Foran Glennon Palandech Ponzi & Rudloff

February 2016

Split 6th Circuit applies subjective knowledge standard to professional liability coverage.

Laura Wetterer

In a 2-1 decision, the 6th Circuit reversed an appeal from the Southern District of Ohio, finding that under a professional errors and liabilities coverage policy, the insured must have subjective knowledge of any existing claims in order for coverage to be barred under an exclusion for knowledge of claims existing prior to the start of coverage.  Mere objective knowledge of potential wrongs will not meet the standard in the policy.


Factual Background. Mulberry Insurance Services, Inc., a wholesale insurance broker, through an agent, sold insurance policies naming AIX Specialty Insurance Company and North American Specialty Company as insurance carriers to National Condo & Apartment Insurance Group (NCAIG), among others. However, neither AIX nor North American issued or approved the policies, meaning Mulberry was essentially selling insurance coverage that did not exist. Beginning in September of 2011, Mulberry received multiple cease-and-desist letters regarding this activity. However, Mulberry applied for professional errors and omissions liability insurance from Maxum Indemnity Corporation on January 31, 2012.  In response to a questionnaire as part of the application, Mulberry denied knowledge of “any potential errors or omissions claims.” The policy contains an exclusion for any claim arising out of or resulting from any wrongful act or personal/advertising injury that “you had knowledge of or information related to, prior to the first inception date of the continuous claims-made coverage with us, and which may result in a claim.”  The policy also contained a duty to defend provision with an exclusion for any suit or action to which the insurance does not apply.  Suit was filed against Mulberry in the spring of 2012 as a result of the nonexistent policies, Maxum thereafter denied coverage and declined to defend on the basis that Mulberry had knowledge of existing claims. On March 20, 2013 Maxum filed suit seeking rescission of the policy or a declaration that they did not have a duty to defend or indemnify.  The district court in the Southern District of Ohio determined that the language of the policy barred coverage. NCAIG appealed.


Discussion. The 6th Circuit first determined that California law applied, a decision which the lower court declined as unnecessary given the similarities between Ohio and California law in this case. The Court deemed California to have the most significant relationship to the Maxum policy, and as such applied California law.


The Court then turned to analyze the meaning of “knowledge” in the exclusion. Maxum argued, and the lower court agreed, that the exclusion applies to all claims where the insured simply had information prior to the coverage period relating to a wrongful act that resulted in a claim. Under that theory, the existence of the cease-and-desist letters were enough to meet the knowledge standard. The letters were sent before the policy period began, and Mulberry failed to notify Maxum of the problems. As such, the lower court found the exclusion applied, and only an objective standard applied – any claims that it should have known existed must be reported.


In the alternative, NCAIG argued that only claims arising from wrongful acts that a party subjectively believed to exist prior to inception of the Policy would result in uncovered claims. In their analysis, the 6th Circuit opined that because the presumption of coverage is so strict, they were unprepared to say that either construction was unreasonable. Therefore, they were obliged to construe the language of the Policy in favor of coverage, thereby adopting NAIC’s argument. The Court noted that Maxum failed to cite any other case law that applied an objective standard to similar language.  Instead, several other courts have found that similar policy language meant to cover only claims that the insured “subjectively anticipated might result in claims.” The Court agreed with the latter, finding that a subjective knowledge standard is appropriate under the contract language.
The Court went on to clarify that Maxum could still evade coverage if they showed that Mulberry was subjectively aware of the potential for suit arising from that unauthorized insurance. However, the cease-and-desist letters alone did not demonstrate such an awareness – they did not demand money or mention any potential lawsuit. Additionally, Maxum did have a duty to defend Mulberry. Under California law, the duty to defend lasts until the lawsuit is concluded or until it is shown that there is no potential for coverage. Any inured who refuses to defend does so at its own risk, the duty depends on facts known to it at the time defense is denied, rather than the ultimate adjudication of coverage. Ultimately, the 6th Circuit reversed the district court’s grant of summary judgment and remanded the case with instructions to enter summary judgment in favor of NCAIG.


Justice Julia Smith Gibbons dissented, arguing that the insurance policy clause is not ambiguous, i.e. not subject to two or more reasonable interpretations. Agreeing with the district court and finding that NCAIG’s reading of the exclusion is strained and unreasonable, the Justice argues that the claims Defendants asserted arose from wrongful acts which Mulberry had information on prior to the insured time period, which is enough to meet the standard set in the exclusion.


Conclusion. The 6th Circuit’s decision establishes a subjective knowledge requirement for exclusions related to knowledge of existing claims, where the policy language is deemed ambiguous.  As such, Insurers should look at existing policy language for similar ambiguities. If the language is similar, when attempting to evade coverage for this lack of disclosure exception, insurers must show that the insured was subjectively aware of the potential for suit prior to the start of coverage.  Simple knowledge of potential wrongful acts will not suffice.


The case is Maxum Indem. Co. v. Drive W. Ins. Servs., Inc., No. 15-3199, 2015 WL 7292722 (6th Cir. Nov. 18, 2015).