The Fifth Circuit reversed the district court's dismissal of the insured's complaint by granting the insurer's motion for judgment on the pleadings. Spec's Family Partners, Ltd. v. Hanover Ins. Co., 2018 U.S. App. LEXIS 17246 (5th Cir. June 25, 2018).
Spec's was a specialty retail chain that accepted payments from major credit card brands like MasterCard and Visa. Spec's had a Merchant Agreement with First Data Merchant Services, LLC (First Data), a company that processed credit and debit card transactions in exchange for a fee.
Between October 2012 and February 2014, Spec's credit card network was hacked by unknown criminals, resulting in First Data's having to reimburse issuing banks the costs associated with the fraudulent transactions. First Data demanded payment from Speci's in a letter dated December 16, 2013, in the amount of $7,624,846.21. A second demand letter was sent by First Data on March 25, 2015, seeking $1,978.019.49. Both demand letters mentioned the establishment of reserve accounts to assure reimbursement and compliance with indemnification obligations by Spec's under the Merchant Agreement.
Spec's had a Private Company Management Liability Policy issued by Hanover. Exclusion N provided:
This insurance does not apply to:
N. "Loss" on account of any "claim" made against any "insured" directly or indirectly based upon, arising out of, or attributable to any actual or alleged liability under a written or oral contract or agreement. However, this exclusion does not apply to your liability that would have attached in the absence of such contract or agreement.
In response to the demand letters, Hanover agreed to defend under a reservation of rights. To recover the money First Data withheld in the reserve accounts, Spec's filed suit. Although Hanover initially paid expenses associated with the litigation against First Data, it eventually refused to do so, taking the position that the expenses were not "defense expenses" because they were incurred in pursuit of an affirmative claim against First Data.
Spec's sued Hanover. Hanover moved for judgment on the pleadings, asserting that Exclusion N relieved it of any duty to defend or indemnify. The district court granted Hanover's motion based upon Exclusion N which precluded coverage because the claim arose out of the Merchant Agreement.
The Fifth Circuit reversed. The pleadings, viewed in the light most favorable to Spec's, did not unequivocally show Exclusion N excused Hanover's duty to defend under any set of facts or possible theory. The demand letters from First Data included references to Spec's "non-compliance" with third-party security standards and demands for non-monetary relief, wholly separate from the Merchant Agreement. Spec's allegations included statements in the demand letters that did not depend upon the Merchant Agreement, such as Spec's negligence in not complying with the Payment Card Industry Data Security requirements and demands for non-monetary relief not contemplated by the Merchant Agreement.