Associated Industries Insurance Company, Inc. v. Woody, et al.

IN THE UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF NORTH CAROLINA
ASHEVILLE DIVISION
CIVIL CASE NO. 1:25-cv-00222-MR-WCM
ASSOCIATED INDUSTRIES )
INSURANCE COMPANY, INC., )
)
Plaintiff, )
)
vs. ) MEMORANDUM OF
) DECISION AND ORDER
STEPHEN WOODY, DAVID FANN, )
and HE, INC., )
)
Defendants. )
________________________________ )
THIS MATTER is before the Court on the Plaintiff’s Motion to Dismiss
HE, Inc’s Amended Counterclaims [Doc. 19].
I. PROCEDURAL BACKGROUND
By the present action, Associated Industries Insurance Company, Inc.
(“AIIC”) seeks a declaration that the insurance policy that it issued to Avadim
Health Inc. (“Avadim”) does not afford coverage for a judgment entered
against two of Avadim’s officers, Defendants Stephen Woody and David
Fann, and in favor of Defendant HE, Inc. (“HE”).1 [Doc. 1]. HE in turn asserts
1 While the Complaint describes HE as a “nominal” defendant, such a designation does
not appear in the Federal Rules of Civil Procedure. See Fed. R. Civ. P. 17. Thus, the
Court treats HE as a standard defendant and, for clarity’s sake, refers to all three
defendants by their proper names.
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counterclaims for breach of contract and a declaration that AIIC is obligated
to indemnify Woody and Fann under the policy for the amount of the
judgment. [Doc. 17]. AIIC now moves to dismiss those counterclaims
pursuant to Rule 12(b)(1) and 12(b)(6) of the Federal Rules of Civil
Procedure. [Doc. 19]. HE has responded [Doc. 21], and AIIC has replied
[Doc. 22]. Accordingly, this matter is ripe for disposition.
II. STANDARD OF REVIEW
A. Rule 12(b)(1) Standard
Because standing is an element of subject matter jurisdiction, a motion
to dismiss for lack of standing is properly analyzed under Federal Rule of
Civil Procedure 12(b)(1). See Martineau v. Wier, 934 F.3d 385, 390 n.2 (4th
Cir. 2019). For such a motion, the moving party bears the burden of proving
that subject matter jurisdiction exists. United States ex rel. Vuyyuru v.
Jadhav, 555 F.3d 337, 347-48 (4th Cir. 2009). The Court should grant the
motion only “if the material jurisdictional facts are not in dispute and the
moving party is entitled to prevail as a matter of law.” Richmond,
Fredericksburg & Potomac R.R. Co. v. United States, 945 F.2d 765, 768 (4th
Cir. 1991). In making this determination, the Court should “regard the
pleadings’ allegations as mere evidence on the issue, and may consider
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evidence outside the pleadings without converting the proceeding to one for
summary judgment.” Id.
B. Rule 12(b)(6) Standard
The central issue for resolving this Rule 12(b)(6) motion is whether the
counterclaims state a plausible claim for relief. See Francis v. Giacomelli,
588 F.3d 186, 189 (4th Cir. 2009). In considering such a motion, the
allegations in the counterclaims are accepted as true and construed in the
light most favorable to the non-movant. Nemet Chevrolet, Ltd. v.
Consumeraffairs.com, Inc., 591 F.3d 250, 255 (4th Cir. 2009). Although well-
pled facts are accepted as true, “legal conclusions, elements of a cause of
action, and bare assertions devoid of further factual enhancement” are not.
Id.
The claims need not contain “detailed factual allegations,” but must
contain sufficient factual allegations to suggest the required elements of the
cause of action. Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007). A
“formulaic recitation of the elements of a cause of action will not do.” Id. Nor
will labels and legal conclusions suffice. Id. Rather, the counterclaims must
contain “enough facts to state a claim to relief that is plausible on its face.”
Id. at 570. “A claim has facial plausibility when the [non-movant] pleads
factual content that allows the court to draw the reasonable inference that
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the [movant] is liable for the misconduct alleged.” Ashcroft v. Iqbal, 556 U.S.
