Innocent Insureds Provision Does Not Save Coverage

BRYAN BROS. INC. v. CONTINENTAL CAS. CO. (E.D. Va., Mar. 25, 2010)

Bryan Bros. was an accounting firm that obtained a claims-made policy from defendant with effective dates of July 1, 2008 to July 1, 2009. Deborah Whitworth worked as a part-time accountant clerk for Bryan Bros. from 1999 through February 2009. Beginning in 2002, Whitworth, while an employee of Bryan Bros., made unauthorized withdrawals from accounts of several clients. Whitworth began making withdrawals from Doris Lansing’s account after July 1, 2008. The embezzlement was eventually discovered in February 2009 and was followed by separate litigations filed by the impacted clients. Bryan Bros. sought coverage under the professional liability policy issued by the defendant.

Continental denied coverage. Continental contended that the underlying actions constituted a single claim under the policy. Moreover, Continental maintained that Whitworth was an insured under the policy and had knowledge of facts and circumstances that could give rise to a claim prior to the effective date of the policy, and the failure to disclose this information amounted to a misrepresentation. Bryan Bros. filed the instant action seeking a declaration of rights under the policy.

With respect to the prior knowledge exclusion, the court noted that the parties stipulated that Whitworth was considered an insured under the terms of the policy. Moreover, it is apparent that Whitworth had embezzled money from clients beginning in 2002, well before the Continental policy became effective in July 2008. Given the nature of the acts, the court concluded that Whitworth had a basis to believe that commission of the intentional and illegal acts might reasonably be expected to be the basis of a claim. As such, her knowledge implicated the policy’s prior knowledge provision.

In response, the policyholders argued that the innocent insureds provision ultimately saved coverage. Under this provision, coverage continues for insureds to the extent they did not participate in any criminal or dishonest conduct. The insurer argued that this savings provision was not triggered because it did not deny coverage based upon the illegal acts exclusion, but rather the prior knowledge exclusion. The court agreed. The court stated the innocent insureds provision specifies when the provision takes effect, and if it does take effect, who is protected. Here, the provision never took effect in this case because the denial was based upon the prior knowledge provision.

With respect to the Lansing claim, the insurer argued that it was part of an interrelated act committed by Whitworth that occurred prior to the effective date of the policy. The court again agreed, noting that the Lansing withdrawals involved the same scheme to defraud clients by the same person using the same modus operandi. Accordingly, the Lansing claim was deemed part of a single interrelated act, and likewise was not covered under the policy.

Impact: The insurer in this case was very strategic in its denial. By relying on the prior knowledge exclusion and not the illegal act exclusion, the insurer was able to step around the savings clause contained in the latter provision. It is important to note whether an exclusion has a savings clause that may revive coverage.

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