by Christopher Graham and Joseph Kelly

May a liability insurer use an exclusion to avoid an indemnity obligation if it breaches a duty to defend?

As we discussed here, New York’s highest court last year initially said no. But when asked to reconsider, a majority of the court said yes. See K2 Investment Group, LLC, et al v. American Guarantee & Liability Ins. Co., 2014 NY Slip Op 01102 (Feb. 18, 2014).

There has been much commentary about K2 in the blogosphere. There is after all a lot of New York insurance business. The original decision also adopted a minority position. And it departed from long-standing New York precedent.

And it was that long-standing precedent, Servidone Construction Corp. v. Security Ins. Co. of Hartford, 64 N.Y.2d 419 (1985), which lead the majority to change its decision. As it explained:

Plaintiffs have not presented any indication that the Servidone rule has proved unworkable, or caused significant injustice or hardship, since it was adopted in 1985. When our Court decides a question of insurance law, insurers and insureds alike should ordinarily be entitled to assume that the decision will remain unchanged unless or until the Legislature decides otherwise. In other words, the rule of stare decisis, while it is not inexorable, is strong enough to govern this case.

The majority also noted cases from Hawaii and Massachusetts following Servidone and that a “federal district judge, writing in 1999, said that ‘the majority of jurisdictions which have considered the question’ follow the Servidone rule.” *See Flannery v Allstate Ins. Co*., 49 F. Supp. 2d 1223, 1227 (D. Col. 1999); *compare Employers Ins. of Wausau v Ehlco Liquidating Trust*, 186 Ill. 2d 127, 150-154 (1999) and Missionaries of Co. of Mary, Inc. v Aetna Cas. and Sur. Co., 155 Conn. 104, 112-114 (1967)(noted as minority view cases).

That Servidone involved a settlement rather than a judgment was deemed a distinction without a difference. And contrary to what the dissent argued, the original K2 decision couldn’t be reconciled with Servidone because both cases addressed whether an insurer could raise an exclusion despite breaching a defense duty.

The dissent argued that under Servidone, an insurer in breach of a duty to defend may avoid an indemnity obligation based on “non-coverage,” but not an exclusion. It explained:

Noncoverage involves the situation where an insurance policy does not contemplate coverage at its inception. For example, a homeowner’s policy would not provide malpractice liability coverage. Exclusions, in contrast, involve claims that fall within the ambit of the policy’s coverage parameters but are excepted by a particular contractual exclusion provision. Hence, a homeowner’s policy might contain an exclusion for certain types of water damage to the house.

The dissent argued “‘[u]nder those circumstances [(namely, non-coverage)], the insurance policy does not contemplate coverage in the first instance, and requiring payment of a claim upon failure to timely disclaim would create coverage where it never existed.'” [citations omitted]. An exclusion differs because it’s a way to avoid coverage that otherwise exists, so says the dissent.

The dissent also argued that Illinois, Massachusetts, and Colorado decisions cited by the majority applied the rule that an insurer breaching a duty to defend may raise a defense of non-coverage, but not an exclusion. *See also Alabama Hosp. Assn. Trust v Mutual Assur. Socy. of Alabama*, 538 So 2d 1209, 1216 (Ala. 1989)(cited by the dissent for the same rule).

None of this persuaded the majority.

Although not cited as a basis for the majority decision, plaintiffs were lenders who sued an entity and its owners to collect on a $2.85 million debt. But then also alleged one of the owner borrowers was their lawyer for the loan and committed malpractice by failing to record a mortgage securing the debt. After his insurer refused to defend, the lawyer allowed a default judgment against him exceeding the $2 million policy limit, though plaintiffs had demanded only $450,000 to settle. Then following the default, the lawyer assigned his rights against the insurer to the plaintiff lenders, who sued the insurer to collect. The lawyer apparently wouldn’t have to pay. And the default was only on the malpractice claim, not on the claim against the lawyer/owner/borrower to collect the $2.85 million debt.

With the majority decision, the insurer will be permitted to prove at trial that the judgment was really about lawyer’s as borrower/business owner, rather than as plaintiff lenders’ supposed lawyer. The insurer may now rely on: (1) a “status exclusion” for a “Claim based upon or arising out of, in whole or in part . . . D. the Insured’s capacity or status as: 1. an officer, director, partner, trustee, shareholder, manager or employee of a business enterprise . . . ;” and a “business pursuits” exclusion for a “Claim based upon or arising out of, in whole or in part . . . E. the alleged acts or omissions by any Insured . . . for any business enterprise . . . in which any Insured has a Controlling Interest.”

The dissent also was troubled that if the insurer defended the insured lawyer it could have addressed the status issues in the underling malpractice suit. It explained:

If, as the majority asserts, [lawyer’s] liability for professional negligence may have partially arisen from his actions as both an attorney and a manager of [a business] — and was therefore precluded under the “insured’s status” or “business enterprise” exclusion clauses — [insurer] should have fully participated in the underlying action and attempted to establish the basis for the exclusion. I believe that these issues should have been resolved in the original action rather than being delayed for years. The majority’s decision to authorize additional litigation and fact finding will prolong final resolution of this matter even further.

But this argument didn’t sway the majority either, particularly given Servidone.

Although now resolved in New York courts, we may see legislative attempts to change the rule and expect the debate isn’t over elsewhere. See our blog discussion here about Columbia Casualty Company v. Hiar Holdings, LLC, No. SC93026 (Mo. Aug. 13, 2013)(failure to defend foreclosed insurer’s coverage defense and opened up limits).

Tags: New York, duty to defend

by Christopher Graham and Joseph Kelly

Claims-made insurers limit risk by insuring only those claims alleging wrongful acts after a certain date. Their means for limiting risk often is a prior acts exclusion. The date often is before, rather than at policy inception and thus is known as a retroactive date.

