Texas Court Holds Prior Knowledge Exclusion in E&O Policy Inapplicable

In its recent decision in OneBeacon Insurance Company v. T. Wade Welch & Associates, et al., 2012 U.S. Dist. LEXIS 178587 (S.D. Tex. Dec. 18, 2012), the United States District Court for the Southern District of Texas had occasion to consider the application of a prior knowledge exclusion in a professional liability policy.

OneBeacon issued a series of lawyers professional liability policies to the law firm of T. Wade Welch & Associates, the first such policy incepting on December 20, 2006.  Each of the policies contained a prior knowledge exclusion applicable to “any claim arising out of a wrongful act occurring prior to the policy period if, prior to the effective date of the first Lawyers’ Professional Liability Insurance Policy issued by [OneBeacon] to [the Welch Firm] and continuously renewed and maintained in effect to the inception of this policy period … you had a reasonable basis to believe that you had committed a wrongful act, violated a disciplinary rule, or engaged in professional misconduct; [or] you could foresee a claim would be made against you.” 

The T. Wade Welch & Associates firm and various attorneys in the firm (the “Welch Defendants”) were named as respondents in an arbitration brought by a former client, the DISH Network.  The Welch Defendants had been representing DISH in a lawsuit preceding the issuance of the first OneBeacon policy.  DISH’s arbitration petition alleged, among other things, that in 2005, the Welch Defendants failed to respond to discovery, and withheld this error and also withheld other subsequent, but related, events from its client.   This misconduct eventually led to a sanctions motion being made against DISH in February 2007, which the Welch Defendants did not disclose to their client until July 2007, when the sanctions motion against DISH was granted. 

Although the sanctions were awarded while the OneBeacon policies was in effect, OneBeacon argued that the prior knowledge exclusion barred coverage for DISH’s malpractice claim since the Welch Defendants knew prior to December 20, 2006 that it had engaged in professional misconduct.  OneBeacon further contended that the sanctions were part of a series of related wrongful acts predating the inception of the first policy it issued to the Welch firm.  The Welch Defendants argued, on the other hand, that DISH’s damages, and the basis for its malpractice claim, was the July 2007 sanctions order, which occurred while the first OneBeacon policy was in effect.  The Welch Defendants further contended that “any acts or omissions prior to the entry of the February 2007 discovery motion and July 2007 discovery order were readily curable and could not, on their own, support DISH’s [malpractice] claim.”

The court agreed that all of the events described in DISH’s arbitration petition were related, but that they constituted “independent wrongful acts.”  Specifically, the court concluded that the Welch Defendants engaged in separate acts of professional misconduct after the inception of the 2006 OneBeacon policy when they failed to advise DISH about the pending sanctions motion and failed to correct the alleged discovery deficiencies.   In reaching this conclusion, the court rejected OneBeacon’s argument that these acts all related back to misconduct from 2005, which predated the inception of the first OneBeacon policy.   In support of this argument, OneBeacon cited to a long line of cases regarding relationship of claims, such as the seminal decision in Continental Casualty Co. v. Wendt, 205 F.3d 1258 (11^th Cir. 2000).  The court found these decisions distinguishable, explaining:

… these cases do not involved relating independent wrongful acts back to the initial wrongful act so that all wrongful acts fall within a prior knowledge exclusion.  Rather, they all deal with whether alleged wrongful acts are related for limits of liability purposes.  Thus, they are not on point.

The court ruled similarly with respect to OneBeacon’s argument that all pre-policy and post-policy wrongful acts should be “linked together” and thus all considered to have happened prior to the inception of the first policy.  In support of this argument, OneBeacon relied on a “Multiple Insureds, Claims or Claimants” condition stating:

Each wrongful act, in a series of related wrongful acts, will be deemed to have occurred on the date of the first such wrongful act. A series of related wrongful acts includes wrongful acts which are logically or causally connected by common facts, circumstances, situations, events, transactions or decisions and which may involve the same person or organization or class of persons or organizations.

