Applying Texas law, a federal district court has held that a jury must decide the issue of whether a reasonable attorney would have expected certain discovery misconduct to give rise to a claim.  OneBeacon Ins. Co. v. T. Wade Welch & Assocs., 2014 WL 2863701 (S.D. Tex. June 24, 2014)

The insured law firm defended a client in a litigation matter from 2005 to 2008.  After the insured attorney failed to respond to discovery requests within thirty days, the opposing party moved to compel.  In February 2006, the court issued an order requiring the client to respond to all requests by March 16, 2006, and providing that, if the client failed to comply in a timely manner, the court could deem the claims established and the client’s defenses precluded.  The insured attorney agreed to comply with the order.  The attorney filed responses on March 16, 2006, but waited several days to produce documents; failed to provide interrogatory responses signed under oath; and failed to identify the documents responsive to the requests.  In August 2006, opposing counsel alerted the attorney that, unless his client complied fully by September 1, 2006, “plaintiff will seek appropriate relief.”  The insured attorney produced an additional 500 documents on September 5, 2006.  Opposing counsel did not immediately complain of the attorney’s noncompliance with the court’s discovery order.

In November 2006, the firm completed an application for professional liability insurance and indicated that neither the firm nor any of its attorneys were aware of any fact, circumstance, act, error or omission that might be expected to be the basis of a claim.  The insurer issued a policy to the firm for the period of December 20, 2006 to December 20, 2007 (the “2006-07 Policy”).

After months of silence, opposing counsel moved for discovery sanctions in February 2007 based on the attorney’s alleged failure to respond fully and properly to the discovery requests.  On July 20, 2007, the court granted the motion and ordered, among other things, that the plaintiff’s claims were established and that the insured’s client was precluded from disputing the plaintiff’s evidence.

In December 2007, the firm filled out an application for coverage from the same insurer (the “2007 Application”) and again indicated that neither the firm nor any of its attorneys were aware of facts, circumstances or situations that “might reasonably be expected to give rise to a claim.”  The 2007 Application also stated that the firm “must report any known claim, suit, or incident, act, or omission that may in the future give rise to a claim or suit, to your current professional liability insurer before the claims-reporting period under that policy expires.”  The insurer issued a policy to the firm for the period of December 20, 2007 to December 20, 2008 (the “2007-08 Policy”), which included a prior knowledge exclusion stating that “[t]his policy does not apply to any claim arising out of a wrongful act occurring prior to the policy period if, prior to the effective date of the [2006-07 Policy] . . . (2) you had a reasonable basis to believe that you had committed a wrongful act, violated a disciplinary rule, or engaged in professional misconduct [or] (3) you could foresee that a claim would be made against you.”

In April 2008, the insured firm notified its insurer of the client’s potential claim.  In August 2011, the insured’s client agreed to settle the underlying case for $12 million.  In February 2012, the client filed an arbitration demand against the firm and ultimately prevailed in arbitration.

During the coverage litigation that followed, the court first held that, on its face, the prior knowledge exclusion applied because (1) prior to the inception of the 2006-07 Policy, the attorney had a reasonable basis to believe that he had violated a disciplinary rule or engaged in professional misconduct by agreeing to the February 2006 discovery order contemplating sanctions and then failing to inform his client about the order; and (2) under Texas’s broad interpretation of the phrase “arising out of,” the client’s claim “arose out of” the attorney’s pre- inception “wrongful acts” because it had an incidental relationship to those acts.

The court rejected the insured’s argument that the prior knowledge exclusion conflicted with the terms of the 2007 Application.  The court agreed that the exclusion “does not require the insured to have reasonably expected the pre-inception wrongful act to result in a claim for the exclusion to apply.”  By contrast, the 2007 Application required disclosure only if the applicant was “aware of any fact, circumstance, or situation which might reasonably be expected to give rise to a claim.”  The court held that this application disclosure requirement is used by the insurer “to evaluate whether to issue a policy” and “is not irreconcilable with” the exclusion.

Despite concluding that there was no facial conflict between the prior knowledge exclusion of the 2007-2008 Policy and the 2007 Application, the court nonetheless held that, if the exclusion were interpreted in accordance with its plain language, there would be an unintended gap in coverage.  Specifically, the court held that “the retroactive coverage [from January 4, 1995] would be illusory because no ‘wrongful act’ that the attorney was aware of, but did not think would result in a claim, would be covered,” even though the 2007 Application only required the applicant to report to its prior insurer known claims and incidents, acts or omissions “that may in the future give rise to a claim or suit to its former insurer.”  To avoid this gap, the court held that the prior knowledge exclusion applies only if the claim arose out of a wrongful act that may have reasonably been expected to give rise to a claim.

Finally, the court held that a jury must decide whether, at the time the 2006-07 Policy incepted, a reasonable attorney with the subjective knowledge of the insured attorney would have expected the attorney’s pre-December 2006 discovery misconduct to give rise to a claim.