But what if a Claim alleges wrongful acts before and after the retroactive date? Insurers also typically limit their risk to claims alleging wrongful acts unrelated to wrongful acts before the retroactive date. They typically wish to avoid insuring a Claim having anything to do with the pre-existing wrongful acts, even if it also alleges new wrongful acts.

But when are pre- and post-retro date wrongful acts related? Insurers address the issue through varying policy wording. But regardless of the wording, it’s a frequently litigated issue.

And so it was in American Guarantee & Liability Ins. Co. v. The Abram Law Group, et al, Case No. 13-13134 (11th Cir. Feb. 14, 2014). In that case, developer and bank sued lawyers alleging in count one malpractice in a January 26, 2006 closing for acquiring vacant land, with bank financing. That January date was before the May 1, 2006 retroactive date in the lawyers’ professional liability policy.

But developer and bank in a second count in the same suit alleged lawyers and title company committed fraud and conspiracy in an April 23, 2007 closing for a loan for developing the vacant land into a subdivision. The second closing thus was after the May 1, 2006 retroactive date.

In the first closing, the lawyers allegedly failed to identify exceptions to “good title.” So developer acquired land with unexpected title exceptions; and bank’s mortgage was subject to those exceptions. After the first closing, developer identified the exceptions. But the lawyers through the April 2007 closing allegedly covered up their earlier malpractice and made it appear that the exceptions weren’t an issue. They did so to avoid liability to developer and so title insurer wouldn’t have to cover the title exceptions. The lawyers also were title insurer’s agents and faced liability to title insurer for any mistakes. Developer and bank’s fraud and conspiracy allegations thus were based on the lawyers’ alleged post-retro date cover up of their pre-retro date mistakes.

The defendant title insurer meanwhile cross-claimed against the lawyers to indemnify it for any judgment for developer and bank involving the January 2006 loan and for negligence in failing to identity title exceptions. So the cross-claim only alleged wrongful acts before the May 1, 2006 retroactive date.

As is typical, this insurer used a prior acts exclusion to limit risk for claims alleging wrongful acts before the May 1, 2006 retroactive date. It also limited risk for claims alleging wrongful acts after the retroactive date, where the Claims nevertheless were based on wrongful acts before the retroactive date.

This is the wording insurer used: “This policy specifically excludes coverage for Damages and Claim Expenses because of Claims brought against any Insured based on any act or omission or any Related Act or Omission that occurred or is alleged to have occurred prior to 5/01/06.”

The insurer defined “Related Act or Omission” as “an act or omission that forms the basis for two or more claims, where a series of continuous, repeated, interrelated or causally connected acts or omissions give rise to one or more claims….”

In the prior acts exclusion, the phrase “that occurred or is alleged to have occurred prior to 5/01/06” modified the phrase “Claim brought against any Insured based on any act or omission or any Related Act or Omission.” It would have made more sense for the exclusion to read: “This policy specifically excludes coverage for Damages and Claim Expenses because of Claims brought against any Insured based on any act or omission that occurred or is alleged to have occurred prior to 5/01/06 or any Related Act or Omission that occurred or is alleged to have occurred on or after 5/01/06.” (Emphasis added).

But the Appeals Court didn’t address that issue and it made no difference in the result at least because the evidence was that the Claims, even those involving post-retro date wrongful acts, otherwise were based on an act or omission that occurred or was alleged to have occurred before the May 1, 2006 retro-date.

According to the Appeals Court: “Though [lawyers] contend Count Two alleging fraud in the underlying lawsuit relates only to the April 23, 2007, Development Loan closing and thus is covered under the policy, the acts and omissions giving rise to the malpractice claim from the January 26, 2006, Acquisition Loan closing also undergird the fraud claim regarding the Development Loan.”

“The alleged negligence involved in the Acquisition Loan closing is the necessary predicate to the fraudulent scheme to extinguish the 2006 lender’s title insurance policy and fraudulent insertion of additional exceptions to the 2007 title insurance policy. Further, the [other] claims . . . all flow from [lawyers’] alleged failure to disclose the restrictions and easements in the January 26, 2006, closing.”

So: “The district court did not err in determining the acts and omissions surrounding the Acquisition Loan closing form the basis of the claims regarding the fraud alleged during the Development Loan closing . . . .”

The Appeals Court also stated that the district court did not err “in finding the other acts or omissions surrounding the [post-retro date] Development Loan closing were interrelated to or causally connected to the acts or omissions at the [pre-retro date] Acquisition closing. Cf. Cont’l Cas. Co. v. Wendt, 205 F.3d 1258, 1262-63 (11th Cir. 2000) (applying plain meaning of the term “related” to a dispute over insurance coverage).” But with the way the prior acts exclusion was worded it’s hard to understand why that would make a difference. The act and omission and “Related Act or Omission” addressed by the prior acts exclusion were all described as before the retro-date. The exclusion thus didn’t explicitly address the relationship of pre- and post-retro date wrongful acts. That made no difference here. But it might in another case. So an insurer with a prior acts exclusion like this would be well-advised to revise it.

Tags: Georgia, professional liability, prior acts exclusion, interrelated or related wrongful acts

by Christopher Graham and Joseph Kelly

Consumers Ins. Co. v. James River Ins. Co., et al, Case No. 12-03303-CV-S-JTM (W.D. Mo. Jan. 14, 2014)

This case involves an insured’s failure to timely report a claim under D&O (US Specialty) and E&O (Houston Casualty) policies. Both policies required notice “as soon as practicable” after Claim is made. The E&O policy also required notice no later than 60 days following the policy period. The insured was an insurer that should have known better. Prejudice from the delayed notice to the insurer was irrelevant.

