Texas Court Holds Prior Knowledge Exclusion in E&O Policy Inapplicable

In its recent decision in OneBeacon Insurance Company v. T. Wade Welch & Associates, et al., 2012 U.S. Dist. LEXIS 178587 (S.D. Tex. Dec. 18, 2012), the United States District Court for the Southern District of Texas had occasion to consider the application of a prior knowledge exclusion in a professional liability policy.
OneBeacon issued a series of lawyers professional liability policies to the law firm of T. Wade Welch & Associates, the first such policy incepting on December 20, 2006. Each of the policies contained a prior knowledge exclusion applicable to “any claim arising out of a wrongful act occurring prior to the policy period if, prior to the effective date of the first Lawyers’ Professional Liability Insurance Policy issued by [OneBeacon] to [the Welch Firm] and continuously renewed and maintained in effect to the inception of this policy period … you had a reasonable basis to believe that you had committed a wrongful act, violated a disciplinary rule, or engaged in professional misconduct; [or] you could foresee a claim would be made against you.”
The T. Wade Welch & Associates firm and various attorneys in the firm (the “Welch Defendants”) were named as respondents in an arbitration brought by a former client, the DISH Network. The Welch Defendants had been representing DISH in a lawsuit preceding the issuance of the first OneBeacon policy. DISH’s arbitration petition alleged, among other things, that in 2005, the Welch Defendants failed to respond to discovery, and withheld this error and also withheld other subsequent, but related, events from its client. This misconduct eventually led to a sanctions motion being made against DISH in February 2007, which the Welch Defendants did not disclose to their client until July 2007, when the sanctions motion against DISH was granted.
Although the sanctions were awarded while the OneBeacon policies was in effect, OneBeacon argued that the prior knowledge exclusion barred coverage for DISH’s malpractice claim since the Welch Defendants knew prior to December 20, 2006 that it had engaged in professional misconduct. OneBeacon further contended that the sanctions were part of a series of related wrongful acts predating the inception of the first policy it issued to the Welch firm. The Welch Defendants argued, on the other hand, that DISH’s damages, and the basis for its malpractice claim, was the July 2007 sanctions order, which occurred while the first OneBeacon policy was in effect. The Welch Defendants further contended that “any acts or omissions prior to the entry of the February 2007 discovery motion and July 2007 discovery order were readily curable and could not, on their own, support DISH’s [malpractice] claim.”
The court agreed that all of the events described in DISH’s arbitration petition were related, but that they constituted “independent wrongful acts.” Specifically, the court concluded that the Welch Defendants engaged in separate acts of professional misconduct after the inception of the 2006 OneBeacon policy when they failed to advise DISH about the pending sanctions motion and failed to correct the alleged discovery deficiencies. In reaching this conclusion, the court rejected OneBeacon’s argument that these acts all related back to misconduct from 2005, which predated the inception of the first OneBeacon policy. In support of this argument, OneBeacon cited to a long line of cases regarding relationship of claims, such as the seminal decision in Continental Casualty Co. v. Wendt, 205 F.3d 1258 (11th Cir. 2000). The court found these decisions distinguishable, explaining:
… these cases do not involved relating independent wrongful acts back to the initial wrongful act so that all wrongful acts fall within a prior knowledge exclusion. Rather, they all deal with whether alleged wrongful acts are related for limits of liability purposes. Thus, they are not on point.
The court ruled similarly with respect to OneBeacon’s argument that all pre-policy and post-policy wrongful acts should be “linked together” and thus all considered to have happened prior to the inception of the first policy. In support of this argument, OneBeacon relied on a “Multiple Insureds, Claims or Claimants” condition stating:
Each wrongful act, in a series of related wrongful acts, will be deemed to have occurred on the date of the first such wrongful act. A series of related wrongful acts includes wrongful acts which are logically or causally connected by common facts, circumstances, situations, events, transactions or decisions and which may involve the same person or organization or class of persons or organizations.
The court concluded that this language was not relevant in considering the application of the prior knowledge exclusion since “the language linking related wrongful acts is in a completely different section of the policies than the exclusions.” The court agreed that OneBeacon’s argument was reasonable, and “perhaps even more reasonable” than the contrary view espoused by the Welch Defendants, which was that the “Multiple Insureds, Claims or Claimants” provision must be read independently of policy exclusions. The court nevertheless agreed that the Welch Defendants argument was “not itself unreasonable,” and as such, there were two reasonable interpretations of the policy, which required the court to construe the policy against OneBeacon. Thus, the court concluded that OneBeacon could not rely on the prior knowledge exclusion to disclaim a duty to defend the wrongful acts that allegedly occurred after the December 20, 2006 inception of the first OneBeacon policy.