Dishonesty Exclusion Does Not Preclude Insurer’s Duty to Defend Where Underlying Complaint Does Not Allege Knowing or Willful Conduct

The United States District Court for the District of Maryland, applying Maryland law, has held that a dishonesty exclusion does not apply to preclude an insurer’s duty to defend where an underlying complaint does not allege that the insured committed certain acts “knowingly or willfully” and does not contain any state of mind allegations against the insured.  Cornerstone Title & Escrow, Inc. v. Evanston Ins. Co., 2014 WL 2215822 (D. Md. May 28, 2014).  The court also held that an exclusion for claims arising out of the Real Estate Settlement Procedures Act (RESPA) or “any similar state or local legislation” did not apply where the underlying alleged violations of a state consumer protection law are not similar to RESPA.

A state attorney general sued the policyholder, a title insurer, and ten co-defendants, seeking restitution and alleging that the defendants defrauded homeowners on the brink of foreclosure through sale-leaseback agreements whereby homeowners sold their houses to the co-defendants only for them to rent the houses back to the homeowners at inflated rates.  The policyholder allegedly provided settlement services for the sale-leaseback transactions and failed to deliver the sale proceed checks to the homeowners.  The attorney general sought to hold the policyholder responsible for its own acts and those of the co-defendants, eventually reaching a settlement under which the policyholder paid $100,100 in restitution.  After the insurer denied coverage for the claim, the policyholder filed suit against the insurer, alleging breach of its duties to defend and indemnify the insured.

The district court originally held that a personal profit exclusion and conversion exclusion precluded a duty to defend.  On appeal, the United States Court of Appeals for the Fourth Circuit reversed and remanded the case to the district court to consider the applicability of the dishonesty exclusion and RESPA exclusion.  (A prior Executive Summary article addressing the Fourth Circuit’s opinion can be found here.)

On remand, the district court first addressed the dishonesty exclusion, which barred coverage for claims “based upon or arising out of any dishonest, deliberately fraudulent, malicious, willful or knowingly wrongful act or omission committed by or at the direction of the Insured.”  The court noted that, as to the acts of the insured title insurer, the underlying complaint only alleged that the insured delivered the settlement checks to the other co-defendants and that the statutory violations at issue were not “by or at the direction of the Insured.”  The court also stressed that neither of the statutes at issue – i.e., the Maryland Consumer Protection Act (CPA) and Protection of Homeowners in Foreclosure Act (PHIFA) – “require that a defendant acted knowingly or willfully in order to be held liable” and that the underlying complaint “does not specifically attribute any state of mind to [the insured]” such that any potential liability would not necessarily implicate the dishonesty exclusion.  Based on this reasoning, the court held that “there remains a potentiality—however slight—that those claims may fall outside of” the dishonesty exclusion.

Next, the court held that the exclusion precluding coverage for claims “based upon or arising out of [RESPA] or any similar state or local legislation” did not apply to relieve the insurer of its duty to defend.  The court recognized that, while RESPA regulates real estate settlements and PHIFA and the CPA regulate aspects of real estate transactions, PHIFA regulates foreclosure consulting services and the CPA affects consumer goods, services, and contracts.  The court held that “[a]lthough all three may share the ultimate goal of protecting consumers, vague coincidence of purpose is plainly not what is meant by the exclusion.”


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