Liability policies commonly contain exclusions precluding coverage when the insured knew or should have known that wrongful acts occurring prior to a policy’s effective date could later result in a claim. In Alps Property & Casualty Insurance Company v. Kalicki Collier, LLP, No. 319CV00709MMDCLB, 2021 WL 1032290, at *1 (D. Nev. Mar. 17, 2021), the United States District Court in Nevada recently granted an insurer’s motion for summary judgment based on such an exclusion. The court, applying a “subjective-objective” test, ruled that the exclusion applies where (1) the insured had knowledge of the relevant suit, act, error, or omission and (2) the suit, act, error, or omission might reasonably be expected to result in a claim or suit.

In Alps, a law firm was hired to confirm a client’s status as the trustee of certain trusts and to assist the client in recovering property that had been improperly taken from those trusts. The law firm successfully petitioned to have the client confirmed as the trustee and later circulated a draft settlement agreement under which the possessor of the trust property would return it. But the possessor later learned that the applicable statute of repose barred any claims against her and refused to sign the agreement.

Although the statute of repose ran about eight months after the client had retained the law firm, the law firm advised the client that it was still possible to bring claims against the possessor. Subsequently, in 2017 and 2018, the law firm filed lawsuits against the possessor on the client’s behalf. The first case was dismissed in 2017 for lack of personal and subject matter jurisdiction. The second case was dismissed in 2019, with prejudice, based on the statute of repose.

In December 2018, the law firm completed an application for the malpractice insurance policy at issue. This was after the law firm knew about the statute of repose, but before the court dismissed the client’s case on that basis. On the application, the law firm responded “no” to questions asking whether the firm was aware of any errors or omissions that could reasonably be expected to be the basis of a claim. The application also advised that any claim arising from an error or omission that should have been disclosed would be excluded from coverage. The insurer issued a claims made and reported policy to the law firm, effective January 9, 2019 to January 9, 2020.

Under the policy, a “Wrongful Act” included an “[a]ct, error, or omission in Professional Services that were or should have been rendered by the insured.” The policy provided coverage for Wrongful Acts only if “[a]t the Effective Date of this Policy, no Insured knew or reasonably should have known or foreseen that the Wrongful Act might be the basis of a Claim[.]” The policy also excluded coverage for any Wrongful Act that occurred prior to the policy’s effective date if “any Insured gave or should have given to any insurer, notice of a … Potential Claim arising from or in connection with the Wrongful Act ….”[1]

In August 2019, the malpractice lawyer for the law firm’s now former client sent a letter to the firm advising that the former client intended to sue them for malpractice if the firm and the former client could not reach a settlement. The law firm sent notice of the malpractice claim to its insurer. The insurer provided a defense to the law firm and later filed a declaratory relief action regarding coverage.

The court in the declaratory relief action granted the insurer’s motion for summary judgment, based on the policy’s prior knowledge exclusion: “the undisputed facts show that [the law firm] knew about the statute of repose issue, and that it was likely fatal to [the client’s underlying] case, before [the firm] completed the Policy application…. [A] reasonable attorney would have known the statute of repose issue might result in a malpractice lawsuit like the one [the client] eventually filed.” The court rejected the law firm’s argument that it effectively did not know that it could be subject to a Claim for a Wrongful Act until it received its former client’s demand letter:  “[I]n attempting to limit Claim, Potential Claim, and the prior knowledge exclusion in the Policy to a demand letter threatening a lawsuit or the actual filing of a lawsuit—and their related arguments that those terms are ambiguous—the Lawyer Defendants attempt to re-write the Policy in a way unreasonably favorable to them. But the Court cannot do that.”

The Alps decision affirms straight-forward policy language that precludes coverage when an insured knows it committed a wrongful act prior to the inception of a claims made policy and knew or should have known that its conduct would give rise to a claim.  In analyzing coverage, the claim professional should first determine whether the facts show that the insured knew it had committed a wrongful act prior to the policy’s inception. If so, the claims professional should then determine whether that wrongful act could reasonably be expected to result in a claim or a suit.

[1] The court found the language for these exclusions to be unambiguous.