662, 678 (2009). Ultimately, the well-pled factual allegations must move the
counterclaims from possible to plausible. Twombly, 550 U.S. at 570.
III. FACTUAL BACKGROUND
Viewing the well-pled factual allegations asserted in the Amended
Counterclaims as true, the following is a recitation of the relevant facts.
In July 2022, HE initiated the underlying lawsuit, HE, Inc. v. Stephen
Woody, et al., No. 22CVS002497-100, against Defendants Woody and Fann
in the Buncombe County General Court of Justice, Superior Court Division.
[Doc. 17 at ¶¶ 4,15]. HE asserted claims for negligent representation and
for unfair and deceptive trade practices in violation of the North Carolina
Unfair and Deceptive Trade Practices Act (“UDTPA”), N.C. Gen. Stat. § 75-
1.1 et seq. [Doc. 1-1: Second Am. Complaint (“SAC”)].2 Specifically, HE
alleged that Woody and Fann had made a series of misstatements and
misrepresentations to HE, in reliance upon which HE entered into a Partial
Debt Settlement Agreement (“PDSA”) with Avadim. Pursuant to this
agreement, HE agreed to convert $1,390,000 of Avadim’s outstanding debt
2 HE’s Amended Counterclaims incorporate all of the exhibits to AIIC’s Original Complaint,
including HE’s Second Amended Complaint in the underlying action [Doc. 1-1]; the
Judgment entered in the underlying action [Doc. 1-2]; the attorney fee award in the
underlying action [Doc. 1-3]; and the Policy [Doc. 1-4].
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into stock and to defer payment of another $1,800,000 of Avadim’s debt until
Avadim had completed its initial public offering. [Id. at ¶ 27]. HE alleged that
in making this agreement, it specifically relied on representations by Woody
and Fann to the effect that they would take Avadim public. [Id. at ¶ 22]. At
the time of the events giving rise to the underlying lawsuit, Woody was
Avadim’s CEO and chairman of its board of directors, while Fann was
Avadim’s President and a member of its board of directors. [Id. at ¶¶ 7, 9].
HE proceeded to trial against Woody and Fann on both claims. [Doc.
17 at ¶ 17]. A jury rendered a verdict in HE’s favor [Doc. 17 at ¶ 19; Doc.
17-2: Verdict], and on March 28, 2025, a Judgment was entered against
Woody and Fann in the amount of $1,770,000, [Doc. 17 at ¶ 20; Doc. 1-2:
Judgment]. More specifically, the Judgment awarded compensatory
damages in the amount of $1,390,000 as follows: (1) $600,000 against
Woody for negligent misrepresentation; (2) $600,000 against Fann for
negligent misrepresentation; (3) $189,999 against Woody for unfair and
deceptive trade practices; and (4) $1 against Fann for unfair and deceptive
trade practices. [Doc. 1-2: Judgment]. The Judgment also awarded treble
damages under the UDTPA of $379,998 against Woody and $2 against
Fann, for a total judgment of $1,770,000. [Id.].
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The Judgment award was a final adjudication of Woody and Fann’s
liability to HE for its negligent misrepresentation and UDTPA claims. [Doc.
17 at ¶¶ 35-36]. Nothing in the Judgment or the Verdict indicates that the
compensatory damages amounted to any disgorgement, restitution of ill-
gotten gains, or recessionary damages. [Id. at ¶ 55]. The SAC does not
indicate that HE was seeking an award of any disgorgement, restitution of ill-
gotten gains, or recessionary damage. [Id. at ¶ 56]. Further, the Jury
Instructions did not prompt the jury to make any findings regarding any
disgorgement, restitution of ill-gotten gains, or recessionary damage. [Id. at
¶ 57]. And nothing in the Judgment indicates or otherwise adjudicates that
Woody or Fann, by their negligent misrepresentations, personally gained any
profit, advantage, remuneration or financial advantage to which they were
not legally entitled. [Id. at ¶¶ 58-59].
