Florida Court Allows Rescission of a Professional Liability Policy

In its recent decision in Zurich American Ins. Co. v. Diamond Title of Sarasota, Inc., 2013 U.S. Dist. LEXIS 170981 (M.D. Fla. Dec. 4, 2013), the United States District Court for the Middle District of Florida had occasion to consider whether an insured’s guilty plea can be used as the basis for rescission of a professional liability policy.

Zurich insured Diamond Title under a title agent’s errors and omissions policy issued in 2007.  The owner/operator of Diamond Title was later indicted on several counts of mortgage fraud, conspiracy, bank fraud, wire fraud, and making false statements in connection with a loan application.  She later pled guilty to two counts, including conspiring to make materially false statements to banks and that she committed several acts of wire fraud.  Her plea agreement stated that the conspiracy ran from 2002 through 2008, the purpose of which was “to obtain loans secured by mortgages from FDIC-Insured banks and mortgage lending businesses.” 

Diamond Title was named as a defendant in an underlying suit relating to its duties as an escrow agent involving the purchase of distressed residential properties.  The suit alleged that Diamond Title negligently released money without prior authorization.  Zurich, in turn, sought rescission of the policy on the basis of material misrepresentations made in the insurance application.  Among other things, the application asked:

Does the Applicant or any prospective Insured know of any circumstances, acts, errors or omissions that could result in a professional liability claim against the Applicant? If "Yes", you must complete the attached claims addendum for each circumstance.

Zurich contended that at the time Diamond Title’s owner completed the application in 2007, and answered “No” in response, she was knowingly committing mortgage fraud and that she confirmed as much in her later plea agreement.   As such, Zurich maintained that Diamond Title should have answered “Yes” in response to the question.  The underlying claimant (named as a party to the rescission action), however, argued that Diamond Title’s response was truthful, since while at the time it was aware that it was committing criminal misconduct, it could not necessarily foresee civil liability for its actions.  In this connection, the claimant pointed out that the question inquired into acts that could result in professional liability claims, not criminal acts that would not come within the policy’s coverage in the first instance.   

Noting that the misconduct described in the plea agreement came within the policy’s definition of professional services, the court rejected the attempt to distinguish criminal misconduct from conduct that could give rise to a professional liability claim, explaining:

… the Court disagrees with the Defendant's assertion that criminal acts cannot result in claims for professional liability. A single act can be a basis for both professional and criminal liability. The Policy makes clear that it does not cover liability for criminal acts, even if they are properly characterized as professional liabilities. Rotolo [the owner of Diamond Title] 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 concludes that Diamond Title's answer to question 21 of the Policy application, that it did not know of any circumstances that could result in a professional liability claim, was a misrepresentation.

The court further reasoned that the misrepresentation was material to the risk.  While the underlying claimant argued that Zurich failed to point to any underwriting guidelines applicable to the facts, the court relied on common sense reasoning that the insured’s failure to disclose a criminal conspiracy was material.  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. … 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.

Eighth Circuit Holds Customer Funds Exclusion Applicable

In its recent decision in Bethel v. Darwin Select Ins. Co., 2013 U.S. App. LEXIS 23183 (8^th Cir. Nov. 18, 2013), the United States Court of Appeals for the Eighth Circuit, applying Minnesota law, had occasion to consider the application of a customer funds exclusion in a professional liability policy.

Darwin insured Zen Title, a title insurance agency, under a claims made and reported professional liability policy.  One of Zen Title’s clients was United General Title Insurance Company ("UGT"), for whom Zen Title had responsibility for recording mortgages, deeds, and mortgage satisfactions and for paying fees associated with those recordings.  Zen Title’s responsibilities also including paying off mortgages on behalf of UGT and its customers in connection with mortgage refinancing transactions.  During the policy period, UGT terminated its relationship with Zen Title and brought suit against the company and its three principals. The court described the underlying complaint as alleging:

… a wide-ranging fraudulent scheme to misappropriate the funds entrusted to Zen Title by UGT. UGT alleged that "Zen, and the other Defendants associated with Zen and acting for same, deliberately chose to delay the recording [of mortgage instruments] so as to benefit from the pool of cash escrowed for the purpose of paying recording fees." In addition, Zen Title allegedly failed to use escrowed funds to pay off existing mortgages in mortgage refinancing transactions. The gravamen of UGT's allegations was that the defendants delayed recording mortgage instruments in order to retain and use funds that had been escrowed to pay fees associated with those recordings.

The complaint alleged several causes of action, including one for negligent failure to file various mortgage instruments in breach of Zen Title’s duties owed to UGT.

Zen Title tendered the suit to Darwin, and Darwin denied coverage on the basis of its policy’s customer funds exclusion, which 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.”  In the ensuing coverage litigation, the United States District Court for the District of Minnesota granted summary judgment in favor of Darwin, concluding that the allegations in underlying complaint fell entirely within the exclusion.

On appeal, Zen Title argued that the cause of action for negligence potentially fell outside of the customer funds exclusion, such that Darwin at least had a duty to defend.  Darwin countered that when read in the context of the complaint, the cause of action for negligence was related to Zen Title’s alleged scheme of misappropriating escrow funds, and thus arose out of the excluded conduct.  The court agreed with Zen Title, observing that:

As described in UGT's complaint, the insureds failed to record mortgage instruments precisely so that they could divert the funds that would have had to be paid as filing fees at the time of recording. Thus, as alleged, the insureds failed to record mortgage instruments only because it constituted a necessary component of the broader scheme to misappropriate funds escrowed for filing fees. As such, there is a direct cause-and-effect relationship between all actionable conduct alleged in UGT's complaint and the loss or improper use of customer funds.

