The United States District Court for the Eastern District of Virginia, applying Virginia law, has held that a professional liability policy’s exclusion for “negligent supervision” of funds applied to bar coverage for damages resulting from an insured attorney’s reckless investment of trust assets.  ALPS Prop. & Cas. Ins. Co. v. Farthing, 2018 WL 4927366 (E.D. Va. Sept. 26, 2018).  The court also held that the insurer was entitled to recoup defense costs paid in the underlying suit.

In the underlying case, a trust beneficiary sued an attorney who had previously served as trustee, alleging that the attorney had collected excessive trustee fees and had engaged in mismanagement of the trust assets, including excessive stock trading.  In a bench trial, the court found that the attorney had collected excessive trustee fees and that, based on his reckless trading activity, he had breached the “prudent investor rule.”  The claimant therefore was entitled to recover as damages excessive trustee fees, investment losses, and attorneys’ fees.

The attorney’s lawyer’s professional liability insurer provided a defense in the underlying action subject to a reservation of rights and filed a declaratory judgment action against the insured attorney and the trust beneficiaries, seeking a judgment establishing that the amounts assessed against the attorney were not covered damages under the policy and that the insurer had no ongoing duty to defend the attorney and could recover defense costs paid in the underlying suit to date.  The insured attorney and the trust beneficiaries conceded that the policy did not provide coverage for the excessive trustee fees or the attorneys’ fees award in the underlying action, but they argued that the policy did cover investment losses.  The insurer moved for summary judgment on the grounds that the policy did not cover the trust’s investment losses for a number of reasons, including that coverage for such damages is barred by the policy’s exclusion for claims “arising from or in connection with” “conversion, misappropriation, or negligent supervision” of funds or property.

In granting the insurer’s motion for summary judgment, the court held that the policy’s “negligent supervision” exclusion unambiguously applied, concluding that the ordinary meaning of “negligent supervision” includes the reckless investment of a stock portfolio in a manner that violates the prudent investor rule.  The court rejected the insured’s arguments that enforcing the “negligent supervision” exclusion not only in the context of the traditional attorney-client relationship but also in the context of acts taken as a trustee would render coverage to trustees illusory.  The court responded that applying the exclusion in this manner would be appropriate and predictable, particularly since the policy as a whole, including the policy’s definition of “professional services,” otherwise makes clear that it is not intended to cover “investment advice.”

Finally, the court held that the insurer was entitled to recoup amounts paid in defense of the underlying case because it provided a defense under a reservation of rights, and the policy expressly provided for recoupment of defense costs associated with non-covered claims.