coverage occurred therein.  The court, however, sided with the insurer, finding that New Jersey did not have a significant interest in applying its own laws since both the insured’s and its broker’s principal locations were in Pennsylvania, and the policy at issue was delivered there.  Because the court found that Pennsylvania was the principal location of the risk insured by the CGL policy and had the most significant relationship to the parties and their dispute, Pennsylvania law was declared the victor.

With respect to the duty to defend, the court noted that under the subject “Advertising Injury and Personal Injury Liability Coverage” provision of the CGL policy, there are several “offenses” to which coverage applies, only one of which was applicable here, namely, damages caused by publication of material that “libels or slanders a person or organization”.  The court, however, concluded that there were no allegations in the underlying complaint of any libel, slander, or other defamatory conduct causing reputational harm.  The court pointed out that the underlying allegations instead showed that the insured had tried to capitalize on its competitor’s good reputation in order to market its own competing product.

Finally, the court found that even if the underlying allegations had triggered coverage, the insurer would still have no duty to defend because the underlying suit fell within the purview of the policy’s “Intellectual Property Laws or Rights” exclusion.  Under that exclusion, coverage for a claim or suit is precluded where they include allegations of an infringement or violation of an “intellectual property law or right”.  The court held that misappropriation of trade secrets is clearly an intellectual property rights violation which implicated this exclusion. 

This is a case where it seems the insured’s best chance of securing coverage was to obtain a ruling that New Jersey law applied, thereby underscoring the critical importance that choice of law plays in commercial insurance coverage disputes.  Even then, it appears that the broad (some may argue harsh) language of the subject IP rights exclusion, which excludes all allegations within a suit, if that suit contains any allegations of intellectual property rights violations, would still have precluded coverage for the action in its entirety.