An Illinois federal court, applying Illinois law, has held that a prior knowledge exclusion precludes coverage for a malpractice claim against a law firm arising out of the firm’s failure to timely serve a party before the policy’s inception date.  Cardenas v. Twin City Fire Ins. Co., No. 1:13-cv-08236 (N.D. Ill. Sept. 24, 2014)

In 2008, the insured began representing its client in a civil rights suit against a police officer.  In 2010, the court dismissed the suit due to the insured’s failure to serve the police officer in a timely fashion, noting that the insured had “only” itself “to blame.”  In 2012, the insured’s client filed a malpractice suit against the insured, which the insured reported to its malpractice carrier.  The insured had four successive one-year insurance policies with its carrier.  Each policy required that the insurer be “notified immediately of any circumstance which may give rise to a claim” and excluded coverage for claims arising out of acts or omissions occurring before each policy’s inception date if the insured “knew or could have foreseen” that the acts “might be expected to be the basis of a claim.”  The insurer denied coverage for the malpractice claim based on the prior knowledge exclusion.  Thereafter, the insured settled with its client and assigned its rights against the insurer to its client.

The court agreed that the prior knowledge exclusion applied.  According to the court, the insured could have foreseen that its failure to timely serve a party would be the basis of a malpractice claim because: (1) no reasonable factfinder could find that failure to meet a “widely recognized” time deadline did not breach the relevant standard of care; and (2) prior to the policy’s inception date, a court had issued an opinion that the insured “had only [itself] to blame” for the dismissal of its client’s suit.

The court also held that – even if the relevant policy covered the insured’s claim – it was “unlikely” that the client would be able to collect the settlement from the insurer.  According to the court, in light of the risk of collusion and fraud, to enforce a settlement agreement assigning the rights of an insured vis-à-vis an insurer, a party must demonstrate that the conduct of the insured during the settlement process “conformed to the standard of a prudent uninsured” and that the dollar amount of the settlement was what “a reasonably prudent person” in the position of the insured would have settled for on the merits of the underlying claim.  The court noted that the insured’s client had met neither burden.