On May 23, 2014, the Ninth Circuit upheld a California district court decision that broadly interpreted the breach of contract exclusion in a commercial general liability policy to preclude coverage for all personal and advertising injury having even a minimal factual connection or incidental relationship to a breach of contract.  Trenches Inc. v. Hanover Ins. Co., No. 12-56642 (9th Cir. May 23, 2014).

The story began when Hoodz International and Hoodz North America entered into franchise agreements with Trenches, Inc., Trenches Holdings, Inc., and their executives.  Those agreements gave Trenches the right to operate a Hoodz franchise in the commercial kitchen exhaust cleaning business.  Hoodz had the right to terminate the agreement if Trenches or its executives had any felony convictions and obligated Trenches to stop using Hoodz’s trademarks in the event of a termination.

After learning about felony convictions against certain Trenches executives, Hoodz simultaneously terminated the franchise agreements and filed a lawsuit against Trenches. The parties reached a settlement a few days later, in which Hoodz agreed to conditionally reinstate the franchise agreements to allow Trenches to sell the franchises, and Trenches agreed to give Hoodz the right to enforce the post-termination obligations under the franchise agreements.  Shortly thereafter, Hoodz terminated the conditional agreement and sued Trenches again, this time alleging that Trenches continued using Hoodz’s trademarks in violation of its post-termination obligations.

Hoodz brought seven claims, including claims for breach of both the franchise and settlement agreements as well as a claim for trademark infringement and unfair competition, which was based on Trenches’ use of Hoodz’s trademark outside the scope of the settlement agreement.  Trenches tendered Hoodz’s complaint to Hanover Insurance Co., which denied the claim.  When Hanover refused to reconsider its denial, Trenches filed a coverage action.  Hanover then filed a motion to dismiss, claiming that the underlying suit did not come within coverage and that even it did, it fell within the policy’s exclusions.

On Hanover’s motion to dismiss, the district court first ruled that contrary to Hanover’s assertions, the claim fell within the policy’s personal and advertising injury coverage.  The policy covered claims arising out of “[t]he use of another’s advertising idea in your ‘advertisement…’” and the underlying complaint alleged both that Hoodz widely advertised and promoted its trademark and that Trenches used Hoodz’s trademark without permission in its own advertising.  Since Hoodz’s trademark was its advertising idea and Trenches allegedly used it in its advertising, the claim fell within personal and advertising injury coverage.

Nonetheless, the district court granted Hanover’s motion to dismiss because the underlying suit fell within the policy’s breach of contract exclusion, which applied to “[p]ersonal and advertising injury arising out of a breach of contract, except an implied contract to use another’s advertising idea in your ‘advertisement.’”  The court rejected Trenches’ position that the exclusion only applied to claims that would not have occurred but for the breach, and instead ruled that under California law, it applied to “any personal and advertising injury that bears a minimal connection or incidental relationship to the breach of contract.”  The court further noted that the exclusion applied if all claims arise out of the same factual situation, regardless of whether the claims had a separate and independent legal basis.  Since Hoodz’s trademark infringement and unfair competition claim arose out of the same factual situation as its breach of contract claim, the district court ruled that it fell within the breach of contract exclusion and was not covered by the policy.  Trenches appealed, but the Ninth Circuit affirmed the district court’s decision in a two page decision.

Breach of contract exclusions are designed to preclude coverage for those who do not fulfill obligations they assumed under a contract. This case is an example of just how broadly courts interpret those exclusions.