The exclusions found in general liability (“CGL”) policies are virtually always preceded by a preamble that there is no coverage “because of,” “arising out of,” or “based on” each of those enumerated exclusions. The interchangeable use of these undefined modifier phrases has required courts around the country to consider whether, based on the interpretation of those modifiers, an exclusion potentially applies as a bar to coverage for a particular claim.

The Superior Court of New Jersey in C.M.S. Investment Ventures v. American European Insurance Company, Docket No. A-2056-17T3, 2019 WL 2266674 (App. Div. May 28, 2019), recently considered this and other fundamental issues of insurance policy construction and interpretation under New Jersey law.

“A CGL policy 'protects business owners against liability to third parties.'” Cypress Point Condominium Association v. Adria Towers,226 N.J. 403, 416 (2016) (citation omitted). It provides two distinct insurer obligations—the duties to defend and to indemnify. “[W]hen a complaint is filed that might be covered by the policy language, evaluating the duty to defend requires 'a comparison between the allegations set forth in the complaint and the language of the insurance policy.' The duty to defend is specific to each claim made against the insured 'irrespective of the claim's actual merit.'” Givaudan Fragrances Corporation v. Aetna Casualty & Surety Company, 227 N.J. 322, 350-351 (2017) (citations omitted). “Well-settled principles governing the interpretation of contracts of insurance mandate broad reading of coverage provisions, narrow reading of exclusionary provisions, resolution of ambiguities in the insured's favor, and construction consistent with the insured's reasonable expectations.” Phibro Animal Health Corporation v. National Union Fire Insurance Company of Pittsburgh, 446 N.J. Super. 419, 428 (2016) (citations omitted). In other words, “'the general rule of construction is that if the controlling language of a policy will support two meanings, one favorable to the insurer and the other to the insured, the interpretation favoring coverage should be applied.'” Cypress Point, 226 N.J. at 416 (citation omitted). An ambiguity may be found in either the “specific words” of the insurance policy itself or “the context in which they are used may create an ambiguity.” Id.

C.M.S. involved coverage for underlying claims of negligence arising out of a sexual assault sustained by a resident of a building managed by the insured. The underlying plaintiff alleged that after reports of a malfunctioning window were lodged and ignored, an intruder broke into the apartment and committed the assault. The underlying complaint alleged that the insured “breached a duty of care to her by failing to adequately maintain the property, by failing to keep the premises safe, and by not taking precautions to protect tenants from reasonably foreseeable criminal activity.” C.M.S. Investment Ventures, 2019 WL 2266674 at *1.

The insured's general liability policy included an “assault and battery exclusion” purportedly barring coverage “for any claim, demand or suit based on Assault and Battery” (id. at *1) and the insurer denied coverage based on the characterization of the suit “as an allegation of assault and battery.” Id. at *2. Following the commencement of this declaratory judgment action, the trial court found in favor of coverage, holding that the phrase “'based on assault and battery' was ambiguous and capable of limitless meaning” (and, for unexplained reasons, appeared under the policy's Liquor Liability Coverage Part). The trial court further found that the claim included allegations of negligence and was not entirely alleging assault and battery.

The finding of coverage was affirmed on appeal, but not based on a holding that the exclusion was ambiguous. The court began by reaffirming certain fundamental tenets of insurance policy interpretation. First, the notion of contra proferentem grounded in premise that there is a “stark imbalance between insurance companies and their insureds in the respective understanding of the terms and conditions of insurance policies.” Id. at *3 (citation omitted). Second, clear language is to be afforded its “plain, ordinary meaning” but ambiguities are resolved “in favor of the insured and against the insurer.” Id. (citations omitted). Finally, New Jersey also adheres to the widely adopted standard governing an insurer's duty to defend as reaffirmed by the C.M.S. court. A complaint is viewed “with liberality” alongside the insurance policy and it is “the nature of the claim asserted, rather than the specific details of the incident or the ligation's possible outcome, that governs the insurer's obligation.” Id.

To reach its conclusion, the C.M.S. court deconstructed the phrase “based on” as follows:

Here, the term “based” is a transitive verb meaning to “make,” “form” or “serve” as the foundation of “any claim, demand or suit.” Use of the preposition “on” followed by “Assault and Battery” puts a limit on possible claims, demands, or suits subject to the exclusion. Read together, the exclusion applies to claims, demands or suits where “Assault and Battery” forms or serves as the claim's foundation.

Id. at *4.

New Jersey courts have conducted a similar analysis of sexual assault exclusions utilizing the “arising out of” modifier. Id. at *3 (citing Flomerfelt v. Cardiello, 202 N.J. 432, 454 (2010) (“arising out of” means “originating from,” “growing out of,” “or having a substantial nexus [to]”); L.C.S. v. Lexington Insurance Co., 371 N.J. Super. 482, 493 (App. Div. 2004) (“Whether used to define or exclude coverage, the phrase 'arising out of' is given a broad definition.”)).

Other courts have conducted similar analyses. California, for example, held that “because of” means “by reason of; on account of,” Saucier's Case, 122 Me. 325, 325 (1923), and indicated that it is used in the same sense as “for,” “on account of,” and “in consequence of.” Kelly v. State Personnel Bd., 31 Cal. App. 2d 443, 447 (1939). In interpreting the term “arising out of” in insurance policies, California courts have indicated that it is a broader term than “caused by” because it “does not import any particular standard of causation or theory of liability into an insurance policy.” Vitton Const. Co. v. Pacific Ins. Co., 110 Cal. App. 4th 762, 766–67 (2003); Health Net v. RLI Ins. Co., 206 Cal. App. 4th 232, 262 (2012) (quoting Vitton). The New York Court of Appeals held that “[w]e have interpreted the phrase 'arising out of' in an additional insured clause to mean 'originating from, incident to, or having connection with.' It requires 'only that there be some causal relationship between the injury and the risk for which coverage is provided.'” Regal Const. Corp. v. National Union Fire Ins. Co. of Pittsburgh, 15 N.Y.3d 34, 38 (2010).

Insurers and practitioners should be mindful that the C.M.S. court did not ultimately find in favor of coverage on the ground that the “based on” modifier was ambiguous. In fact, the court held that the exclusion “would” have applied if the underlying claims were “based only on the sexual assault.” C.M.S. at 8 4 (emphasis in original). Thus, insureds should look to the governing authority in their particular forum to determine how the court will interpret these modifiers and whether they are considered ambiguous. This is critical because virtually all courts will find in favor of coverage if the modifier is found to be ambiguous and/or if there is some potential for coverage based on the allegations of the underlying complaint.

Jeffrey L. Schulman is a partner in the New York office of Pasich LLP. He represents commercial and individual policyholders in complex insurance coverage matters, and handles a wide variety of substantial business/commercial litigation and contract disputes.