Crum & Forster Specialty Insurance Company v. DVO, INC., formerly known as GHD, Inc.

In the
United States Court of Appeals
For the Seventh Circuit
____________________
No. 18‐2571
C RUM & FORSTER SPECIALTY INSURANCE
C OMPANY,
Plaintiff‐Appellee,
v.
DVO, INC., formerly known as GHD,
Inc.,
Defendant‐Appellant.
____________________
Appeal from the United States District Court for the
Eastern District of Wisconsin.
No. 1:16‐cv‐01619‐WCG — William C. Griesbach, Chief Judge.
____________________
A RGUED J ANUARY 16, 2019 — D ECIDED SEPTEMBER 23, 2019
____________________
Before BAUER , R OVNER , and HAMILTON, Circuit Judges.
R OVNER , Circuit Judge. This appeal arises from a diversity
action for declaratory relief brought by Crum & Forster Spe‐
cialty Insurance Company (“Crum”) against GHD Inc., now
known as DVO Inc. (“DVO”), seeking a determination that
Crum does not have a duty to defend DVO in a state court
action filed against DVO. Crum provided insurance to DVO,

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2 No. 18‐2571
and the question is whether the Errors & Omissions (“E&O”)
coverage of the primary and excess insurance policies it pro‐
vided to DVO, along with any exceptions in the policies, co‐
vers the state court claim for a contract violation such that it
imposes a duty for Crum to defend DVO in that action.
The underlying contract claim was brought by WTE‐S&S
AG Enterprise, LLC (“WTE”) against DVO. DVO designs and
builds anaerobic digesters, which use microorganisms to
break down biodegradable materials to create biogas. DVO
and WTE entered into a Standard Form Agreement, created
by the Engineers Joint Contract Documents Committee, un‐
der which DVO was to design and build an anaerobic digester
for WTE. The digester was to be used to generate electricity
from cow manure which would then be sold to the electric
power utility. WTE sued DVO for breach of contract, alleging
that DVO failed to fulfill its design duties, responsibilities,
and obligations under the contract in that it did not properly
design substantial portions of the structural, mechanical, and
operational systems of the anaerobic digester, resulting in
substantial damages to WTE. It sought over $2 million in
damages and fees.
Crum initially provided a defense to DVO under a reser‐
vation of rights, but a couple of months later advised DVO
that it would no longer provide a defense. WTE later filed for
bankruptcy and the case was transferred to the United States
Bankruptcy Court for the Northern District of Illinois. Follow‐
ing a trial, that court found in favor of WTE and ordered DVO
to pay over $65,000 in damages and $198,000 in attorney’s
fees.
Crum issued primary and excess insurance policies to
DVO for periods of time spanning from June 2011 until April

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No. 18‐2571 3
2014. Those policies provided coverage including commercial
general liability (CGL) coverage, pollution liability coverage,
E&O coverage, third party pollution coverage, and onsite
cleanup liability coverage. The issue in this appeal concerns
two provisions. The first is the provision in the E&O profes‐
sional liability coverage, under which Crum is required to pay
“those sums the insured becomes legally obligated to pay as
‘damages’ or ‘cleanup costs’ because of a ‘wrongful act’ to
which this insurance applies.” Dist. Ct. Decision and Order
(“Dist. Ct.”) at 3. The second relevant provision is the breach
of contract exclusion that was added by an endorsement,
which provides that the Policy does not apply to claims or
damages based upon or arising out of breach of contract. Id.
DVO argued that the breach of contract exclusion was so
broad as to render the E&O professional liability coverage il‐
lusory, and therefore could not be enforced to preclude the
duty to defend. The district court held that the professional
liability coverage was not illusory because it would still apply
to third party claims, and that even if it was determined to be
illusory, the remedy would be to reform the contract to allow
coverage to third party claims, not to allow coverage for all
professional liability claims.
A determination of a duty to defend under an insurance
policy involves a three‐part inquiry: first, whether the type of
claim asserted against DVO is the type for which coverage is
provided by the policy; second, whether an exclusion provi‐
sion in the policy precludes coverage; and third, if an exclu‐
sion applies, whether that exclusion contains any exceptions
that would reinstate coverage. Marks v. Houston Cas. Co., 881
N.W.2d 309, 322–23 (Wis. 2016); Am. Family Mut. Ins. Co. v.
American Girl, Inc., 673 N.W.2d 65, 73 (Wis. 2004). There is no
disagreement as to the first part. The state court claim against

