United States: Latest Case Law On Coverage Issues Affecting Professional Liability And Director & Officers Insurance

Originally published in Mealey’s Litigation Reporter

Professional Liability and Directors & Officers insurance policies are generally claims-made policies that restrict coverage to the policy period in effect at the time the claim is asserted against the insured, irrespective of when the alleged damage or injury occurred; or claims-made-and-reported policies, which, besides requiring claims be asserted during the policy period, additionally require the insured report the claim to its insurer during the policy period or the policy's extended reporting period. Such policies provide an insured with a lower cost insurance product than afforded by an "occurrence"-based policy, because the policies allow an insurer to fix within the policy period any potential or actual claims to which the policy may apply.

Some of the common coverage issues raised by these policies include: (1) notice of claim requirements; (2) the effect of the insured's knowledge of a potential claim prior to the policy period; and (3) the number of claims/limits triggered. Case law developments for the past year in these areas are discussed below. Also discussed are waiver and the right to assert estoppel against an insurer.

II. Common Coverage Issues

A. Claims-Made (-And-Reported) Requirement

Claims-made-and-reported policies require that notice be given during the policy period itself or within any other time limits specified in the policy. The notice provision of a claims-made-and-reported policy serves a materially different purpose from the notice provision in an occurrence policy. Whereas giving notice in occurrence policies is only a condition of the policy, in claims-made-and-reported policies the trigger of coverage depends on the claim both being made and reported to the insurer during the policy period or an extended reporting period. The purpose of the reporting requirement in claims-made-and-reported policies is to provide the insurer with certainty that its liability for risks stops after a specified date. This feature also permits insurers to more accurately fix reserves for future liabilities and to compute premiums with greater certainty. The reduction in the insurer's potential liability has the general risk management benefit of reducing the cost of such coverage to the insured.

Among the issues that continue to be addressed by courts throughout the nation are what constitutes sufficient notice of a claim, the effect of the insured's failure to provide notice of a claim, form of notice and whether an insurer must demonstrate prejudice before denying coverage when the insured fails to comply with a claims-made-and-reported policy's notice provision. As discussed below, except in states where state statutes supersede the notice provision of a claims-made-and-reported policy, courts have generally held that the notice provision of a claims-made-and-reported policy must be strictly enforced. See Max H. Stern, William S. Berman, and Helen H. Chen, Recent Developments in Coverage Issues Affecting Claims-Made Policies, Mealey's Litigation Report: Insurance, Vol. 17, # 36, July 22, 2003.

1. What Constitutes A Claim

What constitutes a claim triggering coverage under directors and officers policies and professional liability policies depends on how the term "claim" is defined and construed. Generally, a claim is a demand as of right, i.e., a demand for monetary compensation, or a demand for services arising out of an insured's negligent act, error or omission, but not a request for information, or a request to complete unfinished services.

The United States Court of Appeals for the Eleventh Circuit very recently held that a letter from the insured attorney to the insurance company, indicating that a client had concerns about the attorney’s representation that could potentially result in litigation, only served as notice of a potential claim. Clarendon Nat’l Ins. Co. v. Muller, 2007 U.S. App. LEXIS 13393, at * 2-3 (11th Cir. June 8, 2007). The policy defined a claim as "a demand received by the Insured for money or services arising out of an act or omission, including personal injury, in the rendering of or failure to render legal services," and the court held that coverage was only available for actual claims reported during the extended reporting period. Because the insured’s letter did not state a claim, only a potential claim, notice triggering coverage was therefore not provided within the extended reporting period. Id. at *3.

Many directors and officers and professional liability policies require that an insured provide written notice of a claim to the insurer. Such provisions have generally been upheld, but the form of the insured’s notice sometimes comes into question.

An Illinois federal court recently took a strict position on reporting requirements when it recently found that a letter to the insurance company stating that the insured was considering filing a Chapter 11 bankruptcy petition and that it expected claims to be filed against it as a result was not sufficient notice of a potential claim to trigger coverage when the terms of the directors and officers policy required the insured to list the "circumstances and reasons for anticipating" a claim, as well as the "dates, persons, and entities involved." Chatz v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, 2007 U.S. Dist. LEXIS 27536, at *14-15 (N.D. Ill. Apr. 12, 2007).

