SXSW Makes Rare Appeal of Insurance Loss Over Covid Cancellation

South by Southwest is set to challenge a Chubb Ltd. insurance unit’s refusal to pay for the festival’s Covid-era cancellation, bringing an unusual appeal with broad implications for companies’ directors and officers policies.

The US Court of Appeals for the Fifth Circuit on Thursday will hear arguments from festival organizer, SXSW LLC, and its carrier over who must foot the legal bill in a class action alleging SXSW wrongly withheld customers’ ticket payments after the festival was canceled in 2020. The tech, music, and film festival is typically held each year in Austin.

The dispute is the first D&O insurance case over pandemic-related event cancellations to reach a federal appeals court, industry attorneys say.

Federal courts so far have largely rejected policyholders’ bids seeking business interruption coverage over Covid-related losses under property and business owners’ insurance. This time, the dispute hinges on a standard clause in D&O policies that says insurers are off the hook when a business is sued over an alleged breach of contract.

“This is an important case on the contractual liability exclusion, which is a very consistent provision in D&O policies,” said J. James Cooper, a partner at Reed Smith LLP who represents policyholders.

The Chubb unit, Federal Insurance Co., argues that the contract exclusion applies because the underlying lawsuit alleged a breach of contract. But SXSW says its customers never alleged a breach of legal obligation under the ticketholder sales agreement, which included an explicit no-refund policy.

When reviewing contract exclusions in general liability insurance policies, both the Fifth Circuit and the Texas Supreme Court have held that the existence of a contract on its own doesn’t relieve carriers of their duty to pay, Cooper said. An underlying suit has to specify a legal duty resulting from the contract.

“The law has been very consistent and clear in non-D&O coverage cases on the contractual exclusions. Now the question is, will they apply those precedents to D&O policies or come up with a totally different structure?” Cooper said.

Insurers are keeping an eye on the Fifth Circuit’s ruling in SXSW’s case.

“D&O policies were never intended to allow insureds to shift the risk of their contractual obligations to their insurers,” said Michael Young, a partner at Reichardt Noce & Young, LLC, who represents carriers.

Contractual Liability

SXSW held a $1 million D&O policy with Federal Insurance, and spent beyond the limit to defend and settle the underlying ticketholder lawsuit. The US District Court for the Western District of Texas ruled in favor of the insurer in May 2022, holding that, “but for the Underlying Contract, there would be no Underlying Suit.”

The ticketholders anchored their allegations to the lawfulness of the no-refund policy in the purchasing contract, so the contract exclusion applies, the lower court said.

SXSW subsequently appealed, saying the customers’ allegations of unjust enrichment and conversion were common law claims that didn’t raise any duties relating to a contract.

“SXSW rightly points out in its appeal that the focus of the inquiry needs to be on the underlying liability and not on simply identifying the existence of a contract to negate coverage,” said Geoffrey B. Fehling, a partner at Hunton Andrews Kurth who represents policyholders. “The contract exclusion should not apply where a suit alleges tort claims, like those for unjust enrichment or conversion, with liability created by law and not imposed by contract.”

But Lee S. Siegel of Hurwitz Fine PC, who represents insurers, said the fact that the underlying lawsuit even alleged a breach of contract is fatal to SXSW’s case. In insurance law, “coverage is determined predominantly by the allegations,” not whether an underlying claim has merit, he said.

The case serves as a warning for companies about buying a D&O policy with a broad contract liability exclusion because it could be “misapplied to defeat coverage for tort and similar claims typically covered by D&O policies,” Fehling said.

‘A Significant Change’

Chubb’s insurance unit filed its own appeal challenging other aspects of the SXSW ruling.

The lower court found that Federal Insurance would’ve had to pay for the underlying ticketholder suit without the contract exclusion, but the insurer argues the class action wouldn’t have been a covered loss anyway. D&O policies don’t cover restitution and disgorgement claims for “ill-gotten gains,” such as the charges that SXSW wrongly withheld customers’ payments, Federal Insurance said.

The carrier argues that the policy’s exclusion for lawsuits related to professional services also precludes coverage.

It will be noteworthy if the Fifth Circuit tackles whether a policyholder retaining a customer’s payment can be covered by D&O insurance, Siegel said.

“If a court determines that the wrongful withholding of money can be an insurable loss, it converts the business-to-business engagement and makes the insurer the potential guarantor of the transaction,” he said. “That will be a significant change in how the field understands how these policies are intended to operate.”

Federal Insurance’s attempt to enforce the policy’s professional services exclusion is “an overreach,” Siegel added.

“SXSW sold tickets, not a service,” Siegel said. “They didn’t charge the concertgoers a fee in exchange for service. They provided a commodity, which is the concert.”

SXSW, LLC is represented by Gauntlett & Associates and Graves, Dougherty, Hearon & Moody, P.C. Federal Insurance Co. is represented by Walker Wilcox Matousek LLP.

The case is SXSW v. Federal, 5th Cir., 22-50933.