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4 No. 18‐2571
DVO involves allegations that DVO entered into a contract
with WTE to construct an anaerobic digester which would
generate electricity from cow manure, and that DVO failed to
fulfill its design duties because it did not properly design sub‐
stantial portions of the structural, mechanical, and opera‐
tional systems of the anaerobic digester causing damages. Un‐
der the E&O coverage of the primary and excess insurance
policies from Crum to DVO, Crum agreed to pay those sums
that the insured becomes legally obligated to pay as damages
or cleanup costs because of a wrongful act to which the insur‐
ance applies. “Wrongful act” is defined to include a failure to
render professional services, and “professional services” is
defined as “those functions performed for others by you or by
others on your behalf that are related to your practice as a
consultant, engineer, [or] architect … .” Such a provision is a
common one, and essentially provides coverage for profes‐
sional malpractice. See Marks, 881 N.W.2d at 324, quoting
Grieb v. Citizens Cas. Co. of New York, 148 N.W.2d 103, 106
(Wis. 1967) (“[a]n errors‐and‐omissions policy is professional‐
liability insurance … designed to insure members of a partic‐
ular professional group from liability arising out of the special
risk such as negligence, omissions, mistakes and errors inher‐
ent in the practice of the profession”); 1325 North Van Buren,
LLC v. T‐3 Group. Ltd., 716 N.W.2d 822, 836 n. 13 (Wis.
2006) (same). All parties agree that the alleged conduct here
falls within that provision.
The parties also agree, however, that the exclusion clause
added as an endorsement to the contract, applies to preclude
coverage. That provision states that:

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No. 18‐2571 5
This Policy does not apply to “damages”, “defense ex‐
penses”, “cleanup costs”, or any loss, cost or expense, or
any “claim” or “suit”:
Based upon or arising out of:
a. breach of contract, whether express or oral, nor any
“claim” for breach of an implied in law or an implied
in fact contracts [sic], regardless of whether “bodily in‐
jury”, “property damage”, “personal and advertising
injury” or a “wrongful act” is alleged.
Appellant’s Appendix (“App.”) A116‐A119.
The parties do not dispute that a determination of whether
that exclusion applies must focus on the incident that alleg‐
edly gave rise to the coverage, not the theory of liability. That
is consistent with Wisconsin caselaw. For instance, the Wis‐
consin Supreme Court in 1325 North Van Buren, rejected the
argument that insurance liability is dependent on a theory of
liability, and noted that claims of negligence in the failure to
provide competent professional services could raise both tort
and contract claims. 716 N.W.2d at 838. Therefore, even a
claim that purports to be a tort claim can be excluded under
the breach of contract exclusion if it arises out of that contract.
Here, the state court complaint against DVO alleged that
DVO was contracted to design and construct the anaerobic di‐
gester and, because of its faulty design, damages were in‐
curred. That alleged a claim that arose out of the contract and
therefore falls within the exclusion language.
The sole issue, then, is whether the language in that breach
of contract exclusion renders the exclusion broader than the
grant of coverage, and therefore renders the coverage illu‐