The underlying case against the insured insurance company was a Missouri garnishment action, including a bad faith cross-claim. Dahmer sued the insurer’s insured, Hutchinson, for serious injuries allegedly caused when Hutchinson’s vehicle struck him. Dahmer’s wife also sued. They made a limits demand in July 2007 on the insurer. But it denied coverage. Then they obtained an uncontested $2.7 million judgment against Hutchinson.

Thereafter they filed a garnishment action against Hutchinson and the insurer. The trial court granted the insurer a summary judgment based on a “salvage operations” exclusion. But the appellate court in 2010 reversed. On remand, Hutchinson cross-claimed against his insurer for bad faith. In late November 2010, Hutchinson made a demand on his insurer for $3.5 million, the judgment against him plus interest.

As of the November 2010 demand, the insurer had in effect a claims-made insurance company E&O policy, effective February 16, 2010 to February 16, 2011. It limited coverage to claims made for “wrongful acts” first committed on or after February 16, 2010. And it provided:

As a condition precedent to any right to payment in respect to any Claim, the Insured must give the Underwriter written notice of such Claim, with full details, as soon as practicable after the Claim is first made but in no event later than sixty (60) days after the end of the Policy Period. A Claim is first made when an Insured first receives notice of the filing of a complaint, notice of charges, a formal investigative order or similar document or by the return of an indictment against an Insured or when an Insured first receives the written demand or notice that constitutes a Claim under [another definition].

Beginning February 16, 2005, the insurer also had five claims-made insurance company D&O policies, each for a one year term, with the last expiring February 16, 2010. Those policies provided: “The Insureds must, as a condition precedent to the obligations of the Insurer under this Policy, give written notice, including full details, to the Insurer of any Claim as soon as practicable after it is made.” Claim included “any oral or written demand, including demand for non-monetary relief” or “any civil proceeding commenced by service of a complaint or similar pleading.”

When the Dahmers filed their garnishment action, the insurer didn’t notify its D&O and E&O insurers. When thereafter Hutchinson made his November 2010 demand for $3.5 million, the insurer didn’t notify them either.

Seven months after the E&O policy expired, by November 29, 2011 letter, insurer by its broker first notified the E&O insurer’s claims administrator (HCC Global Financial Products) of the Dahmers’ garnishment action. The notice referenced only the E&O policy.

Fifteen months after Hutchinson’s $3.5 million demand on insurer, by February 22, 2012 letter, insurer’s counsel notified the D&O insurer through its claims administrator of the Dahmers’ garnishment action including Hutchinson’s bad faith cross-claim. This letter referenced only the D&O policy. The D&O and E&O insurers had the same claims administrator, HCC.

After the E&O and D&O insurers denied coverage, insurer sued them for a declaration that they must provide coverage. But this Court, applying Tennessee law, held the E&O and D&O insurers were entitled to a judgment as a matter of law. The Court strictly enforced the E&O policy’s requirement of notice no later than 60 days following policy expiration; notice seven months after expiration wasn’t what the policy required. It also found the insurer’s 15-month delay in notifying the D&O insurer after Hutchinson’s $3.5 million demand was not notice “as soon as practicable,” given the absence of “extenuating circumstances” providing excuse or explanation. Prejudice to the E&O and D&O insurers wasn’t discussed and didn’t factor in the decision. Nor did it matter that the D&O and E&O insurers had the same claims administrator, at least because the notices were specific in identifying which policy was the subject of the notice.

In explaining its decision about the D&O policies, the Court stated:

[I]t has long been the law in Tennessee that “notice provisions of an insurance policy are valid conditions precedent to coverage, and in the absence of notice as required, no coverage is afforded.”

Moral of story for insureds and brokers: Always, always, give notice promptly to insurers; consider the issue any time something like a claim comes to you. Otherwise you may have no coverage. This has been a recurring theme on this blog lately.

Tags: Tennessee, insurance, D&O, E&O, notice

by Christopher Graham and Joseph Kelly

American Guarantee and Liability Ins. Co. v. Cohen, et al, Case No. 113510/2009 (Sup. Ct. N.Y. Jan. 2, 2014)

Background: Investors and attorney loaned pooled funds through attorney’s “interest on lawyer account” (“IOLA”) to a real estate investment fund managed by a non-party. But the fund was that non-party’s Ponzi scheme. And the loan was a loss, which attorney learned in February 2006. Attorney had a professional liability policy. But he didn’t advise insurer of the loan loss or related circumstances. “As a condition to coverage, the policy require[d] [attorney] to notify the insurer immediately if he has reason to expect a claim may be made against him for professional malpractice.”

Attorney provided insurer a renewal application dated November 19, 2008 for a policy effective December 1, 2008 to December 1, 2009. But he didn’t disclose the loan loss or related circumstances then either.

On December 4, 2008, just four days after policy inception, attorney learned investors sued him for legal malpractice in failing to conduct due diligence and obtain security for the loans. He then notified the insurer. Insurer defended attorney under a reservation of rights.

About two years later, insurer sued attorney for a judgment declaring it had no duty to defend or indemnify him and to recoup defense fees. That’s also when insurer first notified attorney that it denied coverage. “Even in extensive correspondence from [insurer] to [attorney] dated July 16, 2009, reserving its rights to raise coverage defenses, [insurer] failed to identify [attorney’s] late notice as a potential coverage defense.”

Investors intervened in the coverage litigation to protect their interests the insurance as a source to pay their malpractice claims. They appeared to carry the laboring oar in opposing the insurer.

The Court denied insurer summary judgment on late-notice and misrepresentation-in-the-application defenses; instead, granted investors summary judgment on insurer’s misrepresentation-in-the-application defense–because (per the Court) the undisputed material facts established disclosure of the investment loss would have been immaterial to insurer; and denied investors summary judgment on its claim that insurer waived the late-notice defense. So, absent a settlement, the case will go to trial on the late-notice defense.

