Prior Acts Exclusion and Insolvency Exclusion Bar Coverage for Claim Against Broker

A Colorado federal court, applying New York law, has held that a prior acts exclusion and an insolvency exclusion both applied to bar coverage for an arbitration award entered against an insured.  Templeton v. Fehn, 2014 WL 2861832 (D. Colo. June 24, 2014).  The court also concluded that the insurer did not breach its duty to defend.

An insurer issued a professional liability policy to a broker-dealer for the policy period of September 1, 2009 to September 1, 2010.  The policy had a retroactive date of September 16, 2005.  In November 2009, customers initiated an arbitration proceeding against the broker-dealer and an individual broker after they lost their investments in a company that was placed into receivership.  The customers alleged that the broker had sold them unsuitable securities in 2004, when he worked at a different broker-dealer, and again in 2007, when he worked at the insured broker-dealer.  The insurer appointed defense counsel, but the broker-dealer replaced defense counsel with a different firm.  The insurer mistakenly understood that the new defense counsel represented both the broker-dealer and individual insured and, at the broker-dealer’s request, authorized a settlement with the claimants.  The insurer later learned that the claimants settled only with the broker-dealer and that the individual insured did not appear at the arbitration hearing that went forward against him.  The arbitrators entered an award against the individual.  The claimants and individual later settled for $555,000, and the broker sought indemnity coverage for the settlement.

In coverage litigation, the insurer argued that an exclusion for any Claim arising out of “any Wrongful Act occurring on or after the Retroactive Date, which, together with a Wrongful Act occurring on or prior to such Retroactive Date, would constitute Interrelated Wrongful Acts” applied to bar indemnity coverage.  The court agreed that the individual insured’s conduct in 2004 had a “similar factual nexus” to his conduct in 2007 and that the Wrongful Acts thus constituted Interrelated Wrongful Acts.  The insurer was not estopped from raising this exclusion because its reservation of rights letter included a broad reservation of the right to deny coverage at any time and a reference to this exclusion, which was sufficient to prevent the insured from claiming justifiable reliance on the letter.

In addition, the court concluded that an exclusion for Claims arising out of the insolvency or receivership of any company in which the Insured placed funds barred indemnity coverage.  The court noted that the customers’ claims against the broker would not have arisen if the company in which they invested had not become insolvent and placed in receivership.  It was irrelevant that the customers’ unsuitability claims accrued, for statute of limitations purposes, before the company became insolvent and placed in receivership.

Finally, the court concluded that the insurer did not breach its duty to defend.  The insurer initially provide a defense to the broker-dealer and individual broker and understood that the replacement defense counsel was representing both insureds.