Prior Knowledge Condition Could Apply to Bar Coverage

In a victory for Wiley Rein’s client, a New Jersey federal court has held that a prior knowledge condition could apply to bar coverage for an underlying claim arising out of a breach of professional duty known to the insured prior to the inception date of the policy, even where the policy at issue was the first and last policy issued to the firm. Darwin Nat’l Assurance Co. v. Fahy Choi, LLC, No. 13-7197 (D.N.J. Dec. 18, 2015).

A lawyers’ professional liability insurer issued a claims-made-and-reported malpractice liability policy to a law firm for the period of August 1, 2012 to August 1, 2013. The insurer had not previously issued an insurance policy to that firm. During the policy period, a former client sued the firm. The underlying complaint alleged that the firm made misrepresentations to the client about the status of a lawsuit filed by the firm on behalf of the client. The conduct alleged in the lawsuit occurred between 2010 and 2012.

The firm reported the suit to its insurer during the policy period and sought defense and indemnity coverage. The insurer denied coverage, citing a prior knowledge condition in the policy. The prior knowledge condition was written directly into the insuring agreement of the policy and provided that it was a condition precedent to coverage that “no Insured had any basis . . . to believe that any Insured had breached a professional duty” for a “Claim” based on a “Wrongful Act” that occurred “prior to the inception date of the first policy issued by the Insurer if continuously renewed.”

In the ensuing coverage litigation, the parties cross-moved for summary judgment. The court granted the insurer’s cross motion for summary judgment, holding that the prior knowledge condition could apply if the insurer showed that the insured had a basis to believe that any insured breached a professional duty prior to the policy’s inception date. The insurer argued that the policy was the “first policy issued by the Insurer” and therefore that the condition applied. The firm argued that because the policy was not renewed, the condition would not apply in any circumstance, focusing on the phrase “if continuously renewed.” The court accepted the insurer’s proposed construction, stating that the condition was not ambiguous, and that the firm’s interpretation would lead to absurd results. The court noted that it would not make sense to have a condition that did not apply if an insurer issued only one policy to an insured.

In addition, the court held that abstention under Burford v. Sun Oil Co., 319 U.S. 315 (1943), was inappropriate as the case dealt with standard issues of contract interpretation. The court also rejected an argument by the firm asserting that New Jersey public policy would bar the application of the prior knowledge condition because an “innocent” third-party purchaser of legal services sued the insured. The court noted that accepting the firm’s argument would result in the prohibition of most contract-based denials of coverage, as a third-party purchaser of legal services would nearly always be “innocent.”

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