Theoretical Amended Complaints and Tortured Grammar not Enough for Duty to Defend

The Second Circuit Court of Appeals, applying New York Law, affirmed summary judgement granted by the district court finding that a fabric manufacturer’s insurer had no duty to defend or indemnify in a suit for copyright infringement.

Spandex House, Inc. (“Spandex House”) was sued by Rex Fabrics for copyright infringement for the “creation, sale, and distribution of fabric bearing designs copyrighted by Rex Fabrics.” Spandex House sought defense and indemnity from its commercial general liability insurer, Hartford Fire Insurance Company, Hartford Casualty Insurance Company, and The Hartford (“Hartford”).

The policy excluded coverage for injuries arising out of “any actual or alleged infringement or violation of any intellectual property rights.” However, the exclusion was subject to an “advertising exception” that provided coverage if the only allegation of Intellectual Property (“IP”) infringement in the suit arises from “infringement, in your advertising or on your website, of” copyrights. In the underlying action, Rex Fabrics sued Spandex House for infringement both for its advertising and for the creation, sale, and distribution of the actual fabric.

Spandex House argued that the district court erred in finding the contract unambiguous. According to Spandex House, the commas setting off the “in your advertising or on your website” clause in the exception language meant that the clause was “non-restrictive” and the entire sentence could be read without the clause present — or it could be read as a description illustrating a type of infringement that resulted in coverage. Thus, according to Spandex House, the exception language was subject to multiple reasonable interpretations and was therefore, ambiguous.

The Second Circuit rejected Spandex House’s overall argument that the exception language was ambiguous, citing its common understanding of similar insurance provisions and the language’s plain meaning. The Second Circuit further rejected Spandex House’s two alternative interpretations – that the clause could be entirely eliminated, and that the clause was a non-exhaustive descriptive list – because each would render language in the insurance contract superfluous. Thus, the Second Circuit found that the exception applied only when the sole allegation of IP infringement arises from the insured’s advertisement or the insured’s website. Accordingly, because the underlying complaint alleged IP infringement also related to the creation, sale, and distribution of the actual fabric, the exception to the IP exclusion did not apply.

Spandex House also argued that, even if the exception was unambiguous, the district court erred in finding Hartford had no duty to defend Spandex House in the underlying action. While the district court found that the underlying action “contained numerous allegations that foreclosed coverage under the Advertising Exception,” Spandex House nevertheless argued that the underlying complaint could be amended such that it would allow coverage.

The Second Circuit rejected this argument. First, there was no indication that such a transformative amendment to the complaint was forthcoming. Second, and more broadly, following a rule that provides  coverage based on what the complaint could allege rather than what it does allege “would effectively make it impossible to condition coverage on the substance of a third party’s complaint.” The court held that “under Spandex House’s rule, the duty to defend would be essentially limitless, as a third party’s complaint could always be amended in the future to add a covered claim for the first time.”

Accordingly, the Second Circuit affirmed the district court’s judgement. Spandex House, Inc. v. Hartford Fire Ins. Co., Case No. 19-2784 (2nd Cir. June 17, 2020).