TITLE
INDUSTRY ASSURANCE
COMPANY, R.R.G., Plaintiff–Appellant,
INDUSTRY ASSURANCE
COMPANY, R.R.G., Plaintiff–Appellant,
v.
FIRST AMERICAN TITLE INSURANCE
COMPANY, et al., Defendants–Appellees.
COMPANY, et al., Defendants–Appellees.
No. 15-3310
Argued April 4, 2016
Decided April 10, 2017
Hamilton, Circuit Judge.
*1 This appeal illustrates a recurring issue for liability
insurers and their insureds: how to determine whether the insurer owes a duty
to defend its insured when a claim is first asserted against the insured,
before the insurer knows the underlying facts. The insured here was Chicago
Abstract Title Agency LLC, which was in the title and escrow services business.
In 2008, Chicago Abstract was sued in state court by a title insurance company
and two financial firms. Chicago Abstract tendered these lawsuits to its
“errors and omissions” liability insurer, plaintiff Title Industry Assurance
Company, R.R.G., known in this case as TIAC. TIAC then faced a choice. It could
(a) defend Chicago Abstract without reservation; or (b) defend while reserving
its rights; or (c) seek a declaratory judgment concerning the scope of
coverage. TIAC could also (d) decline to defend, but only if the allegations in
the complaints against Chicago Abstract clearly fell outside the scope of the
insurance policy, and then only at its peril. Under Illinois law, when a
liability insurer unjustifiably refuses to defend a suit against its insured,
the insurer will be estopped from later asserting policy defenses to coverage.
insurers and their insureds: how to determine whether the insurer owes a duty
to defend its insured when a claim is first asserted against the insured,
before the insurer knows the underlying facts. The insured here was Chicago
Abstract Title Agency LLC, which was in the title and escrow services business.
In 2008, Chicago Abstract was sued in state court by a title insurance company
and two financial firms. Chicago Abstract tendered these lawsuits to its
“errors and omissions” liability insurer, plaintiff Title Industry Assurance
Company, R.R.G., known in this case as TIAC. TIAC then faced a choice. It could
(a) defend Chicago Abstract without reservation; or (b) defend while reserving
its rights; or (c) seek a declaratory judgment concerning the scope of
coverage. TIAC could also (d) decline to defend, but only if the allegations in
the complaints against Chicago Abstract clearly fell outside the scope of the
insurance policy, and then only at its peril. Under Illinois law, when a
liability insurer unjustifiably refuses to defend a suit against its insured,
the insurer will be estopped from later asserting policy defenses to coverage.
TIAC declined to defend the suits. The suits proceeded and
years passed without further communications between TIAC and its insured. In
2014, one of the state court plaintiffs, Coastal Funding, LLC, filed a fourth
amended complaint against Chicago Abstract. An attorney appointed by TIAC then
made a belated appearance in that case. At about the same time, TIAC filed this
diversity jurisdiction action in federal court, seeking a declaration that
coverage was unavailable primarily because of two exclusions in the policy.
Chicago Abstract did not defend in the federal case (the company had been
involuntarily dissolved in 2009), but two of the state-court plaintiffs—Coastal
Funding and First American Title Insurance Company—appeared in this federal
case as defendants. To avoid confusion, we refer to these two firms as the Claimants.
years passed without further communications between TIAC and its insured. In
2014, one of the state court plaintiffs, Coastal Funding, LLC, filed a fourth
amended complaint against Chicago Abstract. An attorney appointed by TIAC then
made a belated appearance in that case. At about the same time, TIAC filed this
diversity jurisdiction action in federal court, seeking a declaration that
coverage was unavailable primarily because of two exclusions in the policy.
Chicago Abstract did not defend in the federal case (the company had been
involuntarily dissolved in 2009), but two of the state-court plaintiffs—Coastal
Funding and First American Title Insurance Company—appeared in this federal
case as defendants. To avoid confusion, we refer to these two firms as the Claimants.
