Honesty is the Best (Insurance) Policy

08.06.2014

In Blum Collins LLP v. NCG Professional Risks, Ltd., the United States District Court for the Central District of California considered a coverage dispute based upon alleged material misrepresentations and omissions in the policy application.  Finding sufficient grounds for the denial of coverage, the court emphasized that when it comes to insurance, honesty makes for the best policy.

In December 2004, Cynthia Beck retained Craig Collins, a partner with the Collins Law Firm, to represent her in a property dispute.  Approximately three years later, Beck and Collins dissolved their attorney-client relationship and entered into an agreement whereby Collins agreed to allow Beck some time to evaluate her assertions of malpractice and her potential damages (the “Agreement”).  The Agreement further provided that the statute of limitations in the underlying suit was suspended.  Ultimately, the property dispute was resolved with a judgment entered against Beck on October 24, 2007.  On February 1, 2009, Beck’s representative e-mailed the her lawyer alleging that the judgment against Beck was the result of Collins’ malpractice.   On March 26, 2009, the Blum Collins law firm gave notice of the Beck malpractice claim to their insurer.

On July 23, 2008, Collins, on behalf of Blum Collins LLP, had applied for professional liability insurance from the Underwriters of Lloyd’s of London.  The application asked the following question: “After enquiry, are any persons listed in Supplement 1 aware of any circumstances, allegations, tolling agreements or contentions as to any incident which may result in a claim being made against the Applicant or any of its past or present Owners [or] Partners?”  The law firm responded “No.”  The policy also defined several grounds of exclusion on which the defendant could deny coverage.

On January 27, 2011, Beck filed suit against Craig Collins, Blum Collins LLP, and other former attorneys alleging professional negligence and breach of fiduciary duty.  A few weeks later, the plaintiffs forwarded Beck’s complaint to the defendant, invoking the defendant’s duty to defend and seeking indemnification.  The defendant later sent a denial letter advising the plaintiffs that no coverage was available under the policy.  One of the bases for this denial was the plaintiffs’ answer to Question 10.C, which, according to the defendant, constituted a material misrepresentation and omission in the policy application. 

After spending months debating whether the denial of coverage was warranted, the plaintiffs filed a complaint in Los Angeles County Superior Court alleging: (1) breach of insurance policy; (2) breach of the duty of good faith and fair dealing; (3) fraud; and (4) declaratory relief.  The case was later removed to the United States District Court.

The central question before the court was whether the plaintiffs’ failure to give the defendant notice of a potential lawsuit was such a material omission as to warrant the defendant’s refusal to defend, or whether such refusal constituted a breach of contract.  The court flatly rejected the plaintiffs’ attempts to justify their answer to Question 10.C in the application.  Specifically, the court found that the absence of Supplement 1 (which was referenced in Question 10.C) did not relieve the plaintiffs from their obligation to respond to Question 10.C, nor did it impair their understanding of Question 10.C.

The court also rejected the firm’s argument that Blum Collins, LLP, the named assured, did not owe the defendant a duty to disclose since Blum Collins, LLP did not represent Beck or enter into any agreement that could result in a claim.  The court explained that Question 10.C clearly contemplated the possibility that claims might be brought against owners or partners of the law firm.

The law firm also argued that as of the effective date, they did not believe there existed any agreements or contentions that would result in a claim.  The court found that this argument ignored the plain language of the Agreement, which clearly contemplated Beck’s assertions of malpractice and potential damages.  According to the court, the Agreement unequivocally gave the plaintiffs notice that there were potential claims arising out of Collins’ representation of Beck.

Next, the court analyzed whether Blum Collins’ omission was material and warranted the defendant’s denial of coverage.  The court determined that the existence of Question 10.C was itself enough to establish materiality.  Importantly, a truthful answer to Question 10.C would have impacted the defendant’s decision to insure the plaintiffs and the type of policy the defendant would have offered. In short, the court found that the materiality of undisclosed potential lawsuits is obvious.

Blum Collins highlights the importance of full disclosure on insurance applications.  What was, at best, a misunderstanding, and at worst, a blatant misrepresentation, resulted in no insurance coverage for the plaintiffs.  When it comes to completing an application for insurance, courts have high expectations.  Subsequent questions or concerns about missing documents will not excuse a misstatement or omission—applicants are required to answer accurately.  Should an applicant not fully understand any question on the application, he would be wise to seek clarification before responding.