Claims Made During Policy Period Barred When Arising Out of Facts Disclosed or Required to be Disclosed in Application

In Crown Capital Securities v. Endurance Amer. Specialty Ins. Co. (No. B256241, filed 4/10/15), a California appeals court affirmed summary judgment for a professional liability insurer on a finding that coverage was barred for claims that had not yet been made against the insured when the policy incepted, based on an exclusion contained in the application for claims arising from the same facts underlying a prior claim that was reported in the application.

The insured was a securities firm that recommended investments in various business entities. One such entity filed for bankruptcy, and the bankruptcy examiner issued a detailed report that the bankrupt entity had been engaged in a Ponzi scheme. A disgruntled investor complained to the securities firm attaching a copy of the bankruptcy examiner’s report, and initiated securities arbitration.

Meanwhile, the securities firm was in the process of applying for professional liability insurance. In response to a question whether any claims, suits or proceedings had been made against the firm during the past five years, the firm’s representative answered “yes.” He then answered “no” to a question whether the firm was aware of any facts or circumstances that might result in a claim. The application was accompanied by a loss run from the previous insurer identifying the disgruntled investor’s claim.

The application also contained an exclusion stating that: “It is agreed that any claim or lawsuit against the Applicant, or any principal, partner, managing member, director, officer or employee of the Applicant, or any other proposed insured, arising from any fact, circumstance, act, error or omission disclosed or required to be disclosed in response to Questions 9, 10 and/or 11, is hereby expressly excluded from coverage under the proposed insurance policy.” The application was stated to become part of the policy as though physically attached.

After the policy was issued and became effective, three more disgruntled investors came forward and commenced arbitration against the firm based on the same Ponzi scheme investment. Coverage was denied, and the securities firm sued for bad faith, contending that the three subsequent claims should have been covered. But the court granted summary judgment for the insurer, which was upheld on appeal.

The appeals court said that the securities firm was aware of the bankruptcy, aware of the examiner’s report of a Ponzi scheme, and aware of the fact that one investor had already made a claim when the application was submitted. The court found that the firm was, therefore, aware of facts that might give rise to additional claims, and that should have been admitted in the application.

The court rejected an argument that the three subsequent claims did not “arise out of” the same facts as the first claim, which was required to be, and had been, disclosed in the application. Citing Davis v. Farmers Ins. Group (2005) 134 Cal. App. 4th 100, and Acceptance Ins. Co. v. Syufy Enterprises (1999) 69 Cal. App. 4th 321, the Crown Capital Securities court stated: “California courts have consistently given a broad interpretation to the terms ‘arising out of’ or ‘arising from’ in various kinds of insurance provisions. It is settled that this language does not import any particular standard of causation or theory of liability into an insurance policy. Rather, it broadly links a factual situation with the event creating liability, and connotes only a minimal causal connection or incidental relationship.”

The Crown Capital Securities court also declined to find coverage on an argument that the latter three claims involved different causes of action than the first, saying that although the investors were advancing different theories of liability, all three concerned purchase of the same investments, and the securities firm was aware of facts that might lead to claims being made based on those investments. Thus, the later claims were still barred from coverage by the application’s exclusion, which had become part of the policy.

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April 14, 2015