TIAC and the Claimants filed cross-motions for summary
judgment. The district court granted judgment to the Claimants. We affirm. We
disagree with portions of the district court opinion, particularly its ruling
that TIAC was required to plead legal theories in its federal complaint. That
ruling is squarely at odds with settled federal pleading practice. See Johnson
v. City of Shelby, 574 U.S. ––––, 135 S.Ct. 346, 190 L.Ed.2d 309 (2014)
(summarily reversing dismissal of action for failure to identify legal theory
in complaint). Nevertheless, we agree that the undisputed facts show that TIAC
breached its duty to defend Chicago Abstract in the underlying litigation. TIAC
is therefore estopped from asserting at this very late stage any policy
defenses to coverage that might have been available if TIAC had made a
different choice when the complaints were first tendered.
judgment. The district court granted judgment to the Claimants. We affirm. We
disagree with portions of the district court opinion, particularly its ruling
that TIAC was required to plead legal theories in its federal complaint. That
ruling is squarely at odds with settled federal pleading practice. See Johnson
v. City of Shelby, 574 U.S. ––––, 135 S.Ct. 346, 190 L.Ed.2d 309 (2014)
(summarily reversing dismissal of action for failure to identify legal theory
in complaint). Nevertheless, we agree that the undisputed facts show that TIAC
breached its duty to defend Chicago Abstract in the underlying litigation. TIAC
is therefore estopped from asserting at this very late stage any policy
defenses to coverage that might have been available if TIAC had made a
different choice when the complaints were first tendered.
I. Undisputed Facts and Procedural Background
A. Errors and Omissions Policy
Chicago Abstract was a title insurance agency operating in
Cook County, Illinois. As an agent for First American, a title insurance
company with a nationwide footprint, Chicago Abstract provided property owners
and lenders with real estate closing, loan closing, and title and escrow
services. In 2008, TIAC issued to Chicago Abstract an “Abstracters, Title
Insurance Agents and Escrow Agents Professional Liability Insurance” policy,
more commonly known as an errors and omissions policy. The policy provided that
TIAC would pay costs for which its “Insured” became liable “by reason of a
wrongful act … aris [ing] out of professional services rendered or that
should have been rendered.” The term “Insured” was defined to include Chicago
Abstract as well as its members and employees acting within the scope of their
duties. Coverage applied both to acts occurring during the policy period and to
prior acts if, as of the policy’s effective date, the Insured had no knowledge
of those prior acts.
Cook County, Illinois. As an agent for First American, a title insurance
company with a nationwide footprint, Chicago Abstract provided property owners
and lenders with real estate closing, loan closing, and title and escrow
services. In 2008, TIAC issued to Chicago Abstract an “Abstracters, Title
Insurance Agents and Escrow Agents Professional Liability Insurance” policy,
more commonly known as an errors and omissions policy. The policy provided that
TIAC would pay costs for which its “Insured” became liable “by reason of a
wrongful act … aris [ing] out of professional services rendered or that
should have been rendered.” The term “Insured” was defined to include Chicago
Abstract as well as its members and employees acting within the scope of their
duties. Coverage applied both to acts occurring during the policy period and to
prior acts if, as of the policy’s effective date, the Insured had no knowledge
of those prior acts.
*2 The policy listed two exclusions relevant in this appeal.
Under exclusion (a), coverage did not apply to any claim arising out of or
relating to “any dishonest, fraudulent, criminal, malicious or intentional
wrongful acts committed by or at the direction of the Insured.” A caveat in the
policy, labeled condition (1), stated that whenever exclusion (a) was
triggered, insurance would remain available for each Insured “who did not
personally commit or personally participate in committing any of the wrongful
acts described in [that] exclusion … and who had neither notice nor knowledge
of such wrongful acts, if such Insured, upon receipt of notice or knowledge
thereof, immediately notifies the Company of the aforesaid wrongful acts.”
Under exclusion (j), coverage did not apply to any claim arising out of or
relating to “any defalcation, commingling of, or failure to pay any funds,
notes, drafts, or other negotiable instruments.”
