Fourth Circuit Rules that FLSA Claims Constitute “Wrongful Act” Under CGL Policy

In a decision published February 24, 2012, the United States Court of Appeals for the Fourth Circuit held that an insured’s violation of the Fair Labor Standards Act (“FLSA”) constituted a “wrongful act” under the terms of the defendant school board’s commercial general liability (“CGL”) policy, thereby reversing a decision by the United States District Court for the Western District of Virginia.

In Republic Franklin Insurance Company v. Albemarle County School Board, employees of the Albemarle County School Board (“Board”) filed an action against the Board alleging the Board had violated the FLSA by failing to pay them the overtime rate when they worked in excess of forty (40) hours a week. The Board tendered the defense of the underlying suit to its insurer, Republic Franklin Insurance Company (“Republic”).

Under the terms of the CGL policy issued by Republic to the Board, Republic agreed to “pay for all ‘loss’ resulting from a ‘claim’ for a ‘wrongful act’ to which this insurance applies.” The policy defined “loss” as “any amount which an insured is legally obligated to pay as damages,” and the term included coverage for punitive damages “where insurable by law.” “Loss,” however, did not include “fines or penalties imposed by law” or “operating costs of [the insured’s] institution such as would be included in [the insured’s] ‘educational institution’s’ budget. “The policy defined “wrongful act” as “any breach of duty, neglect, error, omission, misstatement, or misleading statement in the discharge of ‘educational institution’ duties.”

Republic agreed to defend the underlying action with a reservation of rights to challenge coverage, and filed a declaratory judgment against the Board seeking a declaration that Republic owed no duty to defend the Board in the underlying action, and owed no duty to indemnify the Board for any judgment that might be entered in the underlying action. Specifically, Republic asserted that (1) FLSA violations were not “wrongful acts” as covered by the CGLpolicyRepublic issued to the Board; and (2) that any judgment that might be entered against the board would no impose “losses” on the Board, as “loss” was defined in the policy. The Board counterclaimed for a declaratory judgment that Republic had a duty to defend the underlying action and a duty to indemnify the Board for the amount of any judgment that might be entered.

The parties filed cross-motions for summary judgment. The district court denied the Board’s motion and granted Republic’s motion, declaring that Republic owed no duty to defend or indemnify the Board, and finding that, inter alia, the FLSA complaint did not allege a “wrongful act.” The district court also found that because the claim for back wages was not a claim for “damages,” as required by the definition of loss, but rather an existing operating cost, the claim liquidated damages and attorneys’ fees was also not a loss “because that claim did not exist independently of the claim for back wages.”

The Board subsequently appealed the ruling of the district court, leaving the Fourth Circuit to decide two issues: (1) whether the underlying FLSA complaint alleged a claim for a wrongful act; and (2) whether liquidated damages and attorneys’ fees claimed because of the FLSA violations were losses covered by the policy.

Wrongful Act

With regard to the “wrongful act” issue, Republic argued the Board’s failure to comply with the FLSA could not be a wrongful act because the Board had a preexisting duty to comply with the FLSA, and contended that the Board’s obligation to pay wages arose as soon as the work at issue was performed and therefore could not constitute a later wrongful action covered by the policy.

Rejecting Republic’s argument, the Fourth Circuit found that, “while a preexisting duty might be relevant to whether an insured suffers an insurable loss, it cannot be relevant to whether the insured is the subject of a claim for a wrongful act.” The court further explained:

Every duty breached or violated is necessarily a preexisting duty, and it is the breach or violation of that duty which constitutes a wrongful act. And, this is precisely how the insurance policy in this case defines a wrongful act: “‘Wrongful act’ means any breach of duty, neglect, error, [or] omission.” In the underlying FLSA complaint, the employees allege that the School Board failed to pay them wages for all work done and for overtime work, in violation of the duties imposed by the FLSA. The School Board’s alleged failures are thus breaches of the duty imposed by the FLSA and therefore wrongful acts. By its plain language, the policy covers claims for the wrongful acts alleged in the underlying complaint.

(Emphasis in the original).

The court further noted that Republic’s argument “conflate[d] the concepts of ‘wrongful act’ and ‘loss’”:

Confusingly, [Republic] conflates the concepts of “wrongful act” and “loss,” failing to recognize that a breach of a preexisting duty to pay is a wrongful act but that the resulting obligation to pay back wages may not be a loss resulting from that wrongful act. Such loss could only arise if the failure to fulfill the preexisting duty to pay wages caused “damages” apart from the back wages not paid. See PacificIns. Co. v. Eaton Vance Mgmt., 369 F.3d 584, 590-91 (1st Cir. 2004).
See also Macy Dep’t Stores v. Fed. Ins. Co., 305 F.3d 597 (7th Cir. 2002); Oktibbeha Cnty. Sch. Dist. v. Coregis Ins. Co., 173 F. Supp. 2d 541 (N.D. Miss. 2001). The court explained:
[A] judgment ordering an insured to pay money that the insured was already obligated to pay, either by contract or by statute, is not a “loss” covered under an insurance policy that requires that the loss be caused by a “wrongful act.” The alleged “loss” in such cases arises from the contract or the statute itself, not from the failure to abide by it….[However, the rule is not] that the failure to comply with a preexisting duty cannot be a “wrongful act.” Such a rule would not only be incompatible with the definition of “wrongful act” in such policies—defined broadly to include “any breach of duty”— but also is counterintuitive because no violation of the law could ever be a “wrongful act” as there would always be preexisting duty to follow the law.
Accordingly, the court found that the underlying complaint alleged “wrongful acts” on the part of the Board within the meaning of the policy issued by Republic.
With regard to whether liquidated damages and attorneys’ fees claimed because of the FLSA violations were losses covered by the policy, Republic argued that the liquidated damages and fees were not covered losses because (1) they are inextricably connected with the claims for back wages and overtime pay, which are not losses; (2) they are “fines or penalties imposed by law” and therefore excluded under the policy; and (3) they are restitutionary in nature and therefore not “damages,” as required by the policy’s definition of “loss.” The Board disagreed and argued that unlike back wages, the liquidated damages and attorney’s fees were damages resulting from its alleged wrongful acts.
The Fourth Circuit rejected Republic’s argument and held that “because the underlying FLSA complaint …. demand[ed] not only back wages, but also liquidated damages and attorneys’ fees resulting from the School Board’s wrongful acts….any judgment against the School Board, to the extent it would include liquidated damages and attorneys’ fees, would amount to a ‘loss’…resulting from a claim for a ‘wrongful act.’” In so finding, the court relied on controlling Supreme Court precedent “holding that liquidated damages as authorized by the FLSA are not penalties, but rather, compensatory damages ‘for the retention of a workman’s pay which might result in damages too obscure and difficult of proof for estimate other than by liquidated damages.’”  (Quoting Brooklyn Sav. Bank v. O’Neil, 324 U.S. 697, 707 (1944)). Thus, the Fourth Circuit found that Republic’s policy provided coverage for the liquidated damages and attorneys’ fees as a loss, as defined by the terms of the policy.
About Collins & Lacy, P.C.

Collins & Lacy is a statewide business defense firm in South Carolina that delivers legal representation for our clients through solid preparation, execution, and client-oriented service aimed at success. Located in the State’s capital city of Columbia, the firm represents local, regional and national clients in the areas of construction; hospitality/retail and entertainment law; insurance/bad faith; products liability; professional liability; commercial transportation; privacy, data management, and cybersecurity; mediation; and governmental affairs/issue advocacy.