The court concluded that this language was not relevant in considering the application of the prior knowledge exclusion since “the language linking related wrongful acts is in a completely different section of the policies than the exclusions.”  The court agreed that OneBeacon’s argument was reasonable, and “perhaps even more reasonable” than the contrary view espoused by the Welch Defendants, which was that the “Multiple Insureds, Claims or Claimants” provision must be read independently of policy exclusions.  The court nevertheless agreed that the Welch Defendants argument was “not itself unreasonable,” and as such, there were two reasonable interpretations of the policy, which required the court to construe the policy against OneBeacon.  Thus, the court concluded that OneBeacon could not rely on the prior knowledge exclusion to disclaim a duty to defend the wrongful acts that allegedly occurred after the December 20, 2006 inception of the first OneBeacon policy.

6th Circuit Addresses Prior Knowledge Defense Under Legal Malpractice Policy

In its recent decision in Schwartz Manes Ruby & Slovin, L.P.A. v. Monitor Liability Managers, LLC, 2012 U.S. App. LEXIS 12236 (6th Cir. June 15, 2012), the United States Court of Appeals for the Sixth Circuit, applying Ohio law, had occasion to consider the issue of whether prior to the inception of a policy, the insured reasonably could have foreseen that a claim would be made.

Schwartz Manes involved coverage for alleged legal malpractice under a professional liability policy.  The Schwartz Manes law firm (“SMRS”) represented an individual in connection with a property dispute.  After having failed to appear at a scheduled trial in 2005, judgment was entered against SMRS’ client.  The client later retained a second firm, which after reviewing SMRS’ file, wrote SMRS by letter dated June 15, 2008 to inquire as to why the firm failed to appear at the trial, particularly since its file contained a notice for the trial.  On July 10, 2008, after undertaking an internal investigation, SMRS advised its insurance agent of a potential claim, but the agent apparently never forwarded this information to anyone else.  On July 24, 2008, Carolina Casualty Insurance Company issued to SMRS a legal malpractice policy for the period June 29, 2008 to June 29, 2009. SMRS was later sued for malpractice in January 2009.

The Carolina policy contained the following insuring agreement:

This Policy shall pay on behalf of the Insured all Damages and Claims Expense that the Insured shall become legally obligated to pay, arising from any Claim first made against an Insured during the Policy Period and reported to the Insurer in writing during the Policy Period or within 60 days thereafter, for any Wrongful Act, provided that prior to the inception date of the first Lawyers' Professional Liability Insurance Policy issued by the Insurer to the Named Insured, which has been continuously renewed and maintained in effect to the inception of this Policy Period, the Insured did not know, or could not reasonably foresee that such Wrongful Act might reasonably be expected to be the basis of a Claim.  (Emphasis supplied.)

Carolina disclaimed coverage to SMRS on the basis that prior to its policy’s June 29, 2008 date of inception, SMRS knew and reasonably could have foreseen that a claim would be made relating to its alleged malpractice.  On motion for summary judgment, the United States District Court for the Southern District of Ohio agreed, holding that SMRS’ knowledge of the potential claim prior to the issuance of the Carolina policy negated Carolina’s duty to defend or indemnify.

On appeal, the Sixth Circuit observed that the question of whether SMRS could reasonably foresee that a Wrongful Act “might reasonably be expected” to be the basis of a claim required both a subjective and an objective analysis.  The subjective part of the analysis inquired into what facts SMRS knew of prior to the policy’s date of inception.  The objective analysis, on the other hand, inquired into whether a “reasonable insured” in possession of similar facts, would have expected a claim.

SMRS argued that the phrase “reasonably be expected” was necessarily ambiguous, and that it was not clear whether the claim only be a possibility, or whether the phrase should be interpreted more narrowly to claims that are “probable.”  The court concluded that it need not determine whether the phrase is ambiguous, “because even under a more favorable interpretation, a reasonable insured would have expected a malpractice claim …  against SMRS to be reasonably probable.”  It was the court’s opinion that a reasonable insured having knowledge of the underlying judgment resulting from SMRS’ failure to appear at the trial, would have realized that a claim was “reasonably probable.”