Under exclusion (a), coverage did not apply to any claim arising out of or
relating to “any dishonest, fraudulent, criminal, malicious or intentional
wrongful acts committed by or at the direction of the Insured.” A caveat in the
policy, labeled condition (1), stated that whenever exclusion (a) was
triggered, insurance would remain available for each Insured “who did not
personally commit or personally participate in committing any of the wrongful
acts described in [that] exclusion … and who had neither notice nor knowledge
of such wrongful acts, if such Insured, upon receipt of notice or knowledge
thereof, immediately notifies the Company of the aforesaid wrongful acts.”
Under exclusion (j), coverage did not apply to any claim arising out of or
relating to “any defalcation, commingling of, or failure to pay any funds,
notes, drafts, or other negotiable instruments.”
B. Underlying Complaints and Procedural History
In the fall of 2008, Chicago Abstract was underwater and
failing fast. Records were out of order. Transactions were askew. Employees
were unsupervised. Most alarming, an outside audit uncovered a significant
shortfall in the agency’s escrow account. In this unfolding crisis, without the
benefit of a comprehensive investigation and with only a hazy understanding of
the facts, First American and two lenders that had done business with Chicago
Abstract sought help in court.
failing fast. Records were out of order. Transactions were askew. Employees
were unsupervised. Most alarming, an outside audit uncovered a significant
shortfall in the agency’s escrow account. In this unfolding crisis, without the
benefit of a comprehensive investigation and with only a hazy understanding of
the facts, First American and two lenders that had done business with Chicago
Abstract sought help in court.
On November 5, 2008, First American sued Chicago Abstract
and its two members, Michael Kons and Steve Knupp, in the Circuit Court of Cook
County. First American alleged that Chicago Abstract had facilitated escrow
closings for “irregular and suspicious” real estate “flip” transactions using
First American’s insurance policies and closing protection letters. A “flip” or
A–B–C transaction involves an investor (B) who buys discounted property from a
defaulting homeowner or foreclosing lender (A) using a short-term unsecured
loan and then immediately “flips” the property by selling to a third-party buyer
(C) for a higher price. Assuming both sides of the transaction close, the
investor (B) pays off the short-term loan and pockets the profits. First
American’s complaint accused Chicago Abstract of executing “flip” transactions
“contrary to the spirit and purpose” of its agency contract. First American
added that Chicago Abstract was not maintaining proper documentation; that
Chicago Abstract had commingled escrow funds belonging to property owners,
investors, and lenders; and that Chicago Abstract may have misappropriated some
of those funds. First American sought emergency injunctive relief, up to and
including appointment of a receiver, as well as damages for breach of contract.
and its two members, Michael Kons and Steve Knupp, in the Circuit Court of Cook
County. First American alleged that Chicago Abstract had facilitated escrow
closings for “irregular and suspicious” real estate “flip” transactions using
First American’s insurance policies and closing protection letters. A “flip” or
A–B–C transaction involves an investor (B) who buys discounted property from a
defaulting homeowner or foreclosing lender (A) using a short-term unsecured
loan and then immediately “flips” the property by selling to a third-party buyer
(C) for a higher price. Assuming both sides of the transaction close, the
investor (B) pays off the short-term loan and pockets the profits. First
American’s complaint accused Chicago Abstract of executing “flip” transactions
“contrary to the spirit and purpose” of its agency contract. First American
added that Chicago Abstract was not maintaining proper documentation; that
Chicago Abstract had commingled escrow funds belonging to property owners,
investors, and lenders; and that Chicago Abstract may have misappropriated some
of those funds. First American sought emergency injunctive relief, up to and
including appointment of a receiver, as well as damages for breach of contract.
