Applying Texas law, the United States Court of Appeals for the Fifth Circuit has held that a prior knowledge condition did not relieve an insurer of its duty to defend where an underlying complaint made vague allegations of wrongdoing at an indeterminate time.  Allied World Specialty Ins. Co. v. McCathern, P.L.L.C., 2020 WL 933314 (5th Cir. Feb. 26, 2020).  The court found that the vague allegations could be construed to refer to conduct occurring after the date specified in the prior knowledge condition.

An attorney was sued for malpractice by its former client, who had been adjudged liable in a personal injury action.  The malpractice suit centered on allegations that the verdict would have been averted had the attorney timely accepted a settlement demand from the claimant, as he was instructed to do.  The suit also made more general allegations that the attorney failed to properly monitor the file and research legal issues.

The E&O insurer defended the law firm in the underlying action under a reservation of rights, and brought a declaratory judgment action, seeking a declaration that it had no duty to defend the law firm.  The insurer asserted that the prior knowledge condition of the policy, which applied if the insured had a basis “to foresee that any . . . Wrongful Act or Related Act or Omission might reasonably be expected to be the basis of the Claim” prior to the policy’s inception, was triggered once the firm failed to timely accept the settlement demand.

The court concluded that the insurer had a duty to defend.  The court acknowledged that the firm’s alleged failure to accept the settlement demand occurred prior to the policy period.  However, the court noted that the complaint made additional, general allegations of wrongdoing by the firm at an unspecified time.  Because the court concluded that at least some of these allegations potentially occurred after the policy incepted, it held that it could not determine that the prior knowledge condition applied to preclude coverage at the duty-to-defend stage.  It therefore affirmed the district court’s decision to grant the insured’s motion to dismiss the insurer’s declaratory judgment claims relating to the duty to defend.