A Tennessee Court of Appeals rejected the adequacy of telephonic notice where the professional liability insurance policy stated a claim "shall be deemed to have been reported when written notice of such Claim is received by the Company or its authorized agent." Marlin & Edmonson, P.C. v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, 2005 Tenn. App. LEXIS 811, at *4 (Tenn. Ct. App. Dec. 22, 2005). Upon being notified about a potential lawsuit, the insured contacted its insurance broker to get permission to enter into a tolling agreement to extend the statute of limitations; the broker later stated that the insurer had given permission for the agreement. Id. at *5. The insured never sent direct written notice of the claim to the insurer. Id. at *19-20. Although one of the insurer’s employees testified that she may have had a telephone conversation with the broker regarding the tolling agreement, the conversation did not constitute sufficient notice because it was not in writing. Id. at *5-6. Further, the written document sent to the broker did not constitute notice to the insurer’s authorized agent because the broker had no direct authority to write policies for the insurer. Id. at *21. Therefore, the notice provision of the insurance policy was not satisfied and the insurer was entitled to deny coverage. Id. at *22-23.

The United States District Court for the Northern District of Iowa held that an email sent to the insurer’s claim director by its insurance agent, notifying the insurer of a claim against the insured that had been filed three days earlier, satisfied the written notice provision of a claims-made professional liability policy. Nat’l Union Fire Ins. Co. of Pittsburgh P.A. v. CBE Group, Inc., 2006 U.S. Dist. LEXIS 14474, at *13-14 (N.D. Iowa Mar. 10, 2006).

Because notice of a claim is fundamental to the underwriting basis for claims-made or claims-made-and-reported policies, courts generally have continued to hold that failure to provide timely notice precludes coverage. The majority of courts also hold that the insurer is not required to show prejudice from the late notice in order to deny coverage.

A Tennessee federal court recently explained the principles for the proper application of conditions to late notice under claims-made policies. The Tennessee Supreme Court had previously adopted the notice-prejudice rule for occurrence policies, holding that the insured’s failure to comply with the policy’s notice provisions can be excused if it is shown that the insurer was not prejudiced by the delay. See Wallace v. Gen. Star Indem. Co., 2007 U.S. Dist. LEXIS 40202, at *12 (E.D. Tenn. June 1, 2007) (citing Alcazar v. Hayes, 982 S.W.2d 845, 856 (Tenn. 1998). However, the United States District Court for the Eastern District of Tennessee declined to apply the notice-prejudice rule from occurrence policies to claims-made policies, explaining that to do so would "defeat the purpose of ‘claims-made’ policies, and in effect, change such a policy into an ‘occurrence’ policy." Id. at *14-15. The court noted that the policy reasons for the notice-prejudice rule, such as the public disapproval of allowing insurance companies to deny coverage based on technicalities, do not apply to claims-made policies, where the insured has chosen to benefit from the lower premiums associated with such policies in exchange for the stricter notice requirements. Id. at *16-17.

The Fifth Circuit of Appeals took a strict view on this issue last year. A letter demanding "consideration and adjustment" for damages, providing the amount of the damages, suggesting an amount of payment by the company, and threatening litigation if consideration was not made, constituted a demand for purposes of the company’s D & O insurance policy. Precis, Inc. v. Fed. Ins. Co., 184 F. App’x 439, 441 (5th Cir. 2006). The court then held that a delay of nine months between receipt of the claim and reporting allowed the insurer to deny coverage since reporting was not made "as soon as practicable." Id. at 441-42. Although the company argued that the insurer was required to show prejudice, the court held that an insurer is not required to show prejudice from late notice to avoid coverage under a claims-made policy making timely notification a condition precedent to coverage. Id. at 442.

