Policyholder Pulse
It’s said that an ant can carry fifty times its own weight. That’s nothing.
A recent decision out of the U.S. Court of Appeals for the Fifth Circuit provides a compelling reminder to policyholders and their counsel: Even the smallest word in an insurance policy—and even the placement of a punctuation mark—can carry tremendous weight. In fact, it can alter the meaning of an entire insurance policy. In Paloma Resources, L.L.C. v. Axis Insurance Co., the court vacated summary judgment in favor of the insurer based on the placement of a single word—“the”—in an exclusion clause.
The decision reaffirms the bedrock principle in insurance policy interpretation that where a policy purports to bar coverage for an insured’s claim, it must do so in an unambiguous and clear manner. When a policy exclusion is unclear, courts will construe the provision in favor of coverage for the policyholder.
Paloma’s Claim: A Trade Secrets Lawsuit, a Settlement and a Denial of Coverage
In 2017, Paloma Resources was sued by a business competitor, Continental Resources. Continental’s lawsuit alleged that Paloma misappropriated trade secrets, using the prospect of employment to induce Continental employees to make unauthorized transfers of proprietary information to Paloma. Paloma settled the lawsuit without a judgment, stipulating that “the suit involved the unauthorized disclosure of and access to Continental’s confidential information.”
Paloma then sought coverage from its D&O insurer, Axis Insurance Company, for defense and settlement costs. Axis denied the claim based on the policy’s broadly worded Intellectual Property (IP) Exclusion. A federal district court agreed, granting Axis summary judgment on grounds that the underlying lawsuit fell within the scope of the IP Exclusion because it alleged both “misappropriation of trade secrets” and “unauthorized access to confidential information.”
Paloma appealed.
The IP Exclusion: Language in the Spotlight
Here’s what the exclusion actually said:
The Insurer shall not be liable … for Loss on account of any Claim … based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving any actual or alleged infringement of copyright, patent, trademark, trade name, trade dress, or service mark or the misappropriation of ideas or trade secrets, or the unauthorized disclosure of or access to confidential information; provided that this exclusion shall not apply to Loss on account of a Securities Claim, a Securityholder Derivative Demand, or a derivative action.
Axis’s position appeared to be straightforward. The underlying lawsuit unquestionably involved allegations of misappropriation of trade secrets and unauthorized access to confidential information. Indeed, Paloma stipulated to this fact in the underlying settlement agreement. Thus, Axis argued, the IP Exclusion barred coverage for this “alleged … misappropriation of ideas or trade secrets” and “alleged … unauthorized access to confidential information.”
Not so fast. Paloma focused on the structure and wording of the exclusion, calling attention to the placement of the word “the” in the series of excluded claims:
involving any actual or alleged infringement of copyright, patent, trademark, trade name, trade dress, or service mark or the misappropriation of ideas or trade secrets, or the unauthorized disclosure of or access to confidential information[]
Paloma argued that the use of the word “the” before the “misappropriation” and “unauthorized disclosure” clauses signaled a break in the grammatical structure of the exclusion. As a result, the phrase “any actual or alleged” modified only the list of infringement-related terms, not the “misappropriation” and “unauthorized disclosure” clauses that followed. In other words, Paloma argued that the exclusion must be read to bar coverage only for claims involving:
- Any actual or alleged infringement of copyright, patent, trademark, trade name, trade dress or service mark, or
- The misappropriation of ideas or trade secrets, or
- The unauthorized disclosure of or access to confidential information.
This meant “actual or alleged” only modified the first part of the series, and only actual misappropriation or unauthorized disclosure—not alleged misappropriation—would trigger the exclusion. Because the underlying suit had settled with no finding of actual liability, the exclusion did not apply.