In reaching its holding, the Eighth Circuit rejected the insured’s attempt to divorce the cause of action for negligence from its context within the rest of the complaint.  While the court agreed that plaintiff could have filed a cause of action for negligence that had nothing to do with the alleged fraudulent scheme, the court could not ignore the actual allegations in the complaint.  As the court explained, “Minnesota's notice pleading rules did not require UGT to identify the specific circumstances under which each failure to record occurred, and so UGT's claims could possibly be premised on unspecified failures to record that are unrelated to the fraudulent scheme. This argument underestimates the significance of what UGT actually included in its complaint. UGT did specifically allege that the defendants failed to record mortgage instruments in order to facilitate the misappropriation of customer funds. UGT did not specifically allege any other failures to record.” 

The Eighth Circuit also rejected the insured’s argument that the customer funds exclusion rendered the policy’s coverage illusory, noting that the exclusion would not bar coverage for simple acts of negligence, such as failing to file a mortgage instrument or erring in doing so, since in such scenarios, the underlying actions would not involve the misappropriation of customer funds.  The court also rejected the argument by two of Zen Title’s principals that the wrongful acts of a third principal should not be attributed to them. The court held that the application of the exclusion did not depend on who committed the wrongful act, but instead on what gives rise to the underlying claim.  As the court explained:

The plain language of the exclusion makes clear that it applies regardless of whose conduct caused the loss or improper use of customer funds. … the Customer Funds Exclusion applies to any claim that arises out of any loss or improper use of client funds caused by anyone, be they a "guilty" insured, an "innocent" insured, or even a non-insured. It is irrelevant whether [the individual principals] participated in the wrongful conduct that triggered the Customer Funds Exclusion, so long as UGT's claims arose from some loss or misuse of customer funds.

Texas Court Holds Department of Insurance Proceeding Is a “Claim”

In its recent decision in Regency Title Co. v. Westchester Fire Ins. Co., 2013 U.S. Dist. LEXIS 162772 (E.D. Tex. Nov. 15, 2013), the United States District Court for the Eastern District of Texas had occasion to consider the date on which a claim was first made for the purpose of triggering coverage under a professional liability policy.

Westchester insured Regency Title Company (“Regency”) under a claims made and reported errors and omissions policy.  The policy defined the term “claim” to include:

1.   a written demand against any Insured for monetary or non-monetary damages;

4. a civil, administrative, or regulatory investigation against any Insured commenced by the filing of a notice of charges, investigative order, or similar document.

Subsequent to the policy’s issuance, Regency was named as a defendant in a lawsuit for alleged improper withdrawal of escrow funds in connection with an underlying real estate transaction.  A year prior to filing suit, however, plaintiff in the underlying action filed a complaint with the Texas Department of Insurance (“TDI”).  The TDI complaint involved the same facts as the later filed lawsuit, and it demanded payment of $100,000 or specific performance.  Subsequent to the filing of complaint with the TDI, but prior to the policy’s issuance, the TDI sent a letter to Regency advising of the complaint and of Regency’s opportunity to respond to the complaint.  Regency, in fact, answered the TDI complaint, and nearly a year prior to the inception of the Westchester policy, the TDI completed its investigation, concluding that Regency had not committed a violation of Texas Insurance Code. 

Westchester denied coverage to Regency for the underlying lawsuit on the basis that the claim was first made with the filing of the complaint with the TDI, and that the claim was made prior to the policy’s inception date.  In considering whether Westchester had a duty to defend Regency in the underlying matter, the court likened the “claims made” requirement to an exclusion that must be construed narrowly.  As such, explained the court, if there was any potential that the TDI complaint was not a “claim” as defined by the Westchester policy, then Regency would at the very least be entitled to a defense.

Regency argued that the TDI  complaint did not fall within the first definition of “claim,” of a written demand against any Insured for monetary or non-monetary damages, because the underlying plaintiff filed its complaint with the TDI and did not send any correspondence directly to Regency.   Specifically, Regency argued that “since the complaint was sent to a third party, the complaint does not constitute a ‘demand against an insured.’”  The court rejected this contention, noting that the policy’s first definition of claim only required a written demand “against any Insured,” not a written demand “sent to an insured.”  The court refused to read such an element into the definition of “claim,” finding it to be plain and unambiguous, explaining:

Regency is asking the court to add additional requirements to the definition in the policy. The policy does not indicate that the demand must be made directly to the insured. … The Exhibits indicate that Tower Custom Homes sent TDI a demand for money from Regency … that TDI sent that demand to Regency … that Regency responded directly to the demand … and that TDI sent Regency's response to Tower Custom Homes … .  Tower Custom Homes made a demand against Regency, Regency was informed of the demand, and Tower Custom Homes was informed that Regency was informed of its demand. Had Tower Custom Homes sent the demand to Regency through the U.S. mail with a return receipt requested, the exact same results would have occurred, except that Regency may or may not have sent Tower a response.

The court further observed that even if the TDI complaint did not constitute a written demand made against any insured, then it fell within the fourth definition of “claim” as a civil, administrative or regulatory investigation filed against the insured.  Regency argued that the TDI complaint did not fall within this definition of “claim” because TDI’s actions did not constitute an “investigation” within the meaning of the policy.  Specifically, Regency pointed to a phrase in TDI’s letter to Regency advising that it was “evaluating” whether Regency had committed a violation of the Texas Insurance Code.   Regency also argued that the brevity of TDI’s involvement (its file was closed within a matter of weeks) precluded its evaluation from being considered a formal investigation.  The court rejected this parsing of TDI’s actions, noting that the TDI’s letters made several references to its investigation, and that the duration of its investigation was irrelevant, since “the policy does not indicate that a detailed investigation or an exhaustive investigation must take place, but merely that there is an investigation.”  With this in mind, the court easily concluded that TDI’s actions came within the definition of “claim,” explaining:

…  TDI's actions are consistent with an investigation. TDI sent a letter to Regency asking specifically for information from Regency and that Regency supply TDI with "supporting documentation". … TDI was attempting to obtain information from Regency. Such an action could naturally be considered the first step in a "systematic examination", which is one definition for "investigation" that Regency has put forward. … Moreover, the very fact that TDI found no violation of the Texas insurance laws indicates that TDI must have conducted some type of investigation in order to make such a finding.