Several weeks later, 1st Funding Source, LLC, a private
capital firm, intervened in the First American action. 1st Funding had agreed
to finance the A–B side of four “flip” transactions for which Chicago Abstract
served as title agent. For each transaction, Chicago Abstract was authorized to
disburse the short-term loan proceeds only on condition that both sides (A–B
and B–C) had irrevocably closed. Chicago Abstract allegedly breached its
agreement with 1st Funding by disbursing the proceeds before ensuring that the
B–C transaction closed. 1st Funding pled counts for breach of contract, breach
of fiduciary duty, and negligence.
capital firm, intervened in the First American action. 1st Funding had agreed
to finance the A–B side of four “flip” transactions for which Chicago Abstract
served as title agent. For each transaction, Chicago Abstract was authorized to
disburse the short-term loan proceeds only on condition that both sides (A–B
and B–C) had irrevocably closed. Chicago Abstract allegedly breached its
agreement with 1st Funding by disbursing the proceeds before ensuring that the
B–C transaction closed. 1st Funding pled counts for breach of contract, breach
of fiduciary duty, and negligence.
Finally, on Christmas Eve 2008—less than two months after
First American filed suit—Coastal Funding brought a separate action in the
Circuit Court of Cook County against Chicago Abstract, First American, and a
person named Donnel Thomas (elsewhere spelled “Donell”). Like 1st Funding,
Coastal Funding had supplied short-term financing for “flip” transactions for
which Chicago Abstract served as title agent. Back in October 2008, Coastal
Funding had wired $1,370,000 into Chicago Abstract’s general escrow account
with the expectation that the funds would be segregated in a fiduciary trust
account. According to Coastal Funding, Chicago Abstract breached its fiduciary
duty and committed the tort of conversion by “misappropriating” those funds.
Coastal Funding also alleged that Donnel Thomas duped it into participating in
a Ponzi scheme using Chicago Abstract’s services and that the “flip”
transactions—which it had believed were lawful and legitimate—were mere stages of
the scheme.
First American filed suit—Coastal Funding brought a separate action in the
Circuit Court of Cook County against Chicago Abstract, First American, and a
person named Donnel Thomas (elsewhere spelled “Donell”). Like 1st Funding,
Coastal Funding had supplied short-term financing for “flip” transactions for
which Chicago Abstract served as title agent. Back in October 2008, Coastal
Funding had wired $1,370,000 into Chicago Abstract’s general escrow account
with the expectation that the funds would be segregated in a fiduciary trust
account. According to Coastal Funding, Chicago Abstract breached its fiduciary
duty and committed the tort of conversion by “misappropriating” those funds.
Coastal Funding also alleged that Donnel Thomas duped it into participating in
a Ponzi scheme using Chicago Abstract’s services and that the “flip”
transactions—which it had believed were lawful and legitimate—were mere stages of
the scheme.
*3 Chicago Abstract tendered the three underlying complaints
to TIAC “for defense and indemnification” on February 3, 2009. On July 8, 2009,
Chicago Abstract, operating by then under receivership, notified TIAC of two
potential claims by First American for missing escrow funds. In letters dated
July 31 and August 13, 2009, TIAC denied coverage for the underlying suits and
the potential claims. The denial letters cited policy exclusions (a) and (j)
and asserted that the policy did not cover the remedies that the state court
plaintiffs sought. TIAC reiterated its coverage position without explanation in
a letter dated August 12, 2011.
to TIAC “for defense and indemnification” on February 3, 2009. On July 8, 2009,
Chicago Abstract, operating by then under receivership, notified TIAC of two
potential claims by First American for missing escrow funds. In letters dated
July 31 and August 13, 2009, TIAC denied coverage for the underlying suits and
the potential claims. The denial letters cited policy exclusions (a) and (j)
and asserted that the policy did not cover the remedies that the state court
plaintiffs sought. TIAC reiterated its coverage position without explanation in
a letter dated August 12, 2011.