To satisfy the Judgment, Woody and Fann filed a claim under the
Private Company Management Liability Insurance Policy (the “Policy”)
issued by AIIC to Avadim. [Doc. 1 at ¶¶ 85-110]. This Policy obligates AIIC
to “pay on behalf of an Insured Person all Loss for which such Insured
Person is not indemnified by the Company” and is “legally obligated to pay
as a result of a Claim for a Wrongful Act first made against the Insured
Person during the Policy Period,” and “reported to [AIIC].” [Doc. 1-4 at 11].
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It is undisputed that both Woody and Fann are “Insured Persons” under the
Policy. [Doc. 17 at ¶ 46].
The Policy further provides, in pertinent part, that: “Loss shall not
include: . . . (7) contractually owed amounts; [or] (8) any disgorgement or
restitution of ill-gotten gain or recessionary damages.” [Doc. 1-4 at 18].
Further, the Policy is subject to an Improper Advantage Exclusion, which
states, in pertinent part, as follows:
The Insurer shall not be liable to make any payment
for Loss in connection with any Claim made against
any Insured:
A. alleging, arising out of, based upon, relating to, or
attributable to:
1) an Insured gaining any profit, advantage,
remuneration or financial advantage to which they
were not legally entitled; provided however, this
exclusion shall only apply if it is finally adjudicated
that such conduct occurred.
[Id. at 20-21].
By the present action, AIIC seeks a declaration that it does not have a
duty to indemnify Woody and Fann for the Judgment. [Doc. 1 at ¶ 1]. HE,
in turn, asserts two Amended Counterclaims against AIIC: (1) a claim for a
declaratory judgment that AIIC is obligated to pay HE per its indemnification
obligations to Woody and Fann as “Insured Persons” within the meaning of
the Policy and (2) a claim for breach of contract for AIIC’s failure to pay under
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the Policy. [Doc. 17 at ¶¶ 47-153]. AIIC now moves to dismiss HE’s
counterclaims, arguing that (1) HE lacks standing to assert the
counterclaims, (2) coverage is not available under the Policy because of the
Improper Advantage Exclusion, (3) coverage is not available because of the
restitution exception to “Loss,” and (4) coverage is not available because of
the “contractually owed amounts” exception to “Loss.” [Doc. 19 at 2-3].
IV. DISCUSSION
A. Standing
For a district court to enter a declaratory judgment, “the dispute must
be a ‘case or controversy’ within the confines of Article III of the United States
Constitution.” White v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, 913 F.2d
165, 167 (4th Cir. 1990). In other words, to obtain a declaratory judgment
from a federal court, a claimant must have Article III standing. MedImmune,
Inc. v. Genentech, Inc., 549 U.S. 118, 126-27 (2007).
“The test for a case or controversy . . . is whether the dispute is definite
and concrete, touching the legal relations of parties having adverse legal
interests.” White, 913 F.2d at 167 (internal quotation marks omitted). “It
must be a real and substantial controversy admitting of specific relief through
a decree of a conclusive character, as distinguished from an opinion advising
what the law would be upon a hypothetical state of facts.” Id. Applying this
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standard, the Fourth Circuit has held that a third party to an insurance
contract has Article III standing to seek a declaratory judgment against the
insurer when the third party has obtained, or will soon obtain, a judgment
against the insured. Miller v. Augusta Mut. Ins. Co., 157 F. App’x 632, 637-
38 (4th Cir. 2005) (per curiam).
Here, HE brings claims for declaratory judgment and breach of contract
against the insurer of its judgment debtors. The underlying judgment awards
damages to HE, which “makes the coverage question definite and concrete.”
Id. at 637. Further, HE and AIIC “clearly have adverse legal interests,” and
a ruling on the Policy would “resolve a real, concrete question based on
existing facts.” Id. Thus, the Court concludes that HE has Article III standing
to bring its counterclaims.3
B. Policy Exclusions and Exceptions
The Court now turns to AIIC’s argument that the language of the Policy
itself precludes HE’s counterclaims.
3 AIIC argues that under North Carolina law, HE does not qualify as a third-party
beneficiary of the Policy and thus lacks standing to bring the breach of contract claim.