Accordingly, the court agreed that TDI action constituted a “claim,” and that as such, the “claim” against Regency was first made prior to the policy’s inception date.  The court, therefore, granted Westchester’s motion to dismiss, holding that it had no duty to defend or indemnify Regency in connection with the underlying lawsuit.

Florida Court Holds Criminal Conduct Exclusion In E&O Policy Applicable

In its recent decision in Certain Interested Underwriters at Lloyd’s v. AXA Equitable Life Insurance Company, 2013 U.S. Dist. LEXIS 159639 (S.D. Fla. Nov. 7, 2013), the United States District Court for the Southern District of Florida had occasion to consider the application of a criminal conduct exclusion in an insurance brokers professional liability policy.

Certain Interested Underwriters at Lloyd’s (“Lloyd’s”) insured Steven Brasner, an independent insurance broker, under an errors and omissions policy.  The underlying matter involved Mr. Brasner’s efforts to place life insurance coverage for his client, Geoffrey Glass.  Mr. Brasner proposed the purchase of two life insurance policies, one for $10 million and the other for $20 million, both of which would be purchased through insurance trusts established by Mr. Glass.  Mr. Brasner assisted with the processing of the policy applications, both of which were presented to AXA.  Among other things, both applications asked whether “Do you, the owner, intend to use or transfer the policy for any type of pre-death financial settlement, such as viatical settlement, senior settlement, life settlement, or for any other secondary market?”  Both applications answered this question in the negative.  AXA subsequently issued the two policies.  Only a few months later, however, the insurance trusts sold the policies to another entity – GIII – as investment vehicles.  It was later determined that Brasner, in fact, had falsified information on the applications, and had regularly done so, “to induce insurance companies to issue life insurance policies which would be held beyond the contestability period and then offered for sale on the secondary market.”

When Brasner’s schemes were discovered, AXA and other life insurance companies that had issued policies to Brasner’s clients, brought suits to rescind the policies.  The State of Florida also brought a criminal proceeding against Brasner.  Brasner ultimately pled guilty to several counts, including one that he had defrauded AXA by providing materially false information in the applications, including the applications submitted on behalf of Glass.  Several civil suits eventually followed, including one by GIII based on theories of negligent misrepresentation.  Brasner tendered the GIII matter to Lloyd’s, but Lloyd’s disclaimed coverage based on grounds.  Brasner and GIII later entered into a consent judgment for $1.45 million and an assignment of Brasner’s rights under the policy.

The first coverage defense asserted by Lloyd’s was that the conduct alleged did not fall within its policy’s definition of covered professional services, defined as “the marketing, sale or servicing of insurance products . . . .”  Lloyd’s argued that rather than selling insurance products, the GIII lawsuit related to Brasner’s sale of investment products.  The court found that while this argument might otherwise have merit, Lloyd’s failed to offer any evidence in support of this argument, thus precluding its right to summary judgment.

Lloyd’s also relied on a policy exclusion barring coverage for any claim:

… based upon, arising out of, directly or indirectly relating to or in any way involving . . . Falsification of any offer of an insurance contract or document, including but not limited to quotes, binders, indications or policies.

Lloyd’s argued that this exclusion should be read broadly enough to encompass falsification of any document, including insurance applications.  GIII, on the other hand, contended that documents identified in the exclusion, i.e., quotes, binders, indications, and policies, are all documents issued by insurers rather than by brokers, and that as such, the exclusion applied only to insurer communications.  The court found both interpretations of the exclusion to be reasonable, meaning that the term “document” as used in the exclusion was necessarily ambiguous and therefore must be construed in favor of coverage.

Finally, Lloyd’s relied on a policy exclusion barring coverage for claims:

… based upon, arising out of, directly or indirectly relating to or in any way involving . . . Conduct which is fraudulent, dishonest, criminal, willful, malicious, intentionally or knowingly wrongful, or otherwise intended to cause damage or injury to personal property; however, this exclusion shall not apply . . . unless there is a finding or adjudication in any proceeding of such conduct or an admission by an Insured of such conduct . . . .

Lloyd’s pointed to Brasner’s entry of a guilty plea, specifically with respect to the AXA policies, as to the basis for this exclusion’s application.  Looking to the plea deal, the court concluded that “[t]he totality of admissible evidence establishes conclusively that Brasner victimized AXA by making false and material misrepresentations on insurance applications.”  The court also found notable a portion of the plea agreement that allowed Brasner to continue receiving income from other prior placed policies, but prohibited him from receiving income the policies issued to Glass, thus further evidencing the fact that the Glass policies were part of Brasner’s scheme to defraud.  As such, and because these misrepresentations were central to Brasner’s efforts to resell the Glass policies to GIII, the court found the criminal conduct exclusion applicable to GIII’s lawsuit, and thus precluded coverage.

Florida Court Holds Contract Claim Does Not Trigger E&O Policy

In its recent decision in Public Risk Mgmt. of Fla. v. One Beacon Ins. Co., 2013 U.S. Dist. LEXIS 150091 (M.D. Fla. Oct. 18, 2013), the United States District Court for the Middle District of Florida had occasion to consider whether a breach of contract claim can constitute a professional liability claim.

Public Risk Mgmt concerned coverage for a payment dispute arising out of a  construction contract entered into between the City of Winter Garden (“Winter Garden”) and a contracting entity named Dewitt involving utility relocation along a Florida highway.  The contract called for Winter Garden to pay certain amounts for Dewitt completing the work within an established timeframe.  During the course of the contract, Dewitt encountered conditions out of its control, some of which was attributable to Winter Garden having provided incomplete information concerning the scope of work involved, that made it impossible for Dewitt to complete the project on time.  Upon completion of the work, Winter Garden withheld a portion of the contract funds from Dewitt, prompting Dewitt to file suit for breach of contract and for violation of Florida’s Sunshine Statutes. 

