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Porter v. American International Companies

A-5213-02T2 (N.J. Super. App. Div. 2004) (Unpublished)

INSURANCE —Where a company’s insurance policy excludes claims arising out of contractual obligations, the carrier is not obligated to defend a company officer who is being sued by a supplier for converting payments that should have been directed to the supplier because the underlying obligation arises out of a contract.

A company bought a liability insurance policy. A lawsuit was filed against the company’s CEO as a defendant. The litigation involved a dispute arising out of an Asset Purchase Agreement wherein the injured buyer purchased most of another company’s home medical care business. The purchase was financed. That purchase excluded the seller’s dialysis-related inter-dialytic parenteral nutrition (IDPN) business. The buyer, as borrower, sold the seller’s accounts receivable to the lender. The lender, in turn, transferred the accounts receivable proceeds to its affiliate who then sold the debt or equity interests to investors.

Initially, the buyer operated its acquired home health business in the seller’s name and used the seller’s medical provider numbers to avoid disruption to its homecare patients. The buyer agreed to convert to its own provider numbers within a reasonable time. This transaction was structured as follows. The buyer and seller set up a lock box bank account controlled by the seller. Bills were sent by the buyer under the seller’s name and provider numbers. Collections were deposited into the lock box account. The proceeds would then be swept into the buyer’s bank account. The agreement provided that the buyer would retain the proceeds received from the lock box and on a regular basis remit, to the seller, that portion of the money received for services rendered by the seller’s retained IDPN business.

The seller alleged that the buyer was under-capitalized and after collecting the accounts receivable, turned over all of the proceeds to the lender. In return, the lender advanced limited funds to the buyer on a weekly basis for its operational needs. According to the seller’s complaint, several months after closing, the buyer became “cash-poor” because the lender had significantly reduced its weekly fund allocation. The lender and the buyer then requested the seller to allow money in the lock box accounts to be swept directly into the lender’s bank account instead of into the buyer’s account. Allegedly unaware of its buyer’s financial problems, the seller agreed. The lender promised to directly remit all IDPN business payments to the seller.

While operating under the seller’s name, the buyer stopped paying its debts leading several creditors to seek out the seller for payment. In early 1999, the lender stopped remitting IDPN business payments to the seller. As a result, the seller sued the CEOs of both the buyer and the lender. Its complaint alleged that the buyer’s CEO knowingly and willfully caused his company to undertake unfair and deceptive acts, including misrepresentation, conversion of funds and intentional interference with contractual relations, as well as willful breaches of known contractual obligations. It was further contended that the buyer’s CEO was individually liable as a tortfeasor, asserting that he personally caused his businesses to engage in these unfair and deceptive acts and practices, for which the seller suffered substantial monetary loss and other damages.

On December 21, 2001 and January 3, 2002, the CEO notified his company’s insurance company that he was named in this litigation and requested that it provide a defense. On February 14, 2002, the insurance company told the CEO that the claims against him were not covered under the policy. According to the insurance company, the policy owned by the CEO’s company did not cover losses in connection with a claim arising out of any contractual liability of an insured. The CEO then sought a declaratory judgment action to compel the insurance company to provide him with a defense. The lower court ruled in favor of the insurance company holding that this was not a classic conversion claim. It found that the claim arose out of a contract dispute because the asset purchase agreement covered how the collections were to be treated.

The Appellate Division affirmed, holding there was interdependence between the claims of conversion, unfair practices, and misrepresentation against the CEO and the provisions of the Asset Purchase Agreement. Had there not been a contractual obligation requiring the buyer and the financing company to remit all IDPN payments to the seller, there could have been no claim. The obligation to remit the funds had its origins in the contract, and, therefore, regardless of the reasons or motives for not remitting the funds, the failure to remit was dependent upon the existence of a contract. For that reason, the Court concluded that the claims against the CEO were not covered by his company’s insurance policy.

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