[Doc. 19-1 at 7]. HE’s standing, however, is “a question of federal law, not state law.”
Hollingsworth v. Perry, 570 U.S. 693, 715 (2013).
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1. Choice of Law
As an initial matter, the Court must determine which law to apply in
interpreting the Policy. It is undisputed that the insurance contract at issue
was made in North Carolina. North Carolina law provides that “all contracts
of insurance . . . made within this State . . . are subject to the laws thereof.”
N.C. Gen. Stat. § 58-3-1. The Policy at issue, however, contains a choice-
of-law clause, which states: “All matters arising hereunder, including
questions related to the validity[,] interpretation, performance and
enforcement of this Policy shall be determined in accordance with the law
and practice of the State of New York.” [Doc. 1-4 at 33].
A federal court applies the choice-of-law rules of the forum state.
Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487, 496 (1941). North
Carolina employs the traditional lex loci rule: the court applies “the law of the
situs of the claim.” Boudreau v. Baughman, 322 N.C. 331, 335, 368 S.E.2d
849, 854 (1988). While the situs of a contract claim is typically “the law of
the state where the contract was made,” id. at 336, 368 S.E.2d at 854, North
Carolina has long permitted “contracting parties” to “agree that a particular
jurisdiction’s substantive law will govern their contract, and such a provision
will generally be given effect,” Volvo Const. Equip. N. Am., Inc. v. CLM Equip.
Co., Inc., 386 F.3d 581, 602 (4th Cir. 2004). “The parties’ choice of law is
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generally binding on the interpreting court as long as they had a reasonable
basis for their choice and the law of the chosen State does not violate a
fundamental policy of the state or otherwise applicable law.” Wall v.
Automoney, Inc., 284 N.C. App. 514, 524, 877 S.E.2d 37, 48 (2022).
HE has supplied no reason why the application of New York law lacks
a reasonable basis or violates a fundamental policy of North Carolina law.
Thus, the Court concludes that the parties’ choice of law governs, and the
Court will apply New York law in construing the Policy at issue.
2. The Improper Advantage Exclusion
AIIC first argues that the Judgment in the underlying action constitutes
a final adjudication that Woody and Fann gained a profit or advantage to
which they were “not legally entitled,” thus triggering the Improper Advantage
Exclusion of the Policy. [Doc. 19-1 at 12, 19].
“Under New York law, contracts of insurance are strictly construed in
favor of the insured and against the insurer.” Scholastic Inc. v. St. Paul Fire
& Marine Ins. Co., No. 23-cv-3485 (JMF), 2025 WL 2643981, at *4 (S.D.N.Y.
Sept. 15, 2025). When considering a policy exclusion, “the insurer bears the
heavy burden of demonstrating that the allegations of the complaint cast the
pleadings wholly within that exclusion [and] that the exclusion is subject to
no other reasonable interpretation.” Frontier Insulation Contractors, Inc. v.
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Merchants Mut. Ins. Co., 690 N.E.2d 866, 868 (N.Y. 1997). A court only
applies an exclusion if the insurer’s construction is “the only one that fairly
may be placed upon it.” In re Donald Sheldon & Co., Inc., 186 B.R. 364, 369
(S.D.N.Y. 1995).
Here, HE has plausibly alleged facts to support its claim that the
Improper Advantage Exclusion does not apply. As HE has alleged, nothing
in the judgment or verdict in the underlying action indicates that the
compensatory damages awarded to HE “amounted to any disgorgement,
restitution of ill-gotten gains, or recessionary damages” against Woody and
Fann. [Doc. 17 at ¶¶ 55-57]. Further, HE has alleged that there is nothing
to indicate in the jury’s verdict or the Judgment that there was a final
adjudication that Woody or Fann received any profit, advantage,
remuneration or financial advantage to which they were not entitled. [Id. at ¶
58]. Accordingly, AIIC’s motion to dismiss HE’s counterclaim on the grounds
that it is barred by the Improper Advantage Exclusion is denied.
