Opinion ID: 8414601
Heading Depth: 2
Heading Rank: 3

Heading: TIAC’s Bases for Denying Coverage 1. Exclusion (a)

Text: We turn now to the provisions TIAC invoked in denying coverage back in 2009. Exclusion (a) withheld coverage for any claim relating to “any dishonest, fraudulent, criminal, malicious or intentional wrongful acts committed by or at the direction of the Insured.” Exclusion (a) does not justify TIAC’s refusal to defend against the tendered suits. Later-filed pleadings and subsequent developments show that the Claimants’ damages were attributable at least partly to fraud by someone. But the complaints as tendered did not compel that conclusion. At most they placed TIAC on notice that one or more of the underlying claims might be subject to exclusion (a). The presence of a theory excluded from coverage simply does not excuse an insurer from its duty to defend its insured. Artisan & Truckers, 796 F.Bd at 723; see also Santa’s Best, 611 F.3d at 346 (where underlying complaint presents several theories of recovery, “the duty to defend arises even if only one such theory is within the potential coverage of the policy”) (citation omitted). Most of the allegations in the tendered complaints had no obvious relationship to a fraud claim, though just one path toward a covered claim would have been enough to trigger the duty to defend. First American’s complaint accused Chicago Abstract of breach of contract, and it alleged a host of errors and omissions that could arise as easily from negligence as from intentional wrongdoing. The complaint also alleged “irregular and suspicious” real estate transactions and suggested that Chicago Abstract’s agents may have misappropriated escrow funds. Those nebulous allegations did not indisputably remove the complaint from coverage, which is what would have been required to avoid the duty to defend. 1st Funding settled and has not appeared in TIAC’s federal case, but nothing in 1st Funding’s complaint changes our analysis. 1st Funding alleged that Chicago Abstract disbursed loan proceeds before all conditions were met. It accused Chicago Abstract of negligence and breaches of contract and fiduciary duty. It did not accuse Chicago Abstract of fraud. The Coastal Funding complaint presents a somewhat closer question, but the result is the same. Coastal Funding accused Chicago Abstract of misappropriating and/or converting $1,370,000. Conversion is an intentional tort, but conversion does not include as an element the intent to defraud. It does not require proof of a criminal or otherwise culpable mental state. Rather, the tortfea-sor must simply act intentionally in a manner that exercises dominion over the property of another without authorization. Whether he does so maliciously or by innocent mistake, the action is still conversion. See Longo Realty v. Menard, Inc., 405 Ill.Dec. 708, 59 N.E.3d 1, 11 (2016) (“Conversion requires the plaintiff establish by a preponderance of the evidence: (1) the defendant’s unauthorized and wrongful assumption of control, dominion, or ownership over the plaintiffs personal property; (2) the plaintiffs right in the property; (3) the plaintiffs right to immediate possession of the property, absolutely and unconditionally; and (4) the plaintiffs demand for possession of the property.”); Martel Enterprises v. City of Chicago, 223 Ill.App.3d 1028, 164 Ill.Dec. 945, 584 N.E.2d 157, 159 (1991) (“Although conversion is considered an intentional tort because it requires ‘an intentional exercise of dominion or control over a chattel,’ it does not require proof of malice, culpability, or conscious wrongdoing.”) (citations omitted). Coastal Funding’s allegations of misappropriation and conversion were factually threadbare, amounting to little more than legal conclusions. That’s not surprising, given the urgency with which the complaint had to be prepared. Legal conclusions standing alone will not justify an insurer’s refusal to defend its insured. See Cincinnati Ins. Co. v. Eastern Atlantic Ins. Co., 260 F.3d 742, 745 (7th Cir. 2001) (“What is important is not the legal label that the plaintiff attaches to the defendant’s ... conduct, but whether that conduct as alleged in the complaint is at least arguably within one or more of the categories of wrongdoing that the policy covers.”); International Ins. Co. v. Rollprint Packaging Products, Inc., 312 Ill.App.3d 998, 245 Ill.Dec. 598, 728 N.E.2d 680, 688 (2000) (“The question of coverage should not hinge on the ... whims of the plaintiff in the underlying action.”). 3 Coastal Funding did plead one fraud count that was more factually robust, but that count named only Donnel Thomas, a third party whose association with Chicago Abstract was unexplained. TIAC could not reasonably have construed the allegations against Thomas as somehow excluding coverage for its Insured. This is particularly so in light of the policy’s condition (1), which provided that the fraud exclusion would not bar coverage for any Insured who neither participated in nor knew about the fraud, provided the Insured notified TIAC upon learning of the misconduct. The decisive point is that the underlying complaints, whether read individually or together, did not compel the conclusion that the Claimants’ losses were attributable to intentional wrongdoing by Chicago Abstract and its agents. See U.S. Fidelity & Guaranty Co. v. Wilkin Insulation Co., 193 Ill.App.3d 1087, 140 Ill.Dec. 907, 550 N.E.2d 1032, 1036 (1989) (“[Since the underlying claims arise from the same set of circumstances, the allegations in any single complaint can be inferred in the other complaints.”), aff'd, 144 Ill.2d 64, 161 Ill.Dec. 280, 578 N.E.2d 926 (1991). The undisputed facts show that exclusion (a) could not justify TIAC’s refusal to defend its Insured at the time of tender. 