Public Risk Management of Florida (“PRM”) insured Winter Garden under a public official’s errors and omissions liability policy.  The PRM policy insured against “wrongful acts,” defined as “any actual or alleged error or miss-statement, omission, act or neglect or breach of duty due to misfeasance, malfeasance, and nonfeasance . . . .”  OneBeacon, in turn, reinsured the PRM policy. 

PRM provided Winter Garden with a defense in the Dewitt lawsuit, and paid some $286,000 in legal fees before the matter settled.  PRM then sought reimbursement of these defense costs from OneBeacon under the reinsurance contract.  OneBeacon, however, denied any payment obligation to PRM, contending that PRM should not have defended Winter Garden in the underlying lawsuit since a breach of contract claim is not covered under a professional liability policy.  OneBeacon also asserted that coverage was unavailable to Winter Garden based on a policy exclusion in the PRM policy applicable to intentional breaches of contract.  PRM contended that its policy was triggered as a result of the following assertions in Dewitt’s complaint:

19. Performance of Dewitt's work was far more time-consuming and costly than Dewitt reasonably could have anticipated at the time of contracting as a result of errors and omissions in the City's plans and specifications and the City's engineer's gross under-estimate of quantities of various items, Dewitt would be required to furnish.

                                          *          *          *

24. Dewitt would have timely completed its Work but for the City's misleading information about the utility locations, errors and omissions in the City's plans and specifications, and other hindrances attributable to the City, the FDOT Contractor, and/or other third parties.

PRM contended that these two paragraphs expressly alleged wrongful acts by Winter Garden in connection with its planning of the construction project, and that these wrongful acts are what gave rise to the contract dispute. 

The court rejected PRM’s argument, explaining that the two paragraphs in the complaint on which PRM relied had to be read in the context of the entire complaint, which at its core was a simple payment dispute rather than a claim for any professional negligence.  As the court explained:

The FDOT Project was alleged to have been more complex than originally thought, partly due to information from and actions by Winter Garden. Dewitt alleged it could not finish on schedule and that the materials and labor costs increased due to forces outside of its control, therefore, it claimed that it was owed additional funds under the terms of the Construction Contract.  All of Dewitt's claims in Count I relied on the Construction Contract as the basis for Winter Garden owing it additional money, Dewitt did not rely on negligence.

The court, therefore, concluded that the Dewitt complaint did not allege loss arising out of a “wrongful act” that came within the PRM policy’s coverage.  In passing, the court also noted that the policy’s exclusion applicable to intentional breach of contract served as a secondary basis for noncoverage since the Dewitt complaint alleged that Winter Garden intentionally refused to pay money owed under the construction contract. 

Texas Court Holds No Duty to Defend Under Mortgage Broker E&O Policy

In its recent decision in AXIS Surplus Lines Ins. Co. v. Halo Asset Management, LLC, 2013 U.S. Dist. LEXIS 139065 (N.D. Tex. Sept. 27, 2013), the United States District Court for the Northern District of Texas had occasion to consider whether an underlying complaint alleged conduct falling within the scope of coverage afforded under a miscellaneous errors and omissions policy.

AXIS insured Halo Management under a professional liability policy, providing coverage for damages arising out of Halo’s performance of “insured services,” a term defined by the policy as:

Mortgage broker services consisting of counseling, taking of applications, obtaining verifications and appraisals, loan processing and origination services in accordance with lender and investor guidelines and communicating with the borrower and lender. Debt settlement and credit services including arbitration and negotiations; real estate sales and brokerage services. …

While the policy was in force, Halo was named as a defendant in a lawsuit regarding its participation in an investment vehicle involving the purchase of at-risk residential mortgages for repackaging as a new security.  Halo was to have processed and serviced the mortgages as part of this scheme.  The claimant alleged, however, that the underlying mortgages were never purchased and that his initial $5 million investment was never returned.  The complaint alleged that Halo failed to perform due diligence on the entity that was supposed to have purchased the mortgages, and that Halo failed to inform the claimant that the mortgages, in fact, were not being purchased as intended.  AXIS denied coverage to Halo on the basis that the underlying complaint did not allege misconduct arising out of “insured services.”

On motion for summary judgment, AXIS argued that the underlying complaint did not involve any of the services identified in the policy definition of “insured services,” and that definition provides an “exhaustive definition” of the term.  Halo, on the other hand, argued that by employing the phrase “consisting of” following the words “mortgage broker services,” the definition of “insured services” was only intended to provide examples of covered professional services.  Halo further argued that the non-legal definition of the term “broker” is broad and that as such, the concept of “insured services” should be broadly construed. 

The court rejected Halo’s reliance on a lay dictionary, noting that Black’s Law Dictionary has a specific definition of “mortgage broker,” which is an entity that markets mortgage loans and brings lenders and borrowers together, but that does not originate or service mortgage loans.  The underlying complaint, observed the court, related solely to Halo’s role in processing and servicing loans that were to have been purchased by a third party.  As such, the court concluded that:

The allegations in the underlying action are fundamentally based on the Halo defendant's misuse of the Claimant defendant's invested funds, not in mortgage broker services. Taking the allegations in the petition as true, none of the funds even went to purchase mortgages.  The fact that the proposed investment scheme was supposed to involve mortgages does not overshadow the fact that the allegations ultimately stem from fraud and misappropriation of funds.

Accordingly, the court agreed that AXIS had no duty to defend the underlying complaint.  The court, however, denied AXIS’ motion on the duty to indemnify, noting that under Texas law, the duty to indemnify cannot be determined based on the allegations in the complaint, but instead depended on facts that would be considered at trial.