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6 No. 18‐2571
sory. “In the insurance context, ‘[i]llusory policy language de‐
fines coverage in a manner that coverage will never actually
be triggered.’” Marks, 881 N.W.2d at 328, (quoting Continental
Western Ins. Co. v. Paul Reid, LLP, 715 N.W.2d 689, 691 (Wis.
App. 2006)). If the purported coverage in a policy proves to
be illusory, a court may reform the policy to meet the in‐
sured’s reasonable expectation of coverage. Id. Such contract
reformation, however, is an extraordinary remedy not lightly
taken. Id.
The district court rejected the argument that the coverage
was illusory. It held that although coverage for professional
malpractice would effectively fall within that exclusion as to
claims alleged by the party to the contract, third parties could
still bring tort claims against DVO that would not fall within
the exclusion and would trigger the duty to defend in the
E&O provision of the policy. The district court reasoned that
as a contractor, designer, engineer and builder, DVO has a
duty to use reasonable care in carrying out its contractual ob‐
ligation so as to avoid injury or damage to the person or prop‐
erty of third parties, even though they have no contractual re‐
lationship with DVO.
But that analysis cannot support the court’s conclusion. If
more narrow language was used, the district court’s determi‐
nation that third‐party liability would still be covered might
have merit. But the language in the exclusion at issue here is
extremely broad. It includes claims “based upon or arising out
of” the contract, thus including a class of claims more expan‐
sive than those based upon the contract. Wisconsin courts
have made clear that the “arising out of” language is broadly
construed. For instance, in Great Lakes Beverages, LLC v.
Wochinski, 892 N.W.2d 333, 339 (Wis. App. 2017), the court

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No. 18‐2571 7
held that “the phrase ‘“arising out of” in an insurance policy
is very broad, general and comprehensive and is ordinarily
understood to mean originating from, growing out of, or
flowing from.’” (quoting Trumpeter Developments v. Pierce
County, 681 N.W.2d 269, 271 (Wis. App. 2004)); accord Shelley
v. Moir, 405 N.W.2d 737, 739 (Wis. App. 1987). All that is re‐
quired is some causal relationship between the injury and the
event not covered. Id.
That same language has been applied by Wisconsin courts
to exclude coverage for third‐party claims. For instance, in
Great Lakes Beverages, the court considered whether AMCO In‐
surance’s policies providing coverage for personal and adver‐
tising injuries, including libel and slander, required coverage
of Wochinski’s tortious interference claim which was based
on the allegation that Great Lakes Beverages was falsely in‐
forming people that Wochinski was subject to a non‐compete
agreement. 892 N.W.2d at 339‐40. The insurance policy ex‐
cluded any advertising or personal injury arising out of a
breach of contract, and the court held that the exclusion
barred coverage even though Wochinski had never had a con‐
tract with Great Lakes Beverages. Id. The court held that the
tortious interference claim arose out of a breach of contract
because the truth or falsity of the representations depended
on whether the non‐compete agreement in the contract be‐
tween Wochinski and another party remained in effect. Id.
Therefore, Great Lakes Beverages held that the “arising out of”
language in the exclusion is read broadly, and that it can be
applied to bar a tort claim brought by a third party. See also
Shelley, 405 N.W.2d at 739‐40 (exclusion for claims arising out
of bodily injury operated to exclude third‐party breach of con‐
tract claim).