4 2. Exclusion (j) TIAC also denied coverage based on exclusion (j), which withheld coverage from any claim relating to “any defalcation, commingling of, or failure to pay any funds.” Exclusion (j) also does not justify TIAC’s denial of coverage. Defalcation is an undefined term in the policy. The term is commonly used in the bankruptcy context, where it describes a “culpable state of mind” involving “knowledge of, or gross recklessness in respect to, the improper nature of ... relevant fiduciary behavior.” Bullock v. BankChampaign, N.A., 569 U.S. -, -, 133 S.Ct. 1754, 1757, 185 L.Ed.2d 922 (2013). More generally, the term connotes fraud or embezzlement, though broader usages also have been recognized. See Defalcation, Black’s Law Dictionary 506 (10th ed. 2014). As discussed above, TIAC could not refuse to defend its Insured on the basis of a fraud exclusion. As for commingling, only one underlying pleading — the First American complaint— included such an allegation, and commingling was not an essential aspect of First American’s lawsuit. As for the undefined phrase “failure to pay,” the Claimants argue that they alleged the very opposite in state court: they alleged that Chicago Abstract did pay (i.e., disburse) escrow funds under circumstances in which it should not have done so. TIAC perhaps could have countered that “failure to pay” should be read broadly to encompass Chicago Abstract’s failure to return funds to the lenders, but neither exclusion (j) nor the state court complaints were clear enough to establish that no claim could possibly fall within the scope of coverage. TIAC might have been able to assert a successful defense to coverage during litigation, but even if that were true, it would not follow that TIAC was entitled to abandon its Insured at the outset of litigation. 5 3. Northbrook Property and “Wholly Independent ” Acts TIAC argues that the district court should have enforced exclusion (a) and/or exclusion (j) on the ground that the underlying complaints included some allegations that, if proved, might have fallen outside the scope of coverage. According to TIAC, “where a claim alleges injuries caused by both excluded acts and non-excluded acts,” the insurer must defend only if the non-excluded acts were “wholly independent” of the excluded acts. TIAC’s proposition is difficult to square with the settled principle of Illinois law that if the “underlying complaints allege several theories of recovery ... the duty to defend arises even if only one such theory is within the potential coverage of the policy.” Santa’s Best, 611 F.3d at 346 (citation omitted). In fact, the cases TIAC cites for its “wholly independent” argument are readily distinguishable from this case and illustrate the narrow application of that rule. TIAC relies principally on Northbrook Property & Casualty Co. v. Transportation Joint Agreement, 194 Ill.2d 96, 251 Ill.Dec. 659, 741 N.E.2d 253 (2000), where a general liability policy excluded injuries stemming from “ownership, maintenance, use or entrustment” of a vehicle. Id., 251 Ill.Dec. 659, 741 N.E.2d at 254. The underlying complaints alleged that students were injured when a train collided with the insured school district’s school bus. Those complaints “utterly fail[ed] to state facts which either actually or potentially” brought the complaints “within the policy’s coverage.” Id. While the claimants attempted to argue around the vehicle exclusion by characterizing the students’ injuries as resulting from the school district’s failure to select safe bus routes, those allegations were “nothing more than re-phrasings of the fact that the students’ injuries arose from the school districts’ use or operation of a motor vehicle.” Id. The students were harmed in an excluded bus accident. Causation was not in dispute, and state of mind was irrelevant. No set of facts consistent with the allegations in the underlying complaints could have brought those complaints within the scope of coverage. 6 In this case, when the Claimants filed their initial pleadings, the circumstances surrounding their injuries or possible injuries were murky at best. Records were missing. Transactions were unaccounted for. Chicago Abstract’s escrow account was short of cash, but it was not clear who or what was responsible for the shortage. The Claimants sought emergency judicial intervention to preserve the status quo and to avoid further losses while they sorted through the facts. Their vague pleadings reflected their uncertainty. Many of the allegations related to one another only generally, and at least one theory — in fact, most theories — fell outside exclusions (a) and (j). First American alleged that Chicago Abstract had engaged in “irregular and suspicious” transactions and that its agents appeared to have commingled and misappropriated escrow funds. But First American also accused Chicago Abstract of failing to account for the funds, failing to turn over records, issuing unauthorized insurance policies, neglecting to supervise its employees, and wrongfully holding itself out as an agent of First American. 1st Funding intervened in the First American action, citing a series of incidents in which Chicago Abstract allegedly disbursed loan proceeds before all conditions were satisfied. Coastal Funding filed a separate complaint in which it speculated that Chicago Abstract may have converted its funds. But in that same complaint, Coastal Funding alleged that it had fallen prey to a Ponzi scheme orchestrated by Donnel Thomas, a third party whose association with Chicago Abstract was unclear. We now know that Thomas had an inside man at Chicago Abstract: Juan Or-ozco, the employee who was eventually convicted of wire fraud for his part in Thomas’s Ponzi scheme. But the Claimants did not know that or allege that when they filed their complaints in 2008. Nor is there any indication that anyone at TIAC was aware of Orozco’s crimes when it denied coverage in 2009. Even if TIAC had known about Orozco, a fraud claim — unlike a motor vehicle tort, see Northbrook Property, 251 Ill.Dec. 659, 741 N.E.2d at 254 — requires the finder of fact to ascertain the tortfeasor’s state of mind. Before undertaking fact discovery, TIAC could not possibly have known whether its Insured, defined to include not only Chicago Abstract but also its members and employees acting within the scope of their employment, were in on the scheme, aware of the scheme, or innocent victims of the scheme. TIAC could not preemptively refuse to defend its Insured on the basis of facts it did not and could not then know. The search for Northbrook Property's “wholly independent” cause of injury is futile when the primary cause of injury is unknown. Based on the “eight corners” of the tendered complaints and the insurance policy, see Metro Paramedic, 829 F.3d at 513-14, the undisputed facts show no sufficient basis for TIAC to deny coverage.