Illinois Court Addresses Distinction Between Claim and Potential Claim

In its recent decision in Lexington Ins. Co. v. Horace Mann Ins. Co., 2013 U.S. Dist. LEXIS 127544 (N.D. Ill. Sept. 4, 2013), the United States District Court for the Northern District of Illinois had occasion to consider the issue of what constitutes a claim for the purpose of triggering coverage under a professional liability policy.

Lexington insured Horace Mann under an insurance company errors and omissions policy, providing claims made and reported coverage for the period September 28, 2010 to September 28, 2010.  The policy insured Horace Mann for claims arising out of any act, error or omission in its rendering of or failure to render services in connection with its business as an insurer.  Notably, the Lexington policy defined “claim” as “1. a written demand for monetary damages; or 2. a judicial, administrative, arbitration, or other alternative dispute proceeding in which monetary damages are sought.”  The Lexington policy further clarified that “the Corporate Risk Manager, General Counsel's Office, Claims Legal Department of [Horace Mann] shall notify [Lexington] of the setting of a trial, arbitration or mediation date within 60 days of becoming aware of the date.”

The dispute between Horace Mann and Lexington pertained to Horace Mann’s handling of a loss on a non-commercial auto policy it had issued to a Florida insured.  The auto accident happened in May 2008.  In June 2008, counsel for the injured party issued a time limits policy demand to Horace Mann, offering to settle its claim for the policy’s $25,000 limit of liability, but only if Horace Mann accepted the demand within twenty days.  Horace Mann wrote back immediately to advise that it would take the demand under consideration but that it first needed to review the claimant’s medical records.  The claimant thereafter withdrew its demand and filed suit against Horace Mann’s insured in August 2008.  Horace Mann engaged in subsequent efforts to settle the matter, and in 2009 it retained outside counsel to analyze its own potential bad faith exposure.  In a December 2009 email, counsel advised Horace Mann that if settlement were not reached, Horace Mann likely would lose a bad faith case.

In August 2010, the court in the underlying case scheduled a mediation.  In anticipation of the mediation, counsel for the claimant wrote defense counsel in September 14, 2010 – two weeks prior to the inception of the Lexington policy – to discuss a potential bad faith claim against Horace Mann that could result in extracontractual exposure.  The letter specifically warned defense counsel that Horace Mann would need to “open” its policy limits at the mediation if it desired to settle the case.  Plaintiff’s counsel acknowledged in the letter that defense counsel would not be involved in evaluating the bad faith implications present by the claim, but nevertheless urged that Horace Mann be advised that plaintiff intended to explore extracontractual relief at the mediation, and that as such, the letter should be forwarded to Horace Mann for consideration.  The letter was in fact forwarded to Horace Mann on September 20, 2010 – eight days prior to the inception of the Lexington policy. The mediation was held in December 2010 and proved unsuccessful.   Twenty-seven days after the mediation, Horace Mann gave notice of potential claim to Lexington and advised that it was considering a settlement of the underlying claim for an amount up to $1.5 million.  Settlement, however, was not reached prior to a jury awarding the underlying claimant $17 million, which ultimately was compromised for $7 million.

Lexington subsequently denied coverage to Horace Mann on the basis that the claim was not first made during the policy period, but instead was first made long prior to the inception of its policy.   Lexington advanced two arguments in support of this position.  Lexington first contended that the September 14, 2010 letter from plaintiff’s counsel to defense counsel constituted a “a written demand for monetary damages,” and thus fell within its policy’s definition of “claim.”  Specifically, Lexington argued that by using language such as “extracontractual amounts” and “opening” the policy limit, plaintiff’s counsel signaled its intention to seek recovery directly from Horace Mann.  Horace Mann argued in response that the letter at most was notice of a potential claim rather than an actual claim.  The court agreed with Horace Mann, observing that:

[w]hile the letter is in "written" form, it is not addressed to Horace Mann. The letter is from [plaintiff’s] counsel to [defense] counsel. Because the letter was not addressed to Horace Mann, it can hardly be considered a demand on the same. The express policy language covers wrongful acts by Horace Mann, and therefore, requires that the written demand for damages be made upon the insured, Horace Mann, and not a third-party.

That the letter ultimately was forwarded to Horace Mann, prior to the policy’s inception, did not impact the court’s reasoning.  In fact, explained the court, under Florida law, the underlying plaintiff could not assert a direct claim against Horace Mann prior to a verdict or settlement, which as of September 14, 2010, had not yet happened.

Lexington argued in the alternative that the September 14, 2010 letter advising of the mediation satisfied its policy’s second definition of claim; namely, a “a judicial, administrative, arbitration, or other alternative dispute proceeding in which monetary damages are sought.”  While the mediation happened in December 2010, i.e., during the policy period, Lexington argued that the letter advising of the mediation should be considered when the claim was first made.  The court rejected this argument as well, observing that “[a]t most, the letter constitutes notice of mediation, not the "alternative dispute proceeding" itself as defined by the policy language.”  The court again relied on the reasoning that because the letter was written to defense counsel rather than Horace Mann, it could not satisfy the definition of claim.  The court also rejected Lexington’s argument that Horace Mann was required to give notice of the mediation before it occurred.  The court found no support for this position in the policy language.  While the definition of claim required Horace Mann to give notice of a mediation within sixty days, the policy language was silent as to whether this notice must happen before or after the mediation.  As such, and because Horace Mann gave notice of the mediation twenty-seven days after it happened, the court found that Horace Mann satisfied this policy condition.

Georgia Court Holds No Coverage For Embezzlement Claim

In its recent decision in National Reimbursement Group Inc. v. Gemini Ins. Co., 2013 U.S. Dist. LEXIS 118435 (M.D. Ga. Aug. 21, 2013), the United States District Court for the Middle District of Georgia had occasion to consider whether a company insured under a professional liability policy was entitled to coverage for a claim arising out of embezzlement of client funds committed by one of its employees.