As a secondary argument, SMRS argued that only that aspect of the malpractice claim relating to its failure to appear at the trial should be precluded.  SMRS argued that other aspects of underlying plaintiff’s claim, such as failure to assert certain defenses, should not be precluded from coverage SMRS could not have predicted such aspects of the suit prior to the date of the policy’s inception.  The court rejected this argument, finding that there was no way to meaningfully divorce SMRS’ failure to attend the trial from other aspects of the alleged malpractice.  The court further held that the policy’s “related wrongful act” language precluded such a parsing of claims, observing:

… Section IV(K) of the Policy also excludes coverage for "Related Wrongful Acts." The Policy defines "Related Wrongful Acts" as "Wrongful Acts which are logically or causally connected by reason of any common fact, circumstance, situation, transaction, casualty, event or decision." SMRS's alleged failure to comprehensively research and litigate Kissel's lawsuit and potential countersuit against her step-mother is certainly logically connected to its alleged failure to attend her trial in the same matter.

Thus, the Sixth Circuit upheld the lower court’s grant of summary judgment in Carolina’s favor.

Texas Court Considers Prior Knowledge Condition In D&O Policy

In the recent decision in Deer Oaks Office Park Owners Ass'n v. State Farm Lloyds, 2012 U.S. Dist. LEXIS 19240 (W.D. Tex. Feb. 15, 2012), the United States District Court for the Western District of Texas had occasion to consider a prior knowledge condition in a directors and officers liability policy.

The insured, Office Park, was “an office park condo association which owns, maintains and regulates the 'common areas' between fifteen unconnected office condos” in San Antonio, Texas.  In 2007, it sold one of the condominium units to a doctor who intended to convert the unit for use in his medical practice.  The doctor advised that being able to install an elevator into the unit was an important aspect and condition of his purchase.  After the sale, however, the doctor was unable to obtain a permission from building maintenance to install the elevator.  He subsequently complained to Office Park, and later commenced a lawsuit in Texas state court.

Office Park sought coverage for the suit under the directors and officers coverage of its policy with State Farm Lloyds, effective for claims first made during the period January 30, 2010 to January 30, 2011, which encompassed the period in which the doctor commenced suit.  The policy’s insuring agreement stated that coverage “applies to 'wrongful acts' committed before this optional coverage became effective if the insured had no knowledge of a claim or suit at the effective date of this option and there is no other applicable insurance.”  State Farm Lloyds denied coverage for the suit on the basis that Office Park had knowledge of the doctor’s claim prior to the policy’s inception.  Specifically, State Farm Lloyds relied on a September 23, 2009 letter from the doctor’s attorney that “traced [the doctor’s] multiple complaints about Office Park and attributed monetary losses to Office Park.”  

Office Park argued that the doctor’s letter did not constitute a “claim” or notice of a “claim,” because the letter did not specifically demand any monetary relief.  In support of its position, Office Park pointed out that the State Farm Lloyds policy did not contain a definition of the term “claim,” and that as such, under the Fifth Circuit decision in Int'l Ins. Co. v. RSR Corp., 426 F.3d 281 (5th Cir. 2005), the term “claim” must be narrowly construed as “a demand for money, property, or legal remedy.” Office Park contended that because the doctor’s September 23, 2009 letter did not actually seek monetary relief, it could not constitute a “claim” for the purpose of the policy’s “knowledge of a claim or suit” condition to coverage.

The court disagreed with Office Park’s restrictive reading of RSR Corp., finding that the term “claim” is not limited solely to demands for monetary relief, but instead encompasses any assertion of a legal right.  Such an interpretation, the court explained, ordinarily is favorable to the insured, rather than the insurer, “because the construction gives the insured the right to seek coverage without waiting for the filing of a lawsuit.”  The court went on to conclude that the doctor’s letter qualified as a “claim” because it clearly stated a legal demand for relief and advised of the potential for litigation should an accommodation not be made.  As the court explained:

The only reasonable interpretation of the letter is that [the doctor] asserted a right to hold Office Park liable for all of the costs [he] had spent and lost because of Office Park's acts. The letter's bottom line was: If you do not comply with my demands, I will sue you. Under any construction, the letter constituted a claim.

As such, the court concluded that State Farm Lloyd’s denial of coverage was correct and that it had no duty to defend or indemnify the doctor in connection with the underlying matter.