Misrepresentation: In granting summary judgment on the misrepresentation-in-the-application defense, the Court stressed: “Based on [attorney’s] deposition testimony, [investors] do make a prima facie showing of a reasonable basis for [attorney] to believe that he was not subject to any legal malpractice claim by [investors] arising from his involvement in their investment. [Citations omitted] The record discloses no retainer agreement to provide legal representation to [investors]. No evidence whatsoever contradicts [attorney’s] testimony that he was acting as an investor and not in any legal capacity that reasonably would generate a potential legal malpractice claim, so as to require disclosure of the investments in his renewal application.”

In granting summary judgment on the misrepresentation defense, the Court also focused on what it deemed as the absence of evidence proving attorney’s failure to disclose investor losses and related circumstances was material to insurer: “Nor do [insurer’s] conclusory affidavit and the underwriting guidelines [insurer] presents demonstrate that, even if [attorney’s] belief was not reasonably founded, and he had informed [insurer] of [investor’s] potential claim, [insurer] would not have renewed his policy. . . . Since [insurer’s] own underwriting guidelines do not contemplate a denial of coverage based on an attorney’s involvement with other persons pooling their funds in a joint investment and using an IOLA to hold the funds, the failure to disclose such facts does not amount to a material misrepresentation.”

“[Insurer’s] scant evidence of its underwriting policies and practices fails to rebut [investors’] prima facie showing of no material misrepresentation. [Citations omitted] Absent rebuttal evidence raising a factual issue of materiality, [investors] are entitled to summary judgment on the nonmateriality of [attorney’s] omission in his policy renewal application.”

“The conclusory affidavit by [insurer’s] Assistant Vice President of its Programs Business Unit, that she would have declined a renewed policy to [attorney] had he disclosed the circumstances of the failed investment made through his IOLA, falls short of the showing necessary to establish that [attorney] made a material misrepresentation as a matter of law.”

“[T]he affidavit fails to establish that [she] is an underwriter for [insurer] or any basis for her personal knowledge of [insurer’s] underwriting policies or practices.” And: “Although [she] claims to rely on underwriting guidelines to support her conclusion, . . . [insurer’s] underlying guidelines’ definition of ‘claims’ does not include claims arising from the insured’s investments unrelated to his professional capacity as an attorney. . . . Although ‘claims’ do include ‘pending disciplinary matters’ and ‘disciplinary matters where a decision . . . was rendered,’ none of [attorney’s] conduct at issue in the underlying action falls into either category.”

“[Insurer] provides no evidence of an underwriting policy or practice of denying coverage to similarly situated insureds based on potential liability for failed investments made through an IOLA. . . . Even if [she] possesses personal knowledge of such an underwriting policy or practice by [insurer], absent any corroboration by [insurer’s] underwriting guidelines or comparable documentary evidence, her insistence that she would have declined to renew [attorney’s] professional liability policy is but a conclusory subjective predilection. Without the necessary substantiation by an objective standard, such speculation does not establish the materiality of the claimed misrepresentation by [attorney] and entitle [insurer] to disclaim or deny coverage as a matter of law.”

Comment: So to avoid insurer’s misrepresentation defense, investors apparently argued attorney had a reasonable basis to believe he wasn’t their attorney, seemingly contradicting their position in the underlying malpractice case that he was their attorney. Since it wasn’t in their interests in the coverage case, investors apparently didn’t present any of the evidence they would present in their malpractice case that would prove attorney was representing them. But the insurer apparently didn’t either.

In addition, this Court deemed the insurance executive’s affidavit insufficient to create a fact issue requiring a trial on the misrepresentation defense. That appears to have been for two reasons: (1) she wasn’t the actual underwriter of this risk and so had no personal knowledge about the underwriting decision (not sure why the insurer didn’t have the actual underwriter give the affidavit); and (2) insurer’s underwriting guidelines didn’t corroborate her statement that she wouldn’t have underwritten the risk had attorney disclosed the loan loss and related circumstances. Both points or at least the latter point might be considered credibility issues for the fact finder to address. But this Court didn’t see it that way.

Late-notice defense: In seeking summary judgment on its late-notice defense, “[insurer] relie[d] on [attorney’s] use of his IOLA for the investment to establish that he was acting as an attorney for [investors], triggering his duty to notify [insurer] of the potential legal malpractice claims against him when he learned the investment failed in February 2006. [Insurer] presents no evidence of a retainer agreement establishing an attorney-client relationship between [attorney] and [investors].”

In denying the insurer’s motion for summary judgment on its late-notice defense, the Court explained: “[Attorney] in his deposition testimony, . . . denies any attorney-client relationship with [investors] and maintains that his role was limited to a co-investor and escrow agent and that he never even undertook any responsibility to collateralize the investments. . . . He further testified that, had he had any basis believe a malpractice claim against him potentially would arise from his involvement with the investment, he would have disclosed the potential claim to [insurer] when he renewed his policy. . . . [Attorney’s] deposition testimony, even had [insurer] presented contrary evidence, raises a material factual issue that his belief in the absence of a potential claim by his co-investors for legal malpractice, as distinct from any other negligence or other culpable conduct, causing the lost investment, was reasonable under the circumstances.”

Further: “The underlying claims against [attorney] are predicated on his alleged failure to secure adequate collateral for the investments. Any misconduct in using his IOLA as the escrow account caused no harm to [investors] and therefore may not reasonably be expected to form a basis for a legal malpractice claim against [attorney]. In fact [investors] do not claim any culpable conduct by [attorney] in using his IOLA as the escrow account.”

“[Insurer] has demonstrated neither an attorney-client relationship, nor any factors vitiating [attorney’s] reasonable belief of nonliability for legal malpractice, such that it was unreasonable not to have been aware of such a potential claim from his involvement in the investment before he received the summons in the underlying action. . . . Since [insurer] thus fails to establish, as a matter of law, that [attorney] unreasonably delayed in notifying [insurer] of the claims against him, [insurer] is not entitled to summary judgment awarding declaratory relief on this ground.”