Gemini Insurance Company insured National Reimbursement Group (“NRG”) – a medical billing and collection service company – under a professional liability policy.  Sometime during the policy period, NRG received notice from the U.S. Department of Health and Human Services that it was undertaking an investigation into whether a former NRG employee diverted medical insurance checks intended for a client of NRG’s into her own personal bank account.  NRG sought coverage for the investigation, but Gemini disclaimed coverage.  NRG’s client subsequently filed suit, seeking repayment of the diverted funds.  Gemini did not provide coverage for this suit either.  NRG ultimately settled with the client for approximately $134,000 and then filed a declaratory judgment action against Gemini.  Gemini moved to dismiss NRG’s complaint, arguing that the conduct alleged did not qualify as a wrongful act (defined by the Gemini policy as “any negligent or unintentional breach of duty imposed by law, or Personal Injury, committed solely in the rendering of Professional Services by an Insured”) or that coverage was precluded based on various exclusions. 

The parties disputed what conducted should be considered the “wrongful act” for the purpose of analyzing coverage.  NRG contended that the wrongful act was its own negligent supervision of its dishonest employee while Gemini contended that the wrongful act was the employee’s intentional diversion of client funds, which by its very nature could not be considered a negligent or unintentional breach of a duty. Gemini further argued that negligent supervision of an employee did not fall within the policy definition of wrongful act because NRG’s obligations to its client with respect to the stolen funds arose out of a contract, and its breach of the contractual relationship could not be considered a “breach of a duty imposed by law.”  The court rejected Gemini’s arguments, observing that (a) failure to supervise could be considered the wrongful act since employers have a reasonable duty of care in supervising their employees, and (b) the existence of a contract between NRG and its client did not preclude NRG from breaching a duty imposed by law.  With respect to the latter point, the court reasoned that Gemini’s interpretation would essentially be render coverage under the policy illusory since NRG, presumably, had a contract with each of its clients.

While the court held that the underlying conduct qualified as a wrongful act in the first instance, it agreed with Gemini that coverage was barred based on an exclusion applicable to claims arising out of any actual or alleged criminal, fraudulent, dishonest, or knowingly wrongful act or omission committed by or with the knowledge of any insured.  The policy specifically defined the phrase “arising out of” to mean “connected to, incidental to, originating from or growing out of, directly or indirectly resulting from.”  Looking to Georgia case law construing this phrase in the context of similar exclusions, the court concluded that the test for whether a claim “arises out of” the prohibited conduct is a “but for” test, that requires the court to look to whether the claim would exist in the absence of the prohibit conduct.  In applying this analysis, the court agreed that the underlying negligent supervision claim was barred from coverage since the claim “would not exist but for, and therefore arises out of, [the employee’s] embezzlement.”

In reaching its conclusion, the court considered NRG’s argument that the exclusion did not apply since the individual employee did not qualify as an insured when diverting client funds for her own use, since in doing so, she was operating outside the scope of her employment.  The court rejected this argument, noting that while creative, it was clear that the employee was engaged in billing practices and thus was an insured.  The fact that she embezzled funds while engaged in those billing practices did not have the effect of changing her insured status. 

Tenth Circuit Holds Underlying Securities Claims Interrelated

In its recent decision in Brecek & Young Advisors, Inc. v. Lloyds of London Syndicate 2003, 2013 U.S. App. LEXIS 9599 (10^th Cir. May 13, 2013), the United States Court of Appeals for the Tenth Circuit, applying New York law, had occasion to consider whether an underlying securities arbitration related back to claims first made prior to the policy’s inception date, and if so, whether the insurer was estopped from denying coverage on this basis.

Lloyds insured Brecek & Young Advisors, Inc. (“BYA”) under a claims-made and reported broker/dealer professional liability policy in effect for the period December 1, 2006 to December 1, 2007.  The policy contained an “Interrelated Wrongful Acts” provision stating that all claims based on the same wrongful act or interrelated wrongful acts would be deemed a single claim.  The policy also contained an exclusion applicable to claims arising out of wrongful acts for which notice had been given under any prior policy or “any other Wrongful Act whenever occurring, which together with a Wrongful Act which has been the subject to such claim or notice, would constitute Interrelated Wrongful Acts.”  The policy defined “Interrelated Wrongful Acts” as wrongful acts that are:

1.   similar, repeated or continuous; or

2.   connected by reason of any common fact, circumstance, situation, transaction, casualty, event, decision or policy or one or more series of facts, circumstances, situations, transactions, casualties, events, decisions or policies.

The Brecek decision addressed the interrelatedness of three underlying proceedings.  The first, referred to as the “Wahl Arbitration” was a claim first made against BYA while the Lloyds policy was in effect.  The claim alleged that BYA sold unsuitable investment products and that BYA and a co-defendant engaged in practices of churning investments during the period 1999 through 2005.   The claim alleged causes of action against BYA for various theories of agency liability and failure to supervise.   The complaint filed in the Wahl Arbitration was subsequently amended to add twenty-five additional claimants who claimed similar injuries as a result of similar misconduct.

Relevant to coverage for the Wahl Arbitration was a claim first made against BYA in September 2005, referred to as the Knotts Arbitration.  The Knotts Arbitration contained similar allegations and causes of action as alleged in the Wahl Arbitration, and identified the same individual defendants as those identified in the Wahl Arbitration.  Also relevant was a claim first made against BYA in June 2006, referred to as the Colaner Arbitration, which also contained allegations of unsuitability and churning over the same time period by the same group of individual defendants. 

Lloyds initially took the position that the Wahl Arbitration was interrelated to the Colaner Arbitration and therefore should be covered under BYA’s prior policy which had been issued by Fireman’s Fund.  Lloyds subsequently advised, however, that it had determined the Wahl and Colaner matters were not interrelated.  Lloyds thereafter agreed to provide BYA with a defense in the Wahl Arbitration, but took the position that each claimant in the proceeding represented an entirely unrelated claim subject to a separate $50,000 self-insured retention.  While BYA eventually settled with each of the claimants in the Wahl Arbitration, Lloyds prorated the defense costs among all claims and paid indemnity on those claims which exceeded the $50,000 retention.  As a result, Lloyds indemnified BYA for only $385,000 of some $932,000 incurred by BYA in legal fees and settlement payments.

