Coverage Barred under “Known Risk” Exclusion Where Applicant for Insurance “On Notice” of Potential Malpractice Claim

Applying District of Columbia law, the United States Court of Appeals for the District of Columbia Circuit affirmed summary judgment in favor of an insurer based on a claims-made policy’s “known risk” exclusion where a law firm was on notice of, but failed to disclose, a potential malpractice claim in its application for insurance. Chicago Ins. Co. v. Paulson & Nace, PLLC, 2015 WL 1782273 (D.C. Cir. Apr. 21, 2015). In addition, the court affirmed that the insurer had not waived its right to deny coverage because it invoked the exclusion when it gained actual knowledge of the alleged malpractice.

In 2006, a law firm filed two medical malpractice complaints on behalf of a girl who was paralyzed during surgery. The first, timely complaint was dismissed based on a captioning error, and in June 2007, the same Virginia state court dismissed the second complaint with prejudice on statute of limitations grounds. One month later and while a state court appeal was pending, the firm applied for and obtained a claims-made professional liability insurance policy.  In the application, the firm’s sole member stated that there were no “circumstances which may result in a claim being made against his firm.” The law firm advised the insurer of the incident in May 2009, but it represented that the potential malpractice had occurred in 2008. Two years later, during its investigation of the claim, the insurer discovered the caption error and soon after reserved its rights to deny coverage under the policy’s known risk exclusion. After the claimant prevailed in her legal malpractice action against the firm, the insurer brought a declaratory judgment action and was granted summary judgment that coverage was barred based on the exclusion.

In affirming the district court decision in its entirety, the Court of Appeals first determined that a reasonable attorney under the circumstances would have been on notice of the potential malpractice claim at the time the firm applied for coverage. In finding “no triable question” with respect to whether the firm had a duty to inform the insurer of the caption error, the court rejected the firm’s argument that it expected the error to be corrected on appeal as irrelevant. The court also affirmed that expert testimony was unnecessary, finding that the attorney’s lack of care was so “obvious” that that a lay juror could find negligence as a matter of “common knowledge.”

Next, the court rejected arguments that the insurer had either forfeited or waived its right to deny coverage. In particular, the court declined to adopt the firm’s position that the insurer forfeited its right to deny coverage by failing to comply with a Virginia statute requiring claimant notification of any disclaimer, affirming that District of Columbia law applied and adding that, in any event, Virginia courts have clearly held that the statute may not be enforced by a policyholder against an insurer.

The court also rejected the law firm’s waiver defense. In so doing, the court found that the insurer did not gain “constructive knowledge” of the procedural error when it first obtained documents that contained dates of the underlying medical malpractice proceedings. Instead, the court concluded that the insurer had no duty “during the preliminary stages of the claim process to sift and verify the information provided by” the firm. Lacking a genuine question as to the insurer’s “actual knowledge” of the error and finding no reason that knowledge should be imputed to the insurer, the court affirmed summary judgment.

Wiley Executive Summary

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