Application Exclusion Bars Coverage for Claims Arising from Known, Undisclosed Circumstance

A California Court of Appeal has affirmed a summary judgment in favor of the insurer on defense and indemnity with respect to claims that arose from circumstances known to the policyholder when it applied for professional liability insurance but that were not disclosed to the insurer in the application.  Crown Capital Securities, L.P. v. Endurance American Specialty Ins. Co. (Cal.Ct.App, 2d Dist., Div. 5, 4/10/15).  Because the application stated that a claim is excluded from coverage if arising from any undisclosed circumstance that was required to be disclosed in response to a question asked, and the application requested disclosure of circumstances that may result in a claim, the policyholder was not entitled to coverage for claims arising from the known but undisclosed circumstance.

In Crown Capital, the policyholder seeking coverage was a securities firm that had recommended clients make investments in real estate companies that eventually were determined to be part of a Ponzi scheme, and the investments were lost.   The policyholder firm was the target of one claim and had been provided the findings about the Ponzi scheme at the time it was applying for new claims-made professional liability insurance.  On the application, it was asked to disclose known claims and known circumstances that may result in a claim.  The application further provided that any claim arising out of facts disclosed or required to be disclosed by certain questions were excluded from coverage under the proposed policy.  Although the policyholder firm disclosed the one known claim on a loss run, it did not disclose that it knew of any circumstances that may result in other claims.  When other investors made claims during the policy period, the insurer denied coverage, based on the exclusion in the application.

The Court of Appeal affirmed the trial court’s summary judgment in favor of the insurer.  The court found the exclusion in the application to be unambiguous, and it found that the trial court’s broad interpretation of the scope of the phrase “arising out of” in the exclusion to be correct and consistent with California precedent, including the Davis and Syufy decisions.  Because the newer claims arose out of the Ponzi scheme that was known to the securities firm, and that had the potential to result in other claims, but that was not disclosed in application, the exclusion in the application barred any potential for coverage.  Thus there was no duty to defend or duty to indemnify under the policy.

The Court of Appeal also rejected the policyholder’s argument that the exclusion in the application should only apply to the same cause of action that was asserted in the known, disclosed claim (failure to exercise due diligence) but should not apply to other causes of action (including breach of fiduciary duty, securities laws, unfair competition laws, general negligence, breach of contract, and other causes).  The Court of Appeal found that all causes asserted arose out of the undisclosed circumstance of the recommendation of what turned out to be Ponzi scheme, so there was no potential for coverage for any of the causes of action.

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