The state-court litigation proceeded without TIAC’s
involvement. In 2011, the state court entered two orders granting default
judgment against Chicago Abstract on six counts of Coastal Funding’s
then-controlling complaint. In 2013, First American and 1st Funding reached a
settlement agreement that had the effect of resolving 1st Funding’s claims
against Chicago Abstract. First American has not settled with Chicago Abstract.
involvement. In 2011, the state court entered two orders granting default
judgment against Chicago Abstract on six counts of Coastal Funding’s
then-controlling complaint. In 2013, First American and 1st Funding reached a
settlement agreement that had the effect of resolving 1st Funding’s claims
against Chicago Abstract. First American has not settled with Chicago Abstract.
In 2014, Coastal Funding filed its fourth amended complaint
in state court.1 Chicago Abstract defaulted. Shortly after that, in
an about-face, TIAC appointed counsel to defend Chicago Abstract in the Coastal
Funding action. The state court then entered an order vacating the default,
though the parties dispute whether that order also vacated the prior default judgments.
(That’s a question for the state courts; we do not consider it here.)
in state court.1 Chicago Abstract defaulted. Shortly after that, in
an about-face, TIAC appointed counsel to defend Chicago Abstract in the Coastal
Funding action. The state court then entered an order vacating the default,
though the parties dispute whether that order also vacated the prior default judgments.
(That’s a question for the state courts; we do not consider it here.)
Around the same time that it began defending in state court,
TIAC filed this action for a declaration of non-coverage on the bases of
exclusions (a) and (j), as well as a third defense no longer at issue.
Claimants First American and Coastal Funding appeared as defendants in the
federal action. Coastal Funding filed a counterclaim seeking a declaration that
TIAC breached its duty to defend Chicago Abstract. On the parties’
cross-motions for summary judgment, the district court granted judgment in
favor of the Claimants, finding TIAC in breach and holding that TIAC is
estopped from asserting any defenses to coverage. Title Industry Assurance
Co. v. Chicago Abstract Title Agency, No. 14 C 1906, 2015 WL
5675544, at *6–7 (N.D. Ill. Sept. 24, 2015). This appeal followed.
TIAC filed this action for a declaration of non-coverage on the bases of
exclusions (a) and (j), as well as a third defense no longer at issue.
Claimants First American and Coastal Funding appeared as defendants in the
federal action. Coastal Funding filed a counterclaim seeking a declaration that
TIAC breached its duty to defend Chicago Abstract. On the parties’
cross-motions for summary judgment, the district court granted judgment in
favor of the Claimants, finding TIAC in breach and holding that TIAC is
estopped from asserting any defenses to coverage. Title Industry Assurance
Co. v. Chicago Abstract Title Agency, No. 14 C 1906, 2015 WL
5675544, at *6–7 (N.D. Ill. Sept. 24, 2015). This appeal followed.
II. Analysis
23We review de novo the district court’s grant of
summary judgment, viewing all facts and drawing all reasonable inferences in
favor of TIAC, the party against whom judgment was entered. Ezell v. City of
Chicago, 846 F.3d 888, 892 (7th Cir. 2017), citing Dunnet Bay
Construction Co. v. Borggren, 799 F.3d 676, 688 (7th Cir. 2015). The
interpretation of an insurance policy and the contours of the insurer’s duty to
defend are questions of state law. Illinois substantive law controls here.
summary judgment, viewing all facts and drawing all reasonable inferences in
favor of TIAC, the party against whom judgment was entered. Ezell v. City of
Chicago, 846 F.3d 888, 892 (7th Cir. 2017), citing Dunnet Bay
Construction Co. v. Borggren, 799 F.3d 676, 688 (7th Cir. 2015). The
interpretation of an insurance policy and the contours of the insurer’s duty to
defend are questions of state law. Illinois substantive law controls here.
A. The Duty to Defend
Liability insurers often encounter the problem that TIAC
faced in this case. Liability insurance policies require insureds to notify
their insurers of claims promptly, often on penalty of forfeiting coverage if
they delay. Upon receiving such notice, the insurer then must make a prompt
decision: will it defend or will it deny coverage? Often, as in this case, the
insurer must make this decision before it has time to investigate all the
relevant facts.
faced in this case. Liability insurance policies require insureds to notify
their insurers of claims promptly, often on penalty of forfeiting coverage if
they delay. Upon receiving such notice, the insurer then must make a prompt
decision: will it defend or will it deny coverage? Often, as in this case, the
insurer must make this decision before it has time to investigate all the
relevant facts.
