Source: http://www.joneslemongraham.com/blog/2014/03/
Timestamp: 2019-04-18 15:18:00+00:00

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You’re the D&O, professional liability, or other insurer with a duty-to-defend policy. Your insured is sued in tort. You defend under a reservation of rights. But you don’t believe there’s coverage. And you don’t want to have to continue paying for a defense. So you sue for a declaration of no coverage.
You’re the insured. You’ve been sued by a party claiming injury. Now your insurer sues you. So you have two suits to address and you’re not too happy. You’re also concerned your insurer’s suit will prejudice your defense in the tort suit. You believe insurer’s suit will address issues material to your liability in the tort suit. So you argue it should be stayed. You also claim it would be bad faith for insurer to pursue a coverage suit prejudicial to your tort suit defense.
Insurer argues its suit won’t prejudice your tort suit defense and that delaying resolution of coverage would require funding a defense that isn’t covered. What’s a court to do?
Well, one court, in Federal Ins. Co. v. Holmes Weddle & Barcott P.C., et al, Case No. C13-0926JLR (W.D. Wa. Nov. 14, 2013), deferred deciding on a stay until a legal malpractice insurer and insured law firm briefed three coverage issues. As explained: “It may be that all that is needed to decide this coverage action is to apply settled contract and insurance law to a set of admitted and undisputed facts.” This court wasn’t convinced law firm’s malpractice defense would be prejudiced by addressing those three issues.
So it would allow insurer’s summary judgment motion to proceed on those issues and on whether the firm must reimburse insurer for defense fees. But the court left the door open for firm to object again.
The court will resolve the case by summary judgment only if it wouldn’t prejudice firm’s defense. Otherwise it would stay the case. Insurer meanwhile would continue to defend firm under a reservation of rights. Firm also agreed to indemnify insurer for defense expenses, if there was no coverage.
The court appears to have struck a fair balance between insurer and firm’s interests. Stay tuned because we may see more from this court about issues important to D&O and professional liability insurers.
The 2008 financial crises continues to generate lawsuits affecting professionals, directors, and officers and their insurers. The Fourth Circuit recently addressed an insurer’s duty to defend and indemnify a real estate closing service sued for conspiring to strip equity from homeowners in foreclosure. See Cornerstone Title & Escrow, Inc. v. Evanston Ins. Co., Case No. 13-1318 (4th Cir. Feb. 19, 2014). The opinion is “unpublished” and thus non-binding in the Fourth Circuit, but parties still may cite it in arguing their positions. For D&O and professional liability insurers and their customers, the analysis of the personal profit exclusion thus potentially has broader application. This court says the exclusion won’t apply where the insured allegedly is liable and makes restitution for co-conspirators’ improper gains, but isn’t alleged to have received gains itself.
Remember 2008. Real-estate values collapse. Home equity vanishes. Mortgages exceed collapsing market values. Or equity is substantially diminished. Jobs are lost. Mortgage payments are missed. Foreclosures ramp up.
A foreclosure “consulting” business is born. Consultant joins forces with mortgage broker and real-estate closing service. Consultant’s market? Homeowners facing foreclosure. Its product? Sale-leaseback transactions: we’ll buy your home; you get cash for your home equity; you avoid foreclosure; we’ll lease the home to you; you stay in it; and you re-purchase it later.
And what does consultant get? A consulting fee, it says.
What does consultant really get? The fee. Plus cash homeowner was to get for her home equity. Plus monthly rent much higher than the mortgage payment.
How does consultant get homeowners’ cash for equity? Consultant tells them unspecified closing fees and charges consumed the equity and convinces them to sign over their checks.
How is closing service involved? It supposedly provides closing services for the sale-leaseback, fails to deliver checks to homeowners for their equity, and delivers them instead to consultant.
What else happens? High rent drives homeowners/now-renters from their homes. There’s never a buy-back for homeowners.
