First Circuit Enforces D&O Policy’s Known Circumstances Exclusion

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The First Circuit Court of Appeals recently held that a “Known Circumstances Exclusion” in an insured school’s D&O policy barred coverage for an underlying action involving misrepresentations in soliciting a donation.

In The Clark School for Creative Learning, Inc. v. Philadelphia Indem. Ins. Co., 2013 WL 5737339 (1st Cir. Oct. 23, 2013), the court found that Philadelphia Indemnity Insurance Company (“Philadelphia”) had no obligation to reimburse the insured’s defense costs or settlement payments because the underlying action was plainly excluded by the Known Circumstances Exclusion.

The insured, The Clark School for Creative Learning, Inc. (“the School”), located in Danvers, Massachusetts, had over $300,000 in debt in June 2007.  In May 2008, Marcia and Josepha Valenti (parents of three of students) donated $500,000 to the School.  In May 2009, the Valentis sued the School and its director because the School did not follow through on promises it made in soliciting the donation.  The School notified Philadelphia of the lawsuit, for which Philadelphia denied coverage based on the policy’s Known Circumstances Exclusion.

The Valentis and the School eventually resolved the lawsuit.  Shortly thereafter, the School sued Philadelphia for indemnification of its defense costs and settlement payments in the underlying action.  The trial court granted Philadelphia’s summary judgment motion based on the Known Circumstances Exclusion.  The School appealed.

The issue before the appellate court was how to interpret the policy’s “Known Circumstances Revealed In Financial Statement Exclusion,” which barred coverage for any losses “in any way involving any matter, fact, or circumstance disclosed in connection with Note 8 of the [School’s] Financial Statement.”  Note 8, entitled “Insufficient Net Assets,” provided the following:

Subsequent to the date of the accompanying financial statement, in May of 2008 the School was a recipient of a major gift totaling $500,000 (see Note 7).  The donation is unrestricted and will be used to support the School’s general operations as management’s plans for the School’s future are implemented and allowed time to succeed.  Management feels that its plans and the subsequent major gift will enable the School to operate as a going concern.

Note 7 described the Valentis’ gift in greater detail.

Despite the exclusion’s plain language, the School argued that the coverage for the underlying action should be provided because (1) the exclusion was only intended to exclude the School’s financial difficulties, and not the Valentis’ gift; (2) the canon of ejusdem generis required a different reading of the exclusion; and (3) the exclusion’s plain language must give way to the School’s reasonable expectations of coverage.  The First Circuit rejected each of these arguments.

First, the court noted that the exclusion’s plain language was not limited to losses caused by financial difficulties, and the note explicitly referenced the Valentis’ gift.  The court also refused to construe narrowly the exclusion under the canon of ejusdem generis because the School’s proposed interpretation would render certain words in the policy meaningless.  Lastly, the court rejected the School’s argument that the application of the Known Circumstances Exclusion deprived the School of its reasonable expectations of coverage.  The court noted that, “when a contract is not ambiguous, a party can have no reasonable expectation of coverage when that expectation would run counter to the unambiguous language of an insurance policy.”  The First Circuit affirmed the district court’s decision.

Although the First Circuit had little trouble enforcing the Known Circumstances Exclusion, the Clark School decision is a useful illustration of how courts will enforce broad and clear exclusionary language, despite a policyholder’s creative efforts to avoid the exclusion.