Comment: The policy as a coverage condition required attorney to notify insurer immediately if he had reason to expect a claim may be made against him for professional malpractice. So he says he didn’t have reason to suspect such a claim and, for this Court, his subjective belief was enough as to create a fact issue requiring trial. The insurer would be free to attack the attorney’s credibility regarding his “belief” when the case is tried.

Waiver: Investors didn’t prove insurer waived its right to deny coverage based on the late-notice defense. It didn’t matter that insurer waited until 3 years after notice to disclaim coverage or that it failed to identify late-notice as a coverage defense when it reserved rights in July 2009. Nor did it matter that the insurer controlled attorney’s defense because investors failed to prove that attorney was prejudiced as a result. They “do not show that the underlying action is so close to trial or otherwise has reached a point where the course of litigation has been fully charted. Nor do they show prejudice by any other reason, such as [insurer’s] use against [attorney] of confidential information acquired in defense of the underlying action.”

Tags: New York, professional liability, legal malpractice, notice, material misrepresentation

by Christopher Graham and Joseph Kelly

Grubaugh v. Central Progressive Bank (E.D. La. Dec. 18, 2013 Dec. 17, 2013)

This is a case where a Court strictly enforced the reporting requirement of a claims-made policy and barred an injured party’s direct action right because of the insured’s failure to timely report a claim.

Customer claimed two bank employees, namely, his mother and sister, stole over $70,000 from his account. In June and July, 2008, he sent complaint letters to the FDIC and Louisiana bank regulator. Customer asked the FDIC to “help me get my money back from the bank for the forged checks, unauthorized debit memos, unauthorized payment of bills that do not belong to me, [and] unauthorized disbursement of my social security checks.” In his complaint to the Louisiana regulator, customer stated that the relief he sought was “having my money returned to me and having someone that can do that from [the bank] contact me.” The two regulators notified the bank promptly thereafter.

The bank had a claims-made D&O/bankers professional liability policy, effective from February 1, 2007 through November 15, 2009, and issued by Executive Risk. “Claim” under the D&O coverage section included, among other things, “a written demand for monetary damages . . . against an Insured Person for a Wrongful Act” as well as “a formal civil administrative or civil regulatory proceeding commenced by the filing of a notice of charges or other similar document or by the entry of a formal order of investigation or similar document . . . against an Insured Person for a Wrongful Act.” The policy also provided that a “Claim will be deemed to have first been made when such claim is commenced as set forth in this definition or, in the case of a written demand, when such demand is received by an Insured.” Under the BPL coverage section, the Claim definition varied slightly, in that a Claim as otherwise defined must be brought “by or on behalf of a Customer against an Insured for a Wrongful Act.”

The policy provided further that:

the Insured shall, as a condition precedent to exercising any right to coverage under this Coverage Section, give to the Company written notice of a Claim as soon as practicable, but in no event later than […] sixty (60) days after the date on which any insured first becomes aware that the Claim has been made.

Notice requirements such as the one above are in all types of liability policies, but in occurrence policies they generally are for reporting an occurrence and a suit. For claims-made policies, they are for reporting a Claim, but sometimes the deadline isn’t absolute or it’s for a set period such as 90 days following the Policy Period, and there’s separate wording for reporting a circumstance that may lead to a future Claim. The bank’s policy had a rather short 60 day absolute reporting deadline.

But the bank didn’t notify the insurer that it received customer’s complaint letters within 60 days of receiving them from regulators. Nearly a year thereafter, the customer sued the bank, unnamed bank officers, employees and others, and unnamed liability insurers for breach of contract and negligence. The bank notified its insurer promptly. That was the insurer’s first notice of customer’s allegations.

Over two years later, after the bank failed, customer filed an amended complaint, naming as additional defendants, the bank’s holding company, the FDIC as the bank’s receiver and, under Louisiana’s Direct Action statute, the D&O/BPL insurer. Louisiana is one of several states having a statute permitting an alleged injured party to sue an insurer and its insured simultaneously.

But the Court entered summary judgment for the insurer: the injured customer’s Direct Action rights were no greater than the rights of the insureds, who had no coverage. Customer’s mid-2008 complaints with banking regulators were Claims as defined by the policy, triggering the insured bank’s reporting obligation within 60 days of learning of them; the bank, by waiting about a year to notify the insurer, had no coverage and neither did customer.

According to the Court, customer’s complaints to regulators, which were forwarded to the bank, “could be considered a ‘written demand for monetary damages’ . . . .” “Black’s Law Dictionary defines a demand as the ‘assertion of a legal or procedural right.'” “[T]here is no requirement that [the customer] submit the demand directly to [the bank] and/or [holding company]. Rather, in the case of the D&O coverage section, the demand need only be made against [them] and received by [them], which is exactly what happened here. [Customer] demanded from [bank] what he alleges is legally due to him, and that demand was received by [the bank]. Further, under the BPL Coverage Section, the demand may be made by or on behalf of [the customer]. In this case, the FDIC and the OFI submitted [customer’s] demand on his behalf, thus a claim was made.”

In addition:

[The bank’s] duty to notify [the insurer] was triggered on July 11, 2008 for the FDIC complaint and July 22, 2008 for the [Louisiana regulator’s] complaint, long before [the insurer] received notice of the claim in July 2009 and long after the sixty day reporting period had elapsed. By breaching this requirement, [the bank] failed to comply with a condition precedent of the Policy and coverage was never triggered.

