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Ninth Circuit Finds No Duty To Defend When Claims Arose Out of Excluded Contractual Relationship

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X2 Biosystems, Inc. v. Fed. Ins. Co., No. 14-35125, 2016 WL 4120694 (9th Cir. Aug. 3, 2016). The Ninth Circuit held that damages stemming from X2 Biosystem’s breach of a licensing contract with Bite Tech Incorporated was not covered under an insurance policy issued to X2 by Federal Insurance Company. In 2011 X2 entered into a Technology Licensing Agreement (“TLA”) with Bite Tech that granted Bite Tech a license to certain X2 technology. The TLA provided that Bite Tech pay X2 $2 million in advance royalties as consideration for the agreement. After X2 received the advance royalties it breached the TLA without having generated any revenue for Bite Tech. Bite Tech sued X2, alleging seven causes of action including breach of a special relationship and conversion. Federal refused to defend X2. X2 brought a declaratory judgment action, claiming Federal breached its duty to defend and the covenant of good faith and fair dealing. Federal cross-moved to dismiss X2’s complaint and X2 moved for partial summary judgment. The federal district court below denied X2’s motion and dismissed the company’s complaint with prejudice. 

On appeal, the Ninth Circuit upheld the lower court’s ruling dismissing X2’s complaint.

Federal cited a policy exclusion in denying coverage for claims arising or resulting from X2’s liability “under any contract.” Bite Tech alleged in the underlying complaint that in entering the TLA, the two companies had formed a “special relationship” that gave rise to a duty to disclose when either party was planning on terminating the agreement. Federal argued, and the court agreed, that X2’s duty to disclose therefore “arose out of” X2’s contractual liability under the agreement, because absent the agreement no such duty would exist. Bite Tech’s conversion claim similarly “arose out of” contractual liability, because the advance royalty payments were received as consideration for the TLA and were thus related to X2’s contractual liability.