3. Restitution Exception to “Loss”
The Policy requires AIIC to pay “all Loss” that Woody and Fann are
“legally obligated to pay” because of a “Claim.” [Doc. 1-4 at 11]. The Policy
exempts, however, several categories of payments from the definition of
“Loss.” [Id. at 18]. One of these categories is “any disgorgement or
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restitution of ill-gotten gain or recessionary damages.” [Id.]. AIIC argues that
the underlying damages award constitutes restitution, despite being labeled
“compensatory damages,” because “it is the return of HE’s $1.39M
investment per the PDSA,” and the treble damages are “derivative” of this
restitution. [Doc. 19-1 at 20].
Under New York law, monetary relief is “restitutionary in nature” when
it involves “disgorgement of improper profits.” Falzon v. Ford, 141 N.Y.S.3d
255, 264 (N.Y. Sup. Ct. 2021) (internal quotation marks omitted). For a court
to order restitution, a “benefit must have passed from plaintiff to defendant
for which the plaintiff should be compensated in equity and good
conscience.” Schuler-Haas Elec. Corp. v. Wager Const. Corp., 395
N.Y.S.2d 272, 274 (N.Y. App. Div. 1977). As noted above, HE sufficiently
alleges that nothing in the record of the underlying action indicates that
Woody and Fann’s wrongful conduct resulted in them having received any
“improper profit” through their misrepresentations. [Doc. 17 at ¶¶ 55-57].
Indeed, the Judgment itself explicitly labeled the damage award as
“compensatory,” not restitutionary. [Doc. 1-2 at 6]. As such, AIIC’s motion
to dismiss HE’s counterclaims on the grounds that the judgment in the
underlying action is an award of restitution and thus not a “Loss” is denied.
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4. “Contractually Owed Amounts” Exception to “Loss”
Another one of the categories of payments carved out from the
definition of “Loss” is “contractually owed amounts.” [Doc. 1-4 at 18]. AIIC
argues that “the $1.39 million portion of the Judgment constitutes
‘contractually owed amounts,’ which are not Loss.” [Doc. 19-1 at 24].
“Professional liability policies often contain an exclusion for any claim
arising out of a breach of contract.” 23 Appleman on Insurance Law &
Practice Archive § 146.6 (2nd 2011) (alterations and internal quotation marks
omitted); see Cont’l Cas. Co. v. Cnty. of Chester, 244 F. Supp. 2d 403, 409
(E.D. Pa. 2003) (interpreting an exclusion stating that “coverage does not
apply to any claim arising out of a breach of contract” (alterations and internal
quotation marks omitted)). “Under New York law, this type of exclusion is
governed by a but-for test. Thus, only if the injury suffered by the underlying
plaintiff would not exist but for the breach of contract, would the injury arise
out of a breach of contract.” Lepore v. Hartford Fire Ins. Co., 374 F. Supp.
3d 334, 352 (S.D.N.Y. 2019) (interpreting an exclusion that “limits coverage
for any personal and advertising injury arising out of a breach of contract”
(capitalization and internal quotation marks omitted)) (alterations and internal
quotation marks omitted).
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Here, HE has sufficiently alleged that its underlying lawsuit asserted
claims that sounded in tort, not breach of contract. [Doc. 17 at ¶¶ 51-54].
While HE alleged that Woody and Fann had committed tortious acts during
the negotiating of the PDSA, HE never claimed that such conduct resulted in
a breach of that agreement with Avadim. [Id.]. As such, AIIC’s motion to
dismiss HE’s counterclaims on the grounds that the judgment in the
underlying action is an award of “contractually owed amounts” and thus not
a “Loss” is denied.
V. CONCLUSION
For the foregoing reasons, AIIC’s Motion to Dismiss HE’s Amended
Counterclaims is denied, and HE’s Amended Counterclaims will be allowed
to proceed.
O R D E R
IT IS, THEREFORE, ORDERED that the Plaintiff’s Motion to Dismiss
HE, Inc.’s Amended Counterclaims [Doc. 19] is hereby DENIED.
IT IS SO ORDERED. Signed: May 20, 2026
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