The issue of multiple-retentions eventually was briefed to the United States District Court for the District of Kansas, where the declaratory judgment action was filed.  On motion for summary judgment, Lloyds argued that there was not a sufficient factual nexus between the claimants in the Wahl Arbitration such that they could be considered interrelated, notwithstanding the fact that the claimants were part of the same lawsuit.  In a footnote, Lloyds argued that in the alternative, if the claims asserted in the Wahl Arbitration were found to have arisen from interrelated wrongful acts, then they would necessarily relate back to claims made in the Knotts Arbitration or the Colaner Arbitrations, and therefore excluded by the Lloyds policy.  The district court ruled against Lloyds on the number of retentions, but ordered briefing on Lloyds “relation back” theory.  BYA argued that the Wahl Arbitraiton did not relate back to the earlier claims, but that even if they did, Lloyds was precluded from taking this position based on the doctrines of waiver or estoppel.  The district court ruled against BYA on the issues of waiver and estoppel, but ultimately concluded that the three arbitrations were not interrelated for the purpose of the policy’s exclusion.

On appeal, the Tenth Circuit reasoned that the matters would be deemed interrelated if they shared a “sufficient factual nexus,” which is the standard articulated by New York courts in considering similar “interrelated wrongful act” provisions.  Applying this standard, the court found sufficient common facts to establish interrelatedness.  As the court explained:

Several common facts connect the Wahl, Knotts, and Colaner Arbitrations. All named as respondents BYA, B&G Financial Network, Gergel, and Snyder. Further, both the Wahl and Colaner arbitrations included claims against broker/agents Brandt and Farrar. All of the misconduct was alleged to have taken place during roughly the same time period-from the late 1990s to the mid 2000s. All claims allege the respondents sold unsuitable investment products including various types of annuities. Further, all claims involved allegations of churning or flipping of investment accounts in order to enrich the broker/agents at the expense of account holders. Finally, BYA's liability was predicated on theories of vicarious liability and failure to supervise its broker/agents in each of the claims.

The court concluded that the three arbitrations were connected by common facts, circumstances, decisions and policies such that they were “interrelated” for the purpose of the exclusion in the Lloyds policy.

The court, however, also concluded that Lloyds was potentially estopped from relying on the exclusion as a defense to coverage since it undertook BYA’s defense in the Wahl Arbitration with knowledge of the coverage defense, but only asserted the defense for the first time late in the coverage litigation.  The court agreed BYA was potentially prejudiced in the form of detrimental reliance as a result of Lloyd’s control of BYA’s defense without having properly reserved rights on the “relation back” coverage defense.  The Tenth Circuit, therefore, remanded the proceedings for further consideration of whether BYA detrimentally relied on Lloyds’ conduct, and if so, whether it was entitled to further recovery under the policy notwithstanding the otherwise applicable coverage defense.

Oklahoma Court Holds Failure to Warn Not a Covered Professional Service

In its recent decision in Hanover Am. Ins. Co. v. Saul, 2013 U.S. Dist. LEXIS 29739 (W.D. Okl. Mar. 5, 2013), the United States District Court for the Western District of Oklahoma had occasion to consider whether a chiropractor’s alleged failure to protect her patient from being sexually assaulted triggered coverage under a medical professional liability policy.

NCMIC Insurance Company insured Dr. Debora K. Balfour, and her practice, Dr. Deborah K. Balfour Chiropractic, P.C, (“DKBC”), under a professional liability policy.  Dr. Balfour and DKBC were named as defendants in an underlying suit, along with Dr. Balfour’s ex-husband, in a matter involving alleged sexual assault, on multiple occasions, of one of Dr. Balfour’s patients, who was a minor at the time.  It was alleged that Dr. Balfour’s ex-husband was the perpetrator of these assaults, some of which took place in the office building in which the DKBC practice was located.   The suit alleged medical malpractice against Dr. Balfour for having allowed her husband access to the premises and for having failed to warn her patient regarding her husband’s “history and propensity to sexually molest under age females.”  NCMIC agreed to provide Dr. Balfour and DKBC with a defense, but subsequently denied coverage.

The NCMIC policy insured “all sums to which this insurance applies and for which an insured becomes legally obligated to pay as damages because of an injury. The injury must be caused by an accident arising from an incident during the policy period. The injury must also be caused by an insured under this policy.”  Notably, the policy defined “incident” to mean:

… any negligent omission, act or error in the providing of professional services by an insured or any person for whose omissions, acts or errors an insured is legally responsible.

Professional services, in turn, was defined as:

… services which are within the scope of practice of a chiropractor in the state or states in which the chiropractor is licensed.

NCMIC argued, among other things, that the policy only insured Balfour, and DKBC, for acts of medical malpractice, such as when a patient is injured while receiving chiropractic treatment.  Dr. Balfour’s alleged failure to have warned her patient of a danger posed by her husband, argued NCMIC, did not relate to chiropractic services and thus fell outside the policy’s coverage.  Dr. Balfour, on the other hand, argued that whether or not she had a medical professional obligation to warn her patient of her husband’s proclivities was an issued to be determined in the underlying action, not in the insurance coverage action.  In other words, Dr. Balfour contended that the court in the declaratory judgment action could not adjudicate the scope of her medical professional duties to her patient.

The court rejected Dr. Balfour’s contention, agreeing with NCMIC that the policy insured Dr. Balfour solely with respect to chiropractic treatment per se.  As the court explained:

The policy provides coverage for injuries such as those that result from a misdiagnosis or a negligently performed treatment, or perhaps even a failure to warn about the consequences of certain physical activity on an injury being treated.