The Fifth Circuit’s View: Reasonableness Is Enough
The district court rejected Paloma’s interpretation as unreasonable, concluding that the “arising out of” and “actual or alleged” language within the IP Exclusion applied to broadly restrict coverage. However, the Fifth Circuit reversed the judgment, agreeing that Paloma’s reading was grammatically sound and legally plausible under the so-called “Series-Qualifier Canon.” In another case, United States ex rel. Vaughn v. United Biologics, L.L.C., the Fifth Circuit explained this rule in language only a grammarian could love: “[The] principle of interpretation, known as the ‘Series-Qualifier Canon,’ applies only when context clearly establishes that it is intended. This is usually the case when the nouns and verbs are listed without any intervening modifiers. … The typical way to break the series is to insert a determiner”—such as the critical “the” inserted before “misappropriation” and “unauthorized disclosure” in Paloma’s IP Exclusion.
Applying Texas law, the court then emphasized that exclusions must be construed strictly against the insurer. Where more than one reasonable interpretation exists, the insured’s interpretation must prevail, even if it is not the most natural or the most likely reading. The court also noted that Axis’s reading made little sense in ordinary English usage. Interpreting the clause to apply to “any actual or alleged … the misappropriation of trade secrets” is, at best, awkward and, at worst, linguistically indefensible. But regardless, because Paloma’s construction was reasonable, the court vacated the judgment and remanded the case for further proceedings to determine whether, under Paloma’s construction of the IP Exclusion, Axis had a duty to defend and/or indemnify Paloma.
How Courts Interpret Insurance Policies
The decision in Paloma reinforces several well-established principles of insurance policy interpretation under Texas law—principles that are widely applied in jurisdictions across the country:
- Courts give policy terms their ordinary and generally accepted meaning, unless the policy clearly indicates a different or technical usage.
- Ambiguity arises when language is reasonably susceptible to more than one meaning.
- A court need not adopt the “most natural” or “most likely” interpretation—only a reasonable one.
- Insurance policy language is construed strictly against the insurer and interpreted in favor of preserving coverage.
- When an insured presents a reasonable reading of an exclusion, courts are required to adopt it, even if the insurer’s interpretation seems more commercially intuitive.
Courts in many states follow similar interpretive approaches, particularly with respect to ambiguity and exclusionary clauses, though some jurisdictions may diverge in application.
Paloma shows us that policyholders should not assume exclusions are as broad as they appear on first reading. Careful analysis of the language, in context, can open the door to coverage.
Key Lessons and Practical Takeaways for Policyholders
- Small Words Can Have Big Impact: Even a word seemingly as inconsequential as “the” can have a huge impact. It narrows focus to a particular item or event, and its placement in a series can alter the court’s perspective on every item in the series. Exclusionary language, in particular, should be reviewed carefully and with attention to structure and syntax.
- Ambiguity Should Be Asserted Where It Exists: Texas courts, like many others, require only that the insured’s interpretation be reasonable. If so, it governs. Policyholders do not need to show that their reading is better—just that it is viable.
- Structure and Grammar Arguments Are Legally Valid: Arguments based on linguistic structure, such as the “Series-Qualifier Canon,” are not just theoretical. Courts engage with these principles when policy language is at issue.
- Review and Negotiate Policies Proactively: Standard exclusions can contain subtle limitations. Policyholders should consult experienced coverage counsel to evaluate policy language at placement or renewal and again when a claim arises. Counsel can help identify potential coverage gaps or develop effective claim advocacy strategies tailored to the precise language at issue.
- Consider Coverage Implications in Settlements: Even early settlements can affect coverage outcomes. Counsel should ensure that settlement language and structure preserve (rather than impair) coverage arguments. Coverage counsel can help identify potential problems before they are formalized in a settlement agreement.
Conclusion
The Fifth Circuit’s decision in Paloma reinforces a fundamental principle of insurance recovery. It may seem like making a mountain out of an anthill, but words matter—especially in exclusions. In Paloma, one word—the placement of the definite article “the”—changed the meaning of an entire sentence and gave the policyholder a second chance at coverage.
While exclusionary language may appear routine and broadly worded, careful analysis can reveal opportunities to preserve coverage. The lesson for policyholders is clear: When evaluating coverage or negotiating policies, read closely, advocate clearly and never assume that any word is incidental.
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