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8 No. 18‐2571
Under Wisconsin law, therefore, the term “arising out of”
has been interpreted broadly to reach any conduct that has at
least some causal relationship between the injury and the
event not covered, which sweeps in third‐party claims as well
when so related. And the “event not covered” in the policy
here is itself quite expansive, explicitly applying the breach of
contract exclusion to all contracts whether express or oral, and
even including contracts implied in law or fact. Given that
broad language, the exclusion would include even the claims
of third parties. As to those third parties, the claims of profes‐
sional negligence will fall within the contract exclusion be‐
cause they necessarily arise out of the express, oral or implied
contract under which DVO rendered the professional ser‐
vices. See 1325 North Van Buren, 716 N.W.2d at 838 (noting
that the claim based on a negligent act for its failure to adhere
to professional standards is one sounding in negligence but
arising in the context of a contract); Colton v. Foulkes, 47
N.W.2d 901, 903 (1951) (the contract creates the state of things
which furnishes the occasion of the tort).
To avoid that conclusion, Crum relies primarily on an un‐
published Wisconsin appellate court opinion in General Casu‐
alty Co. of Wisc. v. Rainbow Insulators, Inc., 798 N.W.2d 320
(Wis. App. 2011). In that case, KBS filed a complaint for breach
of contract against E & A Enterprises (“E & A”). E & A had
contracted to handle metal stud framing and drywall for a
condominium project and E & A created noise problems in
the units by attaching resilient channels to drywall in the
wrong direction and by using screws that were too long,
which caused acoustical problems and required KBS to re‐
move and reinstall the channels. Id. at *1.

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No. 18‐2571 9
The court considered whether Acuity, an insurance com‐
pany, had a duty to provide coverage. E & A had a profes‐
sional liability policy with Acuity called the Contractor’s Er‐
ror & Omissions Coverage which provided coverage for
“damages because of property damage to your product, prop‐
erty damage to your work, property damage to impaired
property or recall expense that arises out of your product,
your work, or any part thereof.” Id. at *6‐7. The court held that
the policy provided initial coverage, but held that such cover‐
age was precluded under the “contract” exclusion, which ex‐
cludes coverage for “damages arising out of any … [d]elay or
failure by you or anyone acting on your behalf to perform a
contract or agreement in accordance with its terms.” Id. at 7.
E & A argued that the contract exclusion was inapplicable be‐
cause the alleged property damage arose out of negligent acts,
errors, or omissions. Id. The court held, however, that the
characterization of the claim was not dispositive; it further
held that the conduct alleged in the complaint, if proven,
would constitute failure to perform a contract, and therefore
the exclusion applied. Id. The court rejected the argument that
such an interpretation would render the policy useless, hold‐
ing that the exclusion did not exclude all claims of any sort
that might arise during the course of the work performed un‐
der a contract. The court as an example stated that “because
contractors owe common law duties of care to those with
whom they contract, as to all other persons, the ‘contract’ ex‐
clusion would not operate to preclude E & O policy coverage
arising from a tort claim that involves conduct that is not a
delay or failure to perform under a contract term.” Id. at 8.
Crum relies on that case as support for the notion that the
exclusion does not render the coverage illusory here, but the
comparison is a faulty one. First, the coverage provision was

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10 No. 18‐2571
different in General Casualty in that it covered property dam‐
age not professional malpractice generally. The overlap be‐
tween claims of professional malpractice and breach of con‐
tract is complete, because the professional malpractice neces‐
sarily involves the contractual relationship. Moreover, the ex‐
clusion was more narrow in General Casualty. It applied only
to damages arising out of delays or failures to perform a con‐
tract or agreement in accordance with its terms. Thus, the exclu‐
sion was tied to the terms of the contract, and would not nec‐
essarily include conduct that was merely causally related to
the contract or which flowed from the contract as here. Fi‐
nally, the court’s analysis of the issue as to whether the cov‐
erage was illusory was limited to a couple of sentences, with
no further development of the reasoning, and even inter‐
preted as broadly as Crum argues, we do not find it persua‐
sive in light of the other, published Wisconsin cases consid‐
ered above.
Based on that Wisconsin caselaw, we hold that the breach
of contract exclusion in this case rendered the professional li‐
ability coverage in the E&O policy illusory. The district court
recognized that possibility as well, but held that the contract
could be reformed so as to avoid that impact. Specifically, the
court held that if the policy was read so as to preclude such
third‐party suits, then the exclusion would render the cover‐
age illusory and the contract should be reformed so as to al‐
low such suits. The court held, however, that such a refor‐
mation would not help DVO because the state court suit was
not brought by a third party.
That focus on third‐party suits is misplaced in the context
of the contract reformation here. The court itself raised the
possibility that third‐party suits might not be excluded under