The court agreed that while the plaintiff in the underlying suit alleged that Dr. Balfour breached a duty by failing to protect plaintiff from being assaulted, the duty alleged in the underlying suit was distinct from the medical duties insured under NCMIC’s policy:

Balfour's failure to warn her patient about [her ex-husband] and allowing him to have access to the building where her chiropractic practice was located - may be a violation of some duty, it is not a violation of a professional duty Balfour owed [her patient] as her chiropractor.  

In reaching its decision, the court relied on case law standing for the general proposition that professional liability policies insure services involving specialized skill or knowledge.  The court concluded that warning a person, even a patient, of the harm posed by another person on the premises, does not implicate such specialized skills or knowledge, and thus cannot be considered a professional service for the purpose of an errors and omissions policy.

South Carolina Court Holds No Coverage for Blast Fax Case Under E&O Policy

In its recent decision in BCS Ins. Co. v. Big Thyme Enters., 2013 U.S. Dist. LEXIS 20051 (D.S.C. Feb. 14, 2013), the United States District Court for the District of South Carolina had occasion to consider whether an alleged violation of the Telephone Consumer Protection Act triggered coverage under a professional liability policy.

BSC Insurance Company insured agents of Blue Cross and Blue Shield of South Carolina under an agents and brokers professional liability policy.  One of these agents, and his insurance agency, were named as defendants in an underlying suit alleging violations of the Telephone Consumer Protection Act based on defendants’ action in sending unsolicited facsimiles.  Plaintiff also alleged a cause of action for conversion for having wrongfully misappropriating plaintiff’s paper, fax machines, toner, and employee time.  BSC provided its insureds with a defense under a reservation of rights, and later commenced a declaratory judgment action. 

BCS argued, among other things, that the insureds’ conduct in sending unsolicited facsimiles did not trigger the policy’s insuring agreement, which among other things required a wrongful act arising out of the insured’s “professional services.”  The policy defined “professional services” as “specialized services rendered to a Client as a licensed Life, Accident and Health Insurance Agent.”  BCS argued that sending unsolicited faxes to non-clients as part of an advertising campaign does not involve the insureds’ “specialized knowledge or training as an insurance agent or agency.” The insureds, on the other hand, argued that advertising was central to its business and as such should be considered a professional service.   The court found in BCS’s favor, concluding that sending advertising does not fall within the category of contemplated “special services,” and as such, the policy was not triggered in the first instance.

The court further noted that even if the insureds’ actions in sending facsimiles could be considered professional services, the policy also required that the insured’s professional services be rendered to or on behalf of a client.  Because the facsimiles were sent unsolicited to potential clients rather than actual clients, the court concluded that this requirement of the policy was not satisfied, thus serving as an additional ground for noncoverage. 

Minnesota Court Holds Patient Bodily Injury Exclusion Applicable

In its recent decision in Volk v. ACE Am. Ins. Co., 2013 U.S. Dist. LEXIS 15450 (D. Minn. Feb. 5, 2013), the United States District Court for the District of Minnesota had occasion to consider the application of a patient bodily injury exclusion in the general liability coverage section of a policy issued to a healthcare provider.

The insured, North Country Home Care, Inc. (“North Country”), was in the business of providing personal care attendant (“PCA”) services.  One of the individuals to whom it provided such services, a mentally-handicapped individual, was blinded as a result of a BB gun accident that happened while under North Country’s supervision.  At the time of the accident, North Country was insured by ACE under a combined general liability and healthcare professional liability policy.  The general liability coverage was provided on an occurrence basis whereas the professional liability coverage was provided on a claims made basis.  The ACE policy was in effect from July 5, 2005 through June 26, 2006, which was the date that North Country sold its assets and ceased operations. 

In 2009, the guardian for the injured individual gave notice of its intent to file suit.  This notice was forwarded to ACE, which denied coverage on the basis that the incident was properly considered for coverage under the policy’s professional liability insuring section, but that coverage was not available thereunder since the claim was not made while the policy was in force.  ACE also disclaimed coverage under its policy’s general liability coverage on the basis of an exclusion titled Patient Exclusion that barred coverage for “[a]ny loss, cost or expense arising out of 'bodily injury' to your patients.”  The underlying claimant subsequently entered into a settlement with North Country and later brought suit against ACE, arguing that the Patient Exclusion was inapplicable.

The claimant’s primary argument was that the exclusion did not apply since the injured person was not a “patient” of North Country, but instead was a “recipient” or “consumer” of North Country’s PCA services.  Claimant further argued that the term “patient” was ambiguous since it was not defined by the policy.  The court disagreed, concluding that the term “patient” could only be considered ambiguous if read in isolation from the policy.  Looking to the policy as a whole, however, the court observed that the terms “recipient” or “consumer” were not used, whereas the term “patient” was used in both coverages.  Notably, the policy’s professional liability coverage applied to acts or errors arising out of North Country’s “professional healthcare services,” a term defined as services provided by the insured to “care for or assist your patients.”  The court noted that if claimant’s assertions regarding a distinction between patient and recipient or consumer were correct, then the policy’s professional liability coverage could never be triggered by North Country’s PCA services (which was its primary business), and the coverage provided thereunder would be illusory – an impermissible result for the court.  The court therefore concluded that the claimant necessarily qualified as a patient, and that as a result, the Patient Exclusion was applicable.

The claimant further argued that North Country was statutorily required to maintain liability coverage, and that North Country had a reasonable expectation of coverage.  The court rejected both arguments.  With respect to statutory requirements under Minnesota law, the court observed that North Country had long since ceased operations by the time suit was filed, and that it was not required to maintain coverage indefinitely.  With respect to reasonable expectations, the court held that because the policy was unambiguous, and did not provide illusory coverage as argued by claimant, the doctrine of reasonable expectations was not a relevant consideration.