In its recent decision in Entitle Ins. Co. v. Darwin Select Ins. Co., 2013 U.S. Dist. LEXIS 14218 (N.D. Ohio Feb. 1, 2013), the United States District Court for the Northern District of Ohio had occasion to consider whether a title insurer errors and omissions liability policy was triggered by the insured’s indemnity obligations pursuant to a series of closure protection letters.
Darwin insured EnTitle Insurance Company, a title insurer, under a professional liability policy with the following insuring agreement:
The Insurer will indemnify the Insured for Loss, including Defense Expenses, from any Claim or Extra-Contractual Claim first made against them during the Policy Period or any applicable Extended Reporting period and reported in accordance with Section VIII(G) of this Policy, for Professional Liability Wrongful Acts committed on or after the date of incorporation or formation of the Named Insured and prior to the end of the Policy Period.
The policy defined Professional Liability Wrongful Acts, and the related term Professional Services as follows:
2) Professional Liability Wrongful Act- any actual or alleged act, error, omission, misstatement or misleading statement in the performance of or failure to perform Professional Services....by any Insured, or by an individual or entity for whom the Company is legally responsible.
3) Professional Services-services performed by the Company or any Insured Person on behalf of the Company, for a policyholder, customer or client of the Company, pursuant to a policy of insurance issued by, or a written contract with, the Company, in the usual and customary conduct of the Company's business, for a fee or other business consideration.
In connection with its business, EnTitle hired an agency named Direct Title to offer its title insurance product as a “non-exclusive policy issuing agent.” EnTitle offered “closing protection letters,” obligating EnTitle to reimburse its clients for any loss stemming from Direct Title's fraud, dishonesty or negligence in the handling of the closings of title insurance. Direct Title was later discovered to have misappropriated amounts from client escrow funds, and as a result, these clients demanded reimbursement from EnTitle under the closing protection letters. EnTitle, in turn, sought indemnification from Darwin under its errors and omissions policy on the theory that Direct Title had committed Professional Liability Wrongful Acts for which EnTitle was legally responsible. Darwin denied coverage to EnTitle on the basis that EnTitle’s indemnity obligations pursuant to the letters did not arise out of a “Professional Liability Wrongful Act” and that these obligations did not otherwise qualify as covered Loss under the policy.
In considering the coverage issue, the court observed that to qualify as a “Professional Liability Wrongful Act,” there must be an act, error, omission, misstatement or misleading statement either by EnTitle, as the policy’s insured, or by another entity for whom EnTitle was “legally responsible.” Thus, the court focused on the issue of whether EnTitle was legally responsible to its clients for Direct Title’s malfeasance. EnTitle argued that closing protection letters are customary in the title insurance industry, and as such, a practice that Darwin could have expected EnTitle to engage in.
The court agreed that the protection letters were customary in the industry and, in fact, that Darwin knew EnTitle issued these letters. This, however, was not determinative of the coverage issue for the court. Instead, the issue was whether EnTitle was legally responsible for Direct Title’s wrongful act. Darwin argued, and the court agreed, that EnTitle had no legal responsibility to its clients resulting from Direct Title’s malfeasance. Instead, EnTitle’s liabilities were a matter of contract. The court recognized a distinction:
The issuance of [closing protection letters] did not make EnTitle legally responsible for Direct Title. Instead, the [closing protection letters] made EnTitle contractually responsible. A contractual obligation to pay is not the same as a legal obligation to pay … In addition, even with EnTitle's contractual right to inspect the accounts of Direct Title, the right to inspect an agent's accounts does not demonstrate the control necessary to hold a title insurer liable for the agent's mismanagement of escrow funds.
The court went on to conclude that EnTitle’s obligations under the protection letters did not qualify as “Loss,” a term expressly defined to exclude “amounts due under any contract.” Further, the Darwin policy excluded coverage “for actual or alleged liability under any express contract or agreement.” The court agreed that this exclusion applied. The court also identified a moral hazard in allowing EnTitle to insure contractual obligations such as those set forth in the protection letters, explaining:
A company could enter into a contract safe in the assumption that if he later decides to engage in an act which might be considered a breach, the insurance company will step forward to cover the consequences of his act if he was wrong; and if he was right, he still walks away with no consequence to himself. Such a practice is inimical to the entire concept of insurance.