And . . . the Maryland Attorney General in 2008 sues consultant, mortgage broker, closing company and related parties. AG alleges closing service and all other defendants violated Maryland’s Protection of Homeowners in Foreclosure Act and Consumer Protection Act, by scheming to “take title to homeowners’ residences and strip the equity that the homeowners ha[d] built up in their homes.” AG also alleges closing service, by failing to disclose it provided homeowners’ equity checks to consultant, violated the Consumer Protection Act; and, in acting as settlement agent, “participated in and provided substantial assistance to [consultant’s equity-stripping] scheme.” AG identifies 13 transactions and asks for a variety of relief, including restitution.
AG not only seeks to hold closing service responsible for its alleged non-disclosure, but also for co-defendants’ acts. AG alleges the service’s “concerted action [made] the enterprise possible”; so it’s “jointly and severally liable” for each co-defendant’s acts, including failing to provide written agreements; requiring membership fees before providing consulting services; obtaining interests in homes while offering consulting; representing services were to avoid foreclosure; failing to disclose the nature of services, material terms of sale-leaseback agreements, rental agreements, and of any subsequent repurchase; failing to provide statutorily required forms and notices; failing to determine whether homeowners have reasonable ability to make lease payments and repurchase homes; misleading consumers about entitlement to closing proceeds and about placing them in escrow; taking consumers’ settlement checks; and recording deeds and encumbering properties before rescission periods expire.
Closing service denies AG’s allegations.
But insurer refuses to defend. It cites exclusions for claims arising out of (a) improper personal gain, (b) dishonesty, (c) conversion, theft, and the like, and (d) the Real Estate Settlement Procedures Act.
Closing service settles with AG by agreeing to pay over $100,000 in restitution. And it sues insurer for breach of a duty to defend and indemnify.
Insurer wins a summary judgment. AG’s claims are excluded as arising out of improper personal gain and conversion, theft, and the like. Dishonesty and RESPA exclusions aren’t addressed.
But the appeals court decides the improper personal gain and conversion exclusions are no grounds for avoiding coverage and returns the case to the district court to consider the dishonesty and RESPA exclusions.
So why the result? The duty to defend is broader than the duty to indemnify. If some claims in AG’s complaint are potentially within coverage, insurer must defend all claims, even if others are excluded. This appeals court reasoned that at least some of AG’s claims were outside the scope of the improper personal gain and conversion exclusions. So the district court was wrong in finding no duty to defend, at least based on the two exclusions it cited. Since its decision on defense was in error, and its decision on indemnity was for the same reasons, its indemnity decision was wrong too.
In Maryland, the payee of a check (here, the homeowner) must receive the check before he or she can bring a conversion action based on a misuse or improper delivery of it. [citation omitted] Where the payee has not received the check, the payee retains a cause of action against the drawer (in this case, [closing service]) for the liability reflected in the check, but, at least at that point in time, cannot bring a conversion action. [citation omitted] In this case, [closing service] allegedly misdirected the settlement checks before they ever reached the hands of the homeowners. Thus, the necessary element of delivery for a Maryland conversion action to the payee was absent at the time of the allegedly wrongful transfer by [closing service].
So your client or customer threatens a suit. And the time for suit is about to expire. You can avoid the suit. But you have to agree to extend time to sue. Sounds good. Otherwise you’ll be defending a lawsuit. Maybe you’ll have adverse publicity too. Maybe you can work things out with no suit. Maybe they’ll just drop it. So you agree. A year passes; no suit. More time passes; still no suit. Looks like the problem is over. You say, Hallelujah!
But then the sheriff shows up with that pesky summons and complaint. The suit is by the United States for the Coast Guard. It would be too late for it to sue. But you signed a tolling agreement giving it more time. Your company was sub-contracted work to convert old cutters into new and improved cutters. One of the cutters had a structural failure. The US government alleges you “knowingly misled the Coast Guard to enter into a contract for the lengthening of Coast Guard cutters by falsifying data relating to the structural strength of the converted vessels.” It alleges you violated the False Claims Act and alleges common law fraud, negligent misrepresentations and unjust enrichment.
You have claims-made private company D&O or management liability insurance. The claim involves wrongful acts. So you notify the insurer.
But wait a minute, says the insurer. Our policy covers a Claim first made during the policy period. We defined Claim as including “a written demand for monetary or non-monetary relief.” This Claim was first made well before then, back when you signed a tolling agreement.