The bank had no coverage; so neither did the “injured” customer. Whether the insurer was prejudiced by the untimely reporting didn’t factor into the Court’s decision; it’s not even mentioned. Numerous decisions in fact strictly enforce reporting requirements in claims-made policies without regard to prejudice. See, e.g., U.S. v. A.C. Strip, 868 F.2d 181 (6th Cir. 1989); Pantropic Power Prods v. Fireman’s Fund Ins. Co., 141 F.Supp.2d 1366 (S.D.Fla. 2001).

The Court also rejected the customer’s waiver and estoppel argument, concluding “there is no evidence that [the insurer] ever took any other steps that were contrary to their intent to deny coverage.”

Moral of story for brokers, risk managers, and insureds: Promptly report to the insurer anything that smells like a Claim or potential Claim, even if you’re not sure about it’s nature. You have nothing to lose and the consequences of failing to report can be no coverage. Perhaps the bank employees receiving the regulators’ notice didn’t take the customer “complaints” seriously, particularly as they involved “theft” by the customer’s mom and sister. The bank did take things seriously when it was sued, much later – but by then it was too late. You might also consider a policy with a more-insured friendly notice provision.

Moral of the story for “injured parties” and their counsel: Your ability to collect may be only as good as your target defendant’s insurance. When your target fails to provide timely notice to the insurer, you may have no way to collect. To avoid this scenario, plaintiffs’ counsel will advise the target to provide it’s insurer notice promptly or, if possible, also will put the insurer on notice directly.

Moral of the story for insurers: A specific reporting requirement in a claims-made policy often will be strictly enforced, regardless of whether the insurer was prejudiced by delay. That scenario frequently isn’t the case for occurrence-type liability policies.

Tags: Louisiana, D&O, professional liability, direct action, notice

by Christopher Graham and Joseph Kelly

Ragins v. Hospitals Insurance Company (Ct. Appeals NY Dec. 17, 2013)

This case addresses excess and primary professional liability insurers’ obligations for post-judgment interest on a malpractice judgment against a physician.

The primary policy’s limit was $1 million. The judgment against the insured was $1.1 million. But after the primary’s insurer’s liquidator paid $1 million and the excess insurer paid $100,000, the trial court amended the judgment to add in costs and interest. The excess insurer paid only it’s proportional share of interest – on the $100,000 judgment exceeding the $1 million primary limit — rather than on the full $1.1 million judgment.

After the insured sued the excess insurer, the trial court agreed with the insured that the excess insurer should pay all interest and costs exceeding the $1 million primary limit. The intermediate appeals court reversed, agreeing with the excess insurer that it was only responsible for proportional interest. But the highest appeals court reversed.

The primary policy limited that insurer’s liability to $1 million. It also included a “supplementary payments” section. But that section obligated “the primary insurer to pay post-judgment interest only ‘before’ it has ‘paid that part of the judgment which does not exceed the limit of the company’s liability thereon, . . . .'” The primary insurer had “no responsibility for interest after paying the $1,000,000 liability limit.”

The excess policy required payment of “all sums in excess of the limits of liability of the Underlying Policy” and which the insured “shall become legally obligated to pay as damages.” Neither “Sum,” nor “damages” was defined. Under dictionary definitions — “sum” means “indefinite or specific amounts of money” and “damages” means “the sum of money which the law awards or imposes as pecuniary compensation, recompense, or satisfaction for an injury done or a wrong sustained as a consequence either of a breach of a contractual obligation or a tortious act.”

Explaining why the excess insurers must pay the interest, the court stated: “By those definitions, interest included in any judgment against [the insured] constitutes a ‘sum’ of money that is traceable to the judgment against him for ‘damages’ in satisfaction of the wrong he caused to an injured party. Therefore, if that pre-judgment interest is ‘in excess’ of the primary policy’s $1,000,000 liability limit, [the excess insurers] must pay it.”

“And, although the excess policy does not specifically mention interest as a covered ‘sum’ of ‘damages,’ that is of no moment because the excess policy does not limit the definition of ‘sums’ to any particular category of damages or liability, or otherwise exclude interest from its reach.”

So the moral of the story: If you’re an excess insurer and don’t want to pay interest, you better do better than the policy wording here. You may think that interest isn’t a “sum” your insured is “legally obligated to pay as damages.” But don’t be surprised if a court believes otherwise. Be specific in excluding interest if that’s really what you want. But any insured or broker paying close attention to your interest-exception for coverage presumably will go elsewhere for coverage.

Tags: New York, professional liability, excess, interest

by Christopher Graham and Joseph Kelly

Two recent decisions impose severe consequences upon insurers that breach a duty to defend. A New York case, K2 Investment Group, LLC, et al v. American Guarantee & Liability Ins. Co, 21 N.Y.3d 384 (2013), involved a legal malpractice insurance policy. A Missouri case, Columbia Casualty Company v. Hiar Holdings, LLC, No. SC93026 (Mo. Aug. 13, 2013), involved a CGL policy. But the decisions are important for all duty-to-defend insurers in those states, regardless of the policy-type.

Under the New York K2 decision, an insurer wrongfully disclaiming a duty to defend, must indemnify its insured for any resulting judgment even if policy exclusions otherwise negate coverage. Lenders had sued an entity and its owners to collect on a debt, but then also sued an attorney/owner for legal malpractice, alleging that, as lenders’ counsel, the attorney failed to record a mortgage securing the debt. The legal malpractice insurer refused to defend the attorney/owner, citing exclusions for a “Claim based upon or arising out of, in whole or in part . . . D. the Insured’s capacity or status as: 1. an officer, director, partner, trustee, shareholder, manager or employee of a business enterprise . . . E. the alleged acts or omissions by any Insured . . . for any business enterprise . . . in which any Insured has a Controlling Interest.” The insurer thereafter also refused to settle for $450,000, well under the $2 million policy limit. The trial court in the malpractice and collection case then entered a default judgment against the attorney on the malpractice claim, for over the $2 million policy limit.

