Prior Knowledge Provisions Barred Coverage for Malpractice Claim Based on Pre-Policy Sanctions and Default Judgment

The Montana Supreme Court has held that there was no coverage under a lawyers professional liability policy for a client’s malpractice claim because the lawyer knew of and failed to disclose, prior to the insured law firm’s procurement of the policy, the sanctions and default judgment that were the bases of the client’s claim.  ALPS Prop. & Cas. Ins. Co. v. Keller, Reynolds, Drake, Johnson & Gillespie P.C., 2021 WL 688561 (Mont. Feb. 23, 2021).  The court also held that there was no coverage under the policy’s “innocent insured” provision, and that the common law “innocent insured” and “reasonable expectations” doctrines did not preserve coverage for other members of the insured firm.

The insured lawyer represented the client in two related lawsuits that began in 2008 and 2009.  In July 2014, the court sanctioned the client for discovery abuses in the first lawsuit.  In August 2015, the lawyer failed to file an answer in the second lawsuit, and default judgment was entered against the client in September 2015.  In April 2016, another member of the firm learned of the default judgment and provided notice of a potential claim to the insurer.  The client filed a malpractice suit in September 2016.  The insurer subsequently filed an action for declaratory judgment seeking a determination that it had no duty to defend or indemnify.

The insurer issued a claims-made-and-reported policy to the firm for the December 12, 2015 to December 12, 2016 policy period.  The application process required each member of the firm to complete and sign an individual supplement, which included the following question: “Are you aware of or do you have knowledge of any fact, circumstance, act, error or omission that could reasonably be expected to be the basis of a claim against you, regardless of the merit of such claim?”  All members of the firm answered “No.”

In the ensuing coverage litigation, the Montana Supreme Court held that the prior knowledge provisions in the policy precluded coverage for the malpractice suit.  The court determined that the policy provided coverage only if “at the Effective Date of [the] Policy, no Insured knew or reasonably should have known or foreseen that the act, error, [or] omission . . . might be the basis of a Claim[.]”  The court rejected the firm’s argument that there was coverage for the firm’s other members, who did not know of the sanctions and default judgment prior to the policy’s inception.  The court explained that the policy did not allow a claim to be divided into parts based on the knowledge of the firm’s members.  The court pointed out that, prior to the policy’s effective date, the lawyer knew or reasonably should have known or foreseen that his acts and omissions in the course of his representation of the client might be the basis of a claim.

The court also determined that the policy excluded any claim for “[a]ny act, error, [or] omission . . . that occurred prior to the Effective Date” if, prior to the effective date, “any Insured gave or should have given, to any insurer, notice of a Claim or potential Claim arising from the act, error, [or] omission.”  The policy also precluded coverage if “[t]here [was] an earlier-incepting policy . . . that provide[d] coverage . . . or would have provided coverage if the Insured’s obligations under that policy had been complied with[.]”  The court determined that the lawyer failed to disclose the potential claim in the application, and that the lawyer should have also given notice to the firm’s insurer for the previous policy period.  Because the lawyer failed to notify the insurers, these exclusions precluded coverage.

The court also concluded that the policy’s “innocent insured” exception to the “fraud” exclusion did not apply to preserve coverage.  Although the other firm members did not know of the lawyer’s wrongful conduct, there were no allegations in the malpractice suit that the lawyer’s actions were dishonest, fraudulent, malicious, or intentionally wrongful, so the “fraud” exclusion and its “innocent insured” exception did not apply.

In addition, the court held that the common law “innocent insured” and “reasonable expectations” doctrines did not provide a basis for coverage.  First, the “innocent insured” doctrine did not apply because the doctrine could not displace the clear provisions of the policy, which directly addressed the applicability of the doctrine with respect to the insurer and insureds.  The doctrine “cannot be used to create coverage for [the client’s] malpractice claim when it otherwise would not exist.”  Second, the court opined that the “reasonable expectations” doctrine did not apply because “no reasonable attorney would expect an insurer to cover a malpractice claim that existed prior to the inception of the policy when the malpractice was known to an attorney in the firm,” and that such an expectation conflicts with the policy language.

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