*4 45“The oft-repeated refrain of Illinois insurance law is
that an insurer’s duty to defend is ‘much broader’ than its duty to indemnify.”
Landmark American Ins. Co. v. Hilger, 838 F.3d 821, 824 (7th Cir. 2016),
quoting Crum & Forster Managers Corp. v. Resolution Trust Corp., 156
Ill.2d 384, 189 Ill.Dec. 756, 620 N.E.2d 1073, 1079 (1993). “A duty to defend
will arise when the allegations of the underlying complaint may potentially
come within the coverage of the policy.” Westfield Ins. Co. v. West Van
Buren, LLC, 406 Ill.Dec. 99, 59 N.E.3d 877, 882 (2016). The insurer may not
simply refuse to defend a suit against its insured unless it is clear from the
underlying complaint “that the allegations fail to state facts which bring the
case within, or potentially within, the policy’s coverage.” Employers Ins.
of Wausau v. Ehlco Liquidating Trust, 186 Ill.2d 127, 237 Ill.Dec. 82, 708
N.E.2d 1122, 1136 (1999) (citation omitted).
that an insurer’s duty to defend is ‘much broader’ than its duty to indemnify.”
Landmark American Ins. Co. v. Hilger, 838 F.3d 821, 824 (7th Cir. 2016),
quoting Crum & Forster Managers Corp. v. Resolution Trust Corp., 156
Ill.2d 384, 189 Ill.Dec. 756, 620 N.E.2d 1073, 1079 (1993). “A duty to defend
will arise when the allegations of the underlying complaint may potentially
come within the coverage of the policy.” Westfield Ins. Co. v. West Van
Buren, LLC, 406 Ill.Dec. 99, 59 N.E.3d 877, 882 (2016). The insurer may not
simply refuse to defend a suit against its insured unless it is clear from the
underlying complaint “that the allegations fail to state facts which bring the
case within, or potentially within, the policy’s coverage.” Employers Ins.
of Wausau v. Ehlco Liquidating Trust, 186 Ill.2d 127, 237 Ill.Dec. 82, 708
N.E.2d 1122, 1136 (1999) (citation omitted).
6Illinois law provides two avenues for an insurer that is
uncertain of its obligations under the policy. It may “defend the suit under a
reservation of rights or seek a declaratory judgment that there is no
coverage.” Id. An insurer that fails to take either of these actions
does so at its peril. If a court later finds that the insurer breached its duty
to defend, the insurer will be estopped from asserting policy defenses to
coverage. Edward T. Joyce & Associates, P.C. v. Professionals Direct
Ins. Co., 816 F.3d 928, 932 (7th Cir. 2016), citing Ehlco Liquidating
Trust, 237 Ill.Dec. 82, 708 N.E.2d at 1135.
uncertain of its obligations under the policy. It may “defend the suit under a
reservation of rights or seek a declaratory judgment that there is no
coverage.” Id. An insurer that fails to take either of these actions
does so at its peril. If a court later finds that the insurer breached its duty
to defend, the insurer will be estopped from asserting policy defenses to
coverage. Edward T. Joyce & Associates, P.C. v. Professionals Direct
Ins. Co., 816 F.3d 928, 932 (7th Cir. 2016), citing Ehlco Liquidating
Trust, 237 Ill.Dec. 82, 708 N.E.2d at 1135.
7In deciding whether an insurer breached its duty, Illinois
courts ordinarily apply the “eight-corners” rule: “the court ‘compares the four
corners of the underlying complaint with the four corners of the insurance
policy to determine whether facts alleged in the underlying complaint fall
within or potentially within coverage.’ ” American Alternative Ins. Corp. v.
Metro Paramedic Services, Inc., 829 F.3d 509, 513–14