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No. 18‐2571 11
the language of the breach of contract exclusion, in an effort
to demonstrate that the professional liability coverage was
not therefore illusory (in that it provided coverage for third‐
party suits). As we have held above, that conclusion is incon‐
sistent with the broad “arising out of” language, which would
exclude all claims for professional liability whether or not
brought by third‐parties.
When a policy’s purported coverage is illusory, the policy
may be reformed to meet an insured’s reasonable expectation
of coverage. Marks, 881 N.W.2d at 328. Therefore, the focus
now is not on the hypothetical third‐party actions, but on the
reasonable expectation of coverage of the insured in securing
the policy. There is, after all, no reason to believe that DVO in
purchasing Errors and Omissions coverage to provide insur‐
ance against professional malpractice claims had a reasonable
expectation that it was obtaining insurance only for claims of
professional malpractice brought by third parties.
In determining the reasonable expectation of the insured,
we consider the intended role of the coverage. Tri City Nat.
Bank v. Fed. Ins. Co., 674 N.W.2d 617, 620 (Wis. App. 2003).
“[T]he nature and purpose of the policy as a whole have an
obvious bearing on the insured’s reasonable expectations as
to the scope of coverage … .” Id., quoting Shelley, 405 N.W.2d
at 739. As we noted earlier, “[a]n errors‐and‐omissions policy
is professional‐liability insurance … designed to insure mem‐
bers of a particular professional group from liability arising
out of the special risk such as negligence, omissions, mistakes
and errors inherent in the practice of the profession.” Marks,
881 N.W.2d at 324, (quoting Grieb, 148 N.W.2d at 106); 1325
North Van Buren, 716 N.W.2d at 836 n. 13 (same). Accordingly,

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12 No. 18‐2571
because the breach of contract exclusion renders the profes‐
sional liability coverage illusory, the contract should be re‐
formed so as to meet the reasonable expectations of DVO as
to the E&O policy’s coverage for liability arising out of negli‐
gence, omissions, mistakes and errors inherent in the practice
of the profession. See Marks, 881 N.W.2d at 329 (noting that if
coverage is rendered illusory, “our task would be to reform
the policy so that it ‘conform[s] to [the] real intent’ of the par‐
ties; that is, to reform the policy so that it represents the ‘def‐
inite and explicit agreement’ originally reached by the parties
before any mistake occurred. … If a clause in Marksʹ policy
renders the policy illusory, we consider whether to reform
that clause.”)
The breach of contract exclusion is set forth in an endorse‐
ment. The endorsement modifies the insurance provided un‐
der the following Parts:
Commercial General Liability Coverage Part
Contractors Pollution Liability Coverage Part
Errors and Omissions Liability Coverage Part
Third Party Pollution Liability Coverage Part
Onsite Cleanup Coverage Part
App. at A119. As such, it replaces the standard Contractual
Liability provision. Because the breach of contract exclusion
renders only the E&O coverage illusory, one possible refor‐
mation would be to delete the applicability of the endorse‐
ment only as to the E&O Part, and contractual liability under
that Part would then revert back to the terms of the original
Contractual Liability provision.

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No. 18‐2571 13
But we need not determine precisely what reformation is
appropriate here. DVO did not file a cross‐motion for sum‐
mary judgment. The district court on remand may consider
DVO’s reasonable expectations in securing the coverage, and
can reform the contract so as to give effect to that expectation.
The focus, however, must be on that reasonable expectation,
which was upended by the breach of contract exclusion that
rendered it illusory. The availability of third‐party claims is
irrelevant unless it is determined to be a part of DVO’s rea‐
sonable expectation of coverage.
The decision of the district court is REVERSED and the
case REMANDED for further proceedings consistent with
this opinion.

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