Lenders, as the insured attorney’s assignee, sued the insurer for breach of contract and bad faith. The New York Court of Appeals affirmed a judgment holding the insurer liable for the entire default judgment. It explained that “by breaching its duty to defend [its insured, the insurer] lost its right to rely on these exclusions in litigation over its indemnity obligation.”

Under the Hiar Holdings decision from Missouri, an insurer that wrongfully refuses to defend its insured is liable for all damages flowing from the breach, even exceeding the policy limits. The CGL insurer refused to defend and then settle a class action against its insured alleging violations of the Telephone Consumer Protection Act involving junk faxes. The insured with court approval settled with the class for $5 million, well over the $2 million CGL policy limit. The class then sued the CGL insurer under a garnishment statute, with the insurer counterclaiming for a declaratory judgment. The Court affirmed a judgment against the insurer for the entire $5 million settlement, finding the insurer breached its duty to defend claims alleging both property damage and advertising injury under the policy.

The New York and Missouri decisions are somewhat similar to what Illinois courts have been doing for quite some time. In Illinois, an insurer that fails to defend under a reservation of rights or bring a declaratory action is estopped from raising coverage defenses to an indemnity obligation, where it has breached a duty to defend. Doe v. Illinois State Medical Inter-Insurance Exchange, 599 N.E.2d 983 (1st Dist. 1992).

The insurer in the New York decision is seeking further review. So stay tuned. But these decisions are a red-flag for any insurer that caution is in order when declining a defense obligation in New York, Missouri, and Illinois.

Tags: New York, Missouri, Illinois, legal malpractice insurance, professional liability insurance, duty to defend, estoppel

by Christopher Graham and Joseph Kelly

May an insurer rescind a legal malpractice policy for misrepresentations by one attorney, leaving that attorney’s innocent partner with no coverage? Not when there’s a severability clause; and because of the “innocent insured doctrine,” even if there is no such clause. So says the Court in Illinois State Bar Association Mutual Ins. Co. v. Law Office of Tuzzolino and Terpinas, 2013 IL App (1st) 122660 (Nov. 22, 2013).

Tuzzolino, for his firm, answered “no” to the renewal form question: Has any member of the firm become aware of a past or present circumstance(s) which may give rise to a claim that has not been reported? But he knew he should have answered “yes” because his client had threatened to sue. Terpinas, Tuzzolino’s partner, had no knowledge of the threatened claim then. He learned of the claim upon receiving a lien letter from the client’s attorney and then reported it to ISBA Mutual promptly. Client thereafter sued Tuzzolino, Terpinas, and their firm. ISBA Mutual sued to rescind the policy. The appeals court reversed a summary judgment for ISBA Mutual against Terpinas.

The following severability clause saved Terpinas from Tuzzolino’s false application answer:

The APPLICATION, and any addendum or supplements and the Declarations, are the basis of the Policy. They are to be considered as incorporated in and constituting part of this Policy. The particulars and statements contained in the APPLICATION will be construed as a separate agreement with and binding on each INSURED. Nothing in this APPLICATION will be construed to increase the COMPANY’S Limit of Liability.

Each insured thus had its own policy; so ISBA Mutual could only “partially” rescind — with no rescission for the innocent insured’s, Terpinas’s separate policy.

And based on the common-law innocent insured doctrine, Terpinas had coverage even absent severability: When multiple insureds share a policy and one insured’s actions would void the policy, coverage for the innocent insured remains.

Economy Fire & Casualty Co. v. Warren, 71 Ill. App. 3d 625 (1979) controlled. It addressed a fire insurance policy under which, a husband and wife, settled a claim with their insurer for loss of their home to fire. But the settlement was based on a fraud by the wife, who unbeknownst to the husband, had burned down the house. The insurer tried to rescind the settlement agreement, but the court held that the husband — unaware of the wife’s fraud — could keep half the settlement monies.

The Court in ruling for Terpinas refused to follow Home Insurance Co. v. Dunn, 963 F. 2d 1023 (7th Cir. 1992), where the Seventh Circuit supposedly applying Illinois law allowed a legal malpractice insurer to rescind, even when some insureds weren’t aware of a misrepresentation in the application.

Lesson for insurers: With a severability clause like the above, you won’t be able to rescind as to innocent insureds; and you may not be able to do so even without it, though there’s considerable uncertainty about application of the common-law innocent insured doctrine.

Tags: Illinois, legal malpractice, professional liability, rescission, innocent insured, severability

by Christopher Graham and Joseph Kelly

Zurich American Ins. Co. v. Diamond Title of Sarasota, Inc., Case No. 8:10-cv-383-T-30 AEP (M.D. Fla. Dec. 4, 2013) addresses a common question-type in professional liability insurance applications — namely, did the applicant or prospective insured “know of any circumstances, acts, errors or omissions that could result in a professional liability claim against the Applicant?” Similar questions are in some D&O policy applications.

Rotolo, Diamond Title’s owner and President, answered “No” to the question, although involved in a mortgage fraud. Later, she pled guilty to related crimes.

JLO sued Diamond Title during the policy period for negligence in releasing escrow funds, but not fraud. Zurich then sued Diamond Title to rescind its professional liability policy, joining JLO to bind it to any judgment.

Like the insurance code of many states, Florida’s Code provides that “a misrepresentation in an application for insurance may prevent recovery under the policy if the misrepresentation was material to either the acceptance of risk or the hazard assumed by the insurer.” Fla. Stat. § 627.409.

The Court concluded the undisputed material facts established as a matter of law that Rotolo made a misrepresentation material to acceptance of the risk and the hazard assumed; so Zurich was entitled to summary judgment.

