Wisconsin Supreme Court Strengthens Insurer’s Duty to Defend in ‘Advertising Injury’ Cases

One of the most important features of many liability policies is the “duty to defend”: that part of the policy that obligates insurers to pay the costs of defending a lawsuit alleging covered claims. Two years ago the Wisconsin Supreme Court ruled that, in assessing whether there was a potentially covered claim, courts could look only at the complaint itself, and had to ignore any extrinsic evidence showing such potential. Water Well Sols. Serv. Grp. v. Consolidated Ins. Co. While this holding was nothing new—the “four corners rule” has been around for decades and the court simply said it was not prepared to recognize an exception—Water Well had troubling implications for policyholders because it appeared that the complaint in that case could be read as having pled claims that gave rise to some possibility of coverage, leaving insureds in the difficult position of having no insurance for the defense of claims that might ultimately be covered (and the extrinsic facts presented by the policy holder showed that there likely was coverage in that case). Late last week, the court clarified that this troubling implication may not be quite as well-founded as it initially seemed.

In West Bend Mutual Insurance Company v. Ixthus Medical Supply, Inc., the Wisconsin Supreme Court found that West Bend owed a duty to defend Ixthus because some trademark and fraud claims did not require intent as an element of the claim, leaving the possibility of non-intentional, and therefore covered, claims, even though Abbott’s complaint alleged intentional conduct for each claim that, as pleaded, would fall within an exclusion for “knowing violations” of law.

This holding affirmed that even under the strict “four corners” rule recently applied to defeat coverage in Water Well (and a companion case, Marks v. Houston Casualty Co.) the duty to defend is still broader than the duty to indemnify. Though the duty-to-defend analysis must be limited to the allegations in the complaint—a rule that can cut both ways—the court reiterated that those allegations must be liberally construed and all reasonable inferences taken, meaning that the rule may not favor insurers nearly as often as we feared two years ago.

In the course of this ruling, the Court also preserved defense coverage for advertising injury despite the likely (but not definitive) application of a “knowing violation” exclusion. Allegations that the insured acted knowingly or intentionally cannot defeat defense coverage as long as at least one cause of action does not require a showing of intent as an element of the claim.

Background

Ixthus and over 100 other medical supply companies faced thirteen trademark and fraud claims by manufacturer Abbott Laboratories for allegedly diverting blood glucose test strips intended for international markets, which were not eligible for Medicare reimbursement, and passing them off as domestic test strips, on which then Abbott paid fraudulent Medicare reimbursement claims.

West Bend, Ixthus’s insurer, sought declaratory judgment of no coverage in Racine County. The circuit court found an initial grant of coverage, but ultimately denied coverage under the “knowing violations of the rights of another” exclusion. The court of appeals reversed. The Supreme Court affirmed the court of appeals finding coverage.

Finding Coverage Under the Four Corners Rule

To establish coverage for advertising injury, the complaint must allege, among other things, a causal connection between the plaintiff’s alleged injury and the insured’s advertising activity, meaning, according to Ixthus, allegations that the advertising did, in fact, contribute materially to the injury. The Court affirmed the Court of Appeals ruling that the mere trade design could supply the required “advertising” made in course of a covered offense. As for causation, the Complaint plainly alleged that “Defendants’ unauthorized importation, advertisement and subsequent distribution caused, or is likely to cause, consumer confusion, mistake, and deception to the detriment of Abbott…” West Bend argued that Abbott was not an “advertising defendant”, but a “distributing defendant” who did not advertise or sell products directly to users. The Court rejected this, holding that “West Bend’s post-hoc spin on these causation paragraphs cannot eliminate coverage at the duty-to-defend stage…. Ixthus need not be “the first, last or only entity” alleged to advertise in order to be engaged in covered advertising activity… Further, ‘advertising injury need not be the sole cause of harm…’”

In so holding, the Court relied on the 2016 case Water Well Sols. Serv. Grp. v. Consolidated Ins. Co., which denied an insured defendant’s request that the Court look outside the complaint to ascertain true facts showing the duty to defend was triggered (property damage beyond the insured’s own product, which was excluded). Water Well left insureds increasingly wary that they could be pled out of defense coverage. That risk still exists, but Ixthus shows that Wisconsin’s strict “four corners” rule is much more of a policyholder-friendly rule than had been suggested by Water Well. Ixthus affirms that prior protections broadening an insurer's defense obligations are still in play—“Fleshing out the factual allegations at trial may affect indemnification under the policy, but at the duty-to-defend stage, we liberally construe the allegations in the complaint, and make all reasonable inferences from the allegations.” In a post Water Well Wisconsin, these rules of construction are critical to preserving meaningful defense coverage, and Ixthus proves that they are alive and well.

Preserving Coverage Despite the Knowing Violation Exclusion

As noted above, the case appears to uphold a broad reading of both “what is ‘advertising’”—in this case the alleged offender’s trade dress itself—and the causation element between the advertising and injury, at least at the duty to defend stage. Moreover, the Wisconsin Supreme Court had not previously reviewed the knowing violation exclusion, but approved of a line of appellate cases finding that the exclusion does not bar the defense of claims where intent is not a required element.

The knowing violation exclusion will preclude coverage at the duty-to-defend stage only when every claim alleged in the complaint requires the plaintiff to prove the insured acted with knowledge that its actions “would violate the rights of another and would inflict ‘personal and advertising injury.”’ If the complaint alleges any claims that can be proven without such a showing, the insurer will be required to provide a defense.

Because Abbott’s trademark dilution and deceptive business practices claims did not require intent as an element of the cause of action, and because even one covered offense triggers the duty to defend the entire suit, it followed that the knowing violation exclusion did not bar defense coverage. This holding is important to preserving defense coverage for personal and advertising injury claims, because allegations of knowledge and intent are frequent components of these claims, putting defense at risk even where the plaintiff could ultimately prevail without proving the alleged intent.

In short, the holding provides an important corollary to Water Well’s strict “four corners” rule. Facts not alleged still may not be considered (per Water Well), but not every fact alleged is controlling, and most importantly allegations are liberally construed, ambiguities resolved in favor of coverage, and exclusions narrowly construed, meaning most, or at least more, complaints will now be analyzed based on the mere possibility that they may result in a covered loss. This may have implications for cases where conduct, as alleged, would trigger an exclusion, but the cause of action does not necessarily require such claims to be proven as an element of the claim. In that regard, the case makes less likely the anomalous situation where the insured will have coverage under the policy, but no defense.

For more information, contact your Quarles & Brady attorney or a member of our Insurance Recovery Team:

• Alexandra W. Shortridge: (414) 277-5443 / alexandra.shortridge@quarles.com