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The Illusory Coverage Doctrine: A Critical Review

How should a court handle a liability insurance policy sold to a tavern that purports to cover general commercial liability, yet contains an exclusion for liability “arising out of or in connection with the manufacturing, selling, distributing, serving or furnishing of any alcoholic beverages”? How about a liability insurance policy sold to DISH Network that contains an exclusion for liability “arising out of the ownership, operation or use of any satellite”? Or how about one that purports to cover a business for its liability arising out of “discrimination,” yet contains exclusions for discrimination that either violates a statute, is done knowingly or intentionally, is directed towards prospective, current, or wrongfully terminated employees, or is “committed on the basis of race, creed, color, sex, age or national origin”?

In all three of those cases, the policyholders argued that it would be unfair for the court to enforce the exclusions in their policies as they were written. Those exclusions, the policyholders argued, wiped out so much of the coverage that otherwise would have existed under the policies’ insuring clauses that the coverage would be practically worthless. Thus, the courts were asked to analyze those policies under the doctrine known as the Illusory Coverage Doctrine (ICD). The ICD is implicated when an insurance policy is written in such a way that could give the policyholder the “illusion” that the policy covers risks that are not actually covered. The ICD is somewhat obscure, and no precise formulation of the doctrine has yet achieved predominance among American jurisdictions.

This Comment will discuss the status of the ICD in American insurance law, especially liability insurance law, and will also offer my own views as to how the doctrine can be best understood and refined.