However, a Mississippi court took a much more permissive view of the requirement last year. A healthcare professional liability insurance policy provided claims-made coverage only, and limited coverage to "claims first made against an Insured during the policy period or any extended reporting period." Jones v. Lexington Manor Nursing Ctr., 480 F. Supp. 2d 865, 867 (S.D. Miss. 2006). A suit was filed against the nursing home two days prior to the end of the extended reporting period. Id. The court distinguished between claims-made and claims-made-and-reported policies, indicating that unless the terms of the policy expressly require reporting during the appropriate period, reporting is not required for a claims-made policy. Id. at 868. The court held that the filing of a lawsuit constituted a claim and that the insurance company was required to provide coverage. Id. at 870.

The United States District Court for the Northern District of Illinois earlier this year held that a statute requiring the insurer to provide notice "[w]ithin 30 days after the liability insurer knew or should have known of the coverage defense" applies to a defense based on the insured’s failure to comply with the policy’s notice provisions. Chatz, supra, 2007 U.S. Dist. LEXIS 27536, at *18-19.

In an issue related to the notice and reporting requirements, many policies also contain coverage limitations that negate coverage for acts occurring prior to the policy period where there may be reason to believe an actual claim will develop. This issue arises in factual contexts concerning whether an insured has knowledge of a claim prior to a specified date.

In a case where the policy required that "the insured had no basis to believe that the insured had breached a professional duty," the Court of Appeals for the Third Circuit last year held that the plain meaning of the clause gives rise to a two-step inquiry. Colliers Lanard & Axilbund v. Lloyds of London, 458 F.3d 231, 237 (3d Cir. 2006). First, in the subjective step, the court asks whether the insured knew certain facts. Second, in the objective step, the court asks whether a reasonable lawyer knowing those facts would have a "basis to believe that the insured had breached a professional duty." Id. The court noted that this combined inquiry limits the moral hazard for those who attempt to disingenuously convince a court that they were not aware that a claim could result from their errors. Id. at 240.

The New Jersey Supreme Court this year illustrated how the inquiry under this type of exclusion can be a matter of law. The insurance company denied coverage for a legal malpractice claim on the basis that the insured had a reasonable basis to foresee the claim but failed to disclose it on the claims-made policy application. Liberty Surplus Ins. Corp. v. Nowell Amoroso, P.A., 916 A.2d 440, 440 (N.J. 2007). The trial court and appellate court that had ruled on the underlying case had found that it was not filed within the statute of limitations and dismissed it. Id. at 444. The court held that although both parties agreed that a subjective standard determined whether the firm could foresee a claim against it, the rulings of the court that the statute of limitations had passed meant that the court would have to "ignore reality" to believe that the firm did not know a claim was foreseeable. Id. at 450.

An Arizona federal court likewise took a strict view of prior knowledge existing as a matter of law in a case last year. After submitting an application for insurance, but prior to the issuance of the policy, the insured received a letter from a client indicating his intent to end the firm’s representation and requesting a return of all his files and a write-off of all his bills due to his attorney’s failure to communicate with him. James River Ins. Co. v. Hebert Schenk, P.C., 2006 WL 467938, at *1 (D. Ariz. Feb. 27, 2006). After receiving the letter, the firm received a statement of conditions from the insurance company requiring an update of the application and a statement that the firm did not know of any circumstances that might result in claims against the firm. Id. The firm confirmed that it had "no known claims and no known claims incidents since the time of the application for legal malpractice coverage to date." Id. The court noted that legal fraud can be found where "a question on an insurance application seeks facts which are presumably within the personal knowledge of the insured and are such that the insurer would naturally have contemplated that the answer represented the actual facts, and the answer is false." Id. at *2. The application asked a question of fact, and the insured’s failure to answer it with information regarding the potential claim constituted legal fraud. Id. at *3. The insurance company was therefore entitled to deny coverage. Id. at *4.