You argue the Claim at least for negligent misrepresentation and unjust enrichment was first made when the government sued you. Those two claims aren’t explicitly mentioned in the tolling agreement. And they were in a suit filed during the insurer’s claims-made policy period. Insurer says pound sand! You say see you in court!
The tolling agreement between [subcontractor] and the United States stated that the government believed that it had claims against [subcontractor] arising from its performance of the conversion work for [general contractor], and memorialized [subcontractor’s] agreement to toll the statute of limitations so that the parties could discuss settlement of those claims before engaging in litigation. Clearly, then, under the language of the D&O Policy, the United States’ “claim” against [subcontractor] was first made in 2008, over two years before the policy period began.
So, as an insured, what should you do when asked to agree to toll the time for suit? Well, you better consider whether you have professional liability, D&O, or other insurance? And if you have insurance, you better notify your insurer. It appears this insured may not have had a management liability policy when asked to sign the tolling agreement. We say that because the insured didn’t sue under any policy in effect then.
But if it did have a policy then, it should have notified its insurer promptly after the government threatened suit and before signing any agreement. For an insured, the wisest course is to give prompt notice of anything that might be a Claim or turn into one.
You have a contract. You’re obligated to pay a third party. And naturally, being a capitalist, you’d prefer not to take the hit. You’re creative. And you’re savvy about insurance. And you think, gee, maybe my D&O or professional liability insurer can pay instead of me. So you ask. But they refuse. They say: “That’s your contract, not our policy obligation.” So off to court you go. And the wearers of black robes decide who wins and loses! And so it was in Entitle Ins. Co. v. Darwin Select Ins. Co., Case No. 13-3269 (6th Cir. Jan. 29, 2014.
This time the insured was a title insurer. Its contracts were with mortgage lenders and real-estate sellers and buyer-borrower. The contracts were closing protection letters. And under those contracts, title insurer agreed to indemnify lender, seller, or buyer for certain misconduct by title insurer’s closing agent. The misconduct was agent’s theft. And the theft was of a whopping $3.9 million in escrowed funds.
Yikes, says title insurer. That’s a lot of dough! And, yes, we issued closing protection letters. And so yes, we have to make those who have them whole. But gee wiz, we really would prefer not to take a big hit. Title agent has no money; so out of luck there. But how about Darwin’s professional liability policy? What does that policy provide? Does it fit the claim and cover the loss?
Okay, that’s great–so it can be an actual or alleged act “by an individual or entity for whom the Company [(title insurer)] is legally responsible”? Wouldn’t that include the thieving title agent who stole the $3.9 million, you ask? And as title insurer, isn’t it “legally responsible” for what title agent did? And so shouldn’t Darwin as professional liability insurer pay?
No, says the court. Under the contract between title insurer and agent, the scope of the agency was limited to issuing title policies. It included nothing else; and, thus, none of the closing and escrow services title agent offered.
Title insurer’s liability for agent’s acts was limited to acts within the scope of agent’s very limited agency. And when agent stole the $3.9 million it was acting for itself rather than within the scope of the agency. “To the extent that [title agent] performed closing and escrow-related services for the clients, [it] did so on its own behalf”–so said the appeals court.
Although title agent had many victims, title insurer made whole only the victims having closing protection letter contracts. All victims purchased title insurance from title insurer via the rouge agent. But only some victims paid extra for a closing protection letter. Title insurer paid victims only because of it’s legal liability under closing protection letter contracts, not because it was “legally responsible” for the rouge agent’s acts.
[Title insurer] asks that we interpret its insurance policy to allow [title insurer] to secure business by making contractual guarantees to its clients regarding the performance of third-party business partners that are not its agents and then force its insurer to foot the bill when that third-party fails to perform according to [title insurer’s] guarantee, despite [title insurer’s] disavowal of all non-contractual responsibility, legal or otherwise. Because this interpretation directly contravenes the language of its professional liability insurance policy, we must decline E[title insurer’s] request.
The appeals court didn’t address these issues because it didn’t have to. But they are additional arguments insurers will make when faced with insurance claims such as in this case. This type of litigation is seen with some frequency. And you should expect to see more of it, especially when there’s big money at stake making litigation cost easier to swallow.
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.
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.
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.
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).
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.
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.
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.

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