Source: http://www.joneslemongraham.com/blog/2013/12/
Timestamp: 2019-04-18 15:15:53+00:00

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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.
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.
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 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.
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 DISCOVERY OF ANY FRAUD, INTENTIONAL CONCEALMENT, OR MISREPRESENTATION OF MATERIAL FACT WILL RENDER THIS POLICY, IF ISSUED, VOID AT INCEPTION.
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.
The end of “fraud on the market”?
Adopted by the Supreme Court in 1988, the “fraud on the market” doctrine allows plaintiffs in securities cases to bring a class action without alleging reliance on false statements regarding securities. Much has been written about the Supreme Court’s grant of certiorari in Halliburton v. Erica John Fund and the future of the “fraud on the market” doctrine in securities class actions. The Supreme Court in Halliburton is expected to decide whether “fraud on the market” should continue. As explained by Kevin LaCroix in the D&O Diary and by Douglas W. Greene in D&O Discourse the impact of the Supreme Court’s ruling — expected in mid-2014 — on D&O claims for securities class actions could be significant.
Does a management liability policy require an insurer to defend an IRS claim for alleged failure to pay employment taxes, where “taxes,” “fines,” and “penalties” are exceptions from the definition of “Loss”? Not this one, according to this court.
The IRS claimed the insured hospital failed to pay what was owed for employment taxes for withholding and otherwise under the hospital’s quarterly Form 941. It demanded payment from the hospital and its trustees personally.
The policy included a duty to defend, providing: “The Insurer shall have the right and the duty to defend any Claim regardless of whether any of the allegations are groundless, false, or fraudulent.” Claim included “… any Insured Person Claim . . . .” “Insured Person Claim” included certain written demands, civil and criminal proceedings, and administrative and regulatory proceedings. “Loss” wasn’t incorporated into the “Insured Person Claim” definition, but it was used within the policy’s insuring agreement.
We are not persuaded by this overly-simplistic and literal interpretation of the policy. The notion advanced by plaintiffs would require North River to provide a defense against any and all claims lodged against its insureds, regardless of whether the claim embraced a covered risk. This novel interpretation is contrary to our settled jurisprudence with respect to liability policies, and not supported by principles of interpretation applied to insurance policies in general.
D&O insurance, as far as insurers are concerned, isn’t a means for insureds to transfer liability for contract obligations to their insurers. D&O policies frequently include exclusions for contractual liability. Wording varies. And the exclusions are frequently litigated, as you’ll see from earlier posts to this blog.
Beazley, the D&O insurer here, addressed contractual liability through an exception to the definition of Loss — for “damages representing amounts allegedly owed under an express written contract, including a guarantee or obligation to make payments.” The issue was whether the insured’s $500,000 repayment to the Social Security Administration fell within that exception to the Loss definition. This Federal District Court concluded that it did.
So why did the $500,000 repayment qualify as for “damages representing amounts allegedly owed under an express written contract . . . ?” Family Assistance’s arrangement with the Social Security Administration was subject to a “Form SSA-11” which “includes a term requiring that the representative payee [(Family Assistance)] ‘[r]eimburse the amount of any loss suffered by any claimant due to misuse of Social Security or SSI funds by me/my organization.'” The Form SSA-11 was an express written contract. The $500,000 was damages representing amounts allegedly owed under that contract.
An insured with an $80 million loss takes a $5 million hair-cut off a $10 million limit in settling with a primary insurer and, as a result, is left with no excess coverage for $70 million in additional losses. Settling with the primary insurer for less than limits, thus, backfired.
The insured, Quellos Group — an investment firm — created a tax shelter for clients to offset capital gains with losses. But the shelter ran afoul of IRS’s rules, leading Quellos to pay a $35 million settlement and incur $45 million in defense fees.
Because the exhaustion language in the Federal and Indian Harbor excess insurance policies is clear and unambiguous, we must enforce it as written, and affirm summary judgment dismissal of the lawsuit against Federal and Indian Harbor.
It didn’t matter that the insured paid the $5 million the primary insured didn’t pay, so that the insured’s and primary insurer’s combined payments totaled $10 million, the full amount of the primary policy. The excess policies’ wording required that the primary insurer actually pay its $10 million primary limit before any excess coverage would attach.
The Court also rejected the insured’s arguments that: (1) “only after” in the excess policies’ insuring agreements made exhaustion a condition, shifting the proof burden to the excess carriers to show prejudice; and (2) enforcement of the exhuastion language would violate public policy.

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