In an interesting development for litigation of the prior-notice issue, an Illinois appellate court last year found this provision to entitle the insurer to broader discovery. In negotiating the terms of its professional liability insurance policy, which included a standard provision that the policy excluded claims that the Chief Financial Officer could reasonably have foreseen, the insured changed the policy language so as to exclude any claims arising out of prior conduct that the General Counsel knew about on the effective date. Sharp v. Trans Union L.L.C., 845 N.E.2d 719, 724 (Ill. App. Ct. 2006) (emphasis added by court). When the insured filed claims for coverage based on lawsuits that had been filed against it, the insurer requested documents that the insured refused to produce due to attorney-client privilege. Id. at 725. The court held that because the policy defined an excludable claim in terms of the general counsel’s knowledge, the only way to determine what counsel knew on the effective date was to require production of otherwise privileged documents. Id. at 727.

In the Supreme Court of Delaware earlier this year, the insurance company successfully argued that "when a demand is made in the form of a lawsuit, one lawsuit equals one ‘Claim,’ which is defined by the policy as "any written or oral demand for damages or other relief [or] any civil . . . proceeding." AT&T Corp. v. Faraday Capital Ltd., 918 A.2d 1104, 1107 (Del. 2007). The insured argued that the number of "Claims" in a complaint "equals the aggregated number of causes of action that arise from the same alleged underlying wrongful conduct." Id. at 1108. The court agreed with the insured, holding that each cause of action in the lawsuits for which coverage was requested could constitute a separate claim. Id. at 1109.

A New York federal decision last year also tended toward aggregating allegedly separate claims. A claim for securities fraud was first made against the insured during the coverage period. Zahler v. Twin City Fire Ins. Co., 2006 U.S. Dist. LEXIS 14263, at *3-4 (S.D.N.Y. Mar. 30, 2006). Subsequently, when the insured was covered by a different insurance company, a claim was filed against it alleging fiduciary breaches under ERISA. Id. at *5. Both directors and officers policies were claims-made policies that only applied to claims first made during the policy period. Id. at *13-14, 21. The second insurer argued that the ERISA claim arose from wrongful acts that were interrelated with wrongful acts leading to the securities fraud claim. It denied coverage because its policy contained a provision excluding coverage for interrelated wrongful acts that were first claimed against the insured during a previous policy period. Id. at *7-8. The first insurer argued that the claims were not interrelated and that the second insurer was responsible for coverage of the ERISA claim because it arose during the second policy period. Id. at *8. Both policies defined interrelated wrongful acts as acts involving connected facts, circumstances, situations, transactions, or events. Id. at *14-15, 20-21. The court found that the facts in the securities fraud and ERISA cases were "in many cases identical," because they alleged the same class period and the same misleading statements. Id. at *17-18. The plain language of the second insurance policy dictated that the second insurer be permitted to deny coverage under the interrelated wrongful acts and prior notice provisions. Id. at *19-20. For the same reason, the first insurer was required to provide coverage since the ERISA claim arose from a wrongful act interrelated to the securities fraud claim, which arose during the first insurance policy period. Id. at *23-25.

A Nevada federal court recently affirmed the uphill battle faced by an insured trying to argue for a waiver of coverage defense. Under Nevada Law, to establish estoppel, the party asserting estoppel must show that the other party intended its conduct to be relied on and that the asserting party relied to its detriment. Prime Ins. Syndicate, Inc. v. Damaso, 471 F. Supp. 2d 1087, 1097 (D. Nev. 2007). More specifically, the asserting party must show that the other party’s conduct induced it to change its position. Id. at 1098. The fact that the insurance company paid the insured’s legal bill did not estop it from later denying coverage because of late notice under the claims-made professional liability insurance policy. Id. at 1097-98. Additionally, the court adopted the majority rule that waiver "cannot be used to extend the coverage or scope of the policy." Id. at 1098.

The latest cases on coverage issues affecting directors and officers policies and professional liability policies generally follow established rule of law governing claims-made or claims-made-and-reported policies, but the exception of a few cases that seemed to have expanded or relaxed established rules regardless of the clarity of the policy language or the special characteristics of claims-made or claims-made-and-reported policies, demonstrate that this area of coverage law continues to evolve.

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