The Court rejected defendants’ argument that there was no misrepresentation. Citing the policy’s professional services definition and dishonesty exclusion, defendants argued in essence that because criminal mortgage fraud couldn’t result in a covered professional liability claim, Rotolo while knowing of mortgage fraud had no knowledge of acts that could result in professional liability claims. But according to the Court: “Rotolo was not relieved of her duty in the application to report acts that could result in a professional liability claim simply because the Policy may not have covered those acts.”

The Court also rejected defendants’ argument that the application wording altered Florida law, by requiring proof that Rotolo’s misrepresentation was intentional. The following “supporting” application wording said no such thing:

THE DISCOVERY OF ANY FRAUD, INTENTIONAL CONCEALMENT, OR MISREPRESENTATION OF MATERIAL FACT WILL RENDER THIS POLICY, IF ISSUED, VOID AT INCEPTION.

The Court also rejected defendants’ argument that Zurich failed to prove materiality. Contrary to defendants’ argument, it was immaterial that Zurich did not conduct the policy’s underwriting and immaterial that the underwriter’s affidavit referenced no underwriting guidelines. As the Court explained:

The Court does not need an underwriter or guidelines to appreciate how not knowing Rotolo and her employee had been committing mortgage fraud in excess of five years left Zurich unable to adequately estimate the nature of risk in issuing the Policy. [Citation omitted]. As previously discussed, many of these acts could have resulted in claims against the Policy. An objective insurer may not have issued a policy at all. Certainly a policy would not have been issued under the same terms and pricing knowing that Diamond Title was engaged in an ongoing scheme to commit mortgage fraud.

Tags: Florida, E&O, rescission, material misrepresentation

by Christopher Graham and Joseph Kelly

Bethel, et al v. Darwin Select Insurance Company, Case No. 12-3528 (8th Cir. Nov. 18, 2013)(MN law)

This case involves professional liability insurance for title agents and a broadly-worded exclusion for claims against the title agent and it’s employees involving misappropriation of customer funds held in escrow or otherwise. The broad wording that is the first part of the exclusion is common in many professional liability and D&O policy exclusions. Here, as in other cases where plain language is problematic, the insureds try to avoid that language by arguing coverage is “illusory” if coverage is denied and denying coverage is contrary to the insureds’ “reasonable expectation” and impermissible because these insureds are “innocent.” But those creative arguments have limited application; a broadly worded exclusion can be and in this instance was applied.

Zen Title, as agent of United General Title Insurance Company, recorded mortgages, deeds, and mortgage satisfactions and paid related fees; and paid off mortgage loans for United General’s customers in refinancing transactions. For that work, United entrusted Zen with millions of dollars, albeit to be held in segregated escrow accounts.

United Title sued Charles Bethel and Jennifer Frantz — Zen investors and, in Frantz’s case, a Zen bookkeeper and title agent as well — Zen, and others under various liability theories for a “wide-ranging fraudulent scheme to misappropriate the funds entrusted to Zen Title by [United].”

Darwin Select issued a professional liability policy to Zen Title including Bethel and Frantz as Insureds.

Under that policy, Darwin was obligated to defend and indemnify Insureds against any claim for any “[n]egligent act, error, omission, misstatement, misleading statement, neglect or breach of duty … by an Insured, in the performance of or failure to perform Professional Services.”

But the policy’s “Customer Funds Exclusion” barred coverage for “any Claim … based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving … any actual or alleged … loss, disappearance, pilferage or shortage of, or commingling or improper use of, or failure to segregate or safeguard, any client or customer funds, monies, or securities.”

Bethel and Frantz tendered defense of United’s suit to Darwin. Darwin denied coverage based on the Customer Funds Exclusion.

Bethel and Frantz sued Darwin for breach of its duty to defend and bad faith.

The District Court granted Darwin’s summary judgment motion. Bethel and Frantz appealed.

Customer Funds Exclusion

Bethel and Frantz argued that United’s allegations regarding failure to record mortgage instruments were outside the scope of the Customer Funds Exclusion; so Darwin should defend.

Darwin argued that United’s claims “arise out of”, result from, or in some way involve the loss of, or improper use of customer funds; so the Customer Funds Exclusion applies.

The Eighth Circuit noted that “the Minnesota Supreme Court has defined ‘arising out of’ broadly as ‘originating from,’ ‘growing out of,’ or ‘flowing from'”; and “‘but for’ causation, a cause and result relationship, is enough to satisfy the [“arising out of”] provisions of the policy.”

Applying that Minnesota law, the Eighth Circuit sided with Darwin: “all of [United’s] claims flow from, grow out of, or originate in the loss or improper use of [United’s] funds” and United’s ‘complaint explicitly links its allegations regarding the failure to record mortgage instruments to the scheme to misappropriate [United’s] escrowed funds.”

Illusory Coverage

Bethel and Frantz argued that applying the Customer Funds Exclusion to bar coverage would in essence mean coverage was “illusory.” The Eighth Circuit disagreed: “even reading the Customer Fund Exclusion broadly, the Policy covers a wide range of Zen Title’s professional activities.”

Reasonable Expectations Doctrine

Bethel and Frantz argued that under the reasonable expectations doctrine Darwin must defend them even if United’s allegations are within the Customer Funds Exclusion. The Eighth Circuit once again disagreed: the reasonable expectations doctrine applies only to resolve policy wording ambiguities; there were none here. And the customer funds exclusion wasn’t hidden within the policy; it was clearly set forth in the exclusions section of the policy.

Innocent Insured Doctrine

Bethel and Frantz argued that they were “innocent insureds” and shouldn’t lose coverage because of wrongdoing by Zen Title and others. But the Eighth Circuit again disagreed: “application of the Customer Funds Exclusion does not depend on who caused the loss or misuse of customer funds. Instead, it focuses on what gave rise to the claim.” “[T]he plain language of the exclusion makes clear that it applies regardless of whose conduct caused the loss or improper use of customer funds.”