Insureds’ Settlement with Bank of its Loan Defaults Not Covered

Applying Virginia law, the United States District Court for the Eastern District of Virginia has held that an insured’s settlement of a bank’s claim based on the insured’s loan defaults is not covered under the insured’s professional liability policy because the claim was not first made during the policy period and the insured’s notice was untimely; the insured previously tendered the claim to a prior carrier; the loan defaults did not constitute insurable loss; and the insured breached the policy’s cooperation provision by settling the claim without the insurer’s consent.  Lessard v. Continental Casualty Co., 2014 WL 4162006 (E.D. Va. Aug. 19, 2014).  Wiley Rein represented the insurer. 

An insured individual and his companies defaulted on certain loans, and the bank commenced collection efforts.  In September 2010, the insureds confessed judgments in favor of the bank.  On February 1, 2011, the insureds provided notice of the dispute with the bank to its then-insurance carrier.  On February 2, 2011, the insureds purchased a new policy from another carrier.  Thereafter, the bank filed a lawsuit alleging that the insureds engaged in a fraudulent scheme to avoid the corporate debts.  The insureds eventually settled the dispute with the bank and with the insurer that issued the first insurance policy. The insureds then sought coverage under the second insurer’s policy for both amounts paid in settlement to the bank and defense costs incurred in connection with the bank’s collection action.  The second insurer denied coverage on several grounds, and the insured commenced coverage litigation.

The court sided with the second insurer on all five of its grounds for denial of coverage.  First, the court agreed that the claim was first made during the prior policy period when the bank made a demand for the amounts in default, and that the bank’s lawsuit filed during the second policy period related back to, and was deemed a single claim with, the initial demand made during the first policy period.  Second, the court ruled that the second policy’s prior notice exclusion barred coverage because the insureds reported the bank’s demands to the first carrier.  Third, the court held that the loan amounts the bank recovered from the insureds are not “Loss” because such amounts were merely the insureds’ contractual guaranty obligations and as such are not insurable.  Fourth, the court held that the insureds had violated the second policy’s requirement of notice of claims “as soon as practicable.” Although the insureds notified the first carrier of the dispute on February 1, 2011, they did not provide notice to the second carrier until January 24, 2012, nearly a year after that initial notice and almost five months after the lawsuit was filed.  Finally, the court ruled that the insureds’ failure to obtain the second carrier’s consent prior to settling the bank’s claim was a violation of the policy’s cooperation clause.  Based on each of these five reasons, the court held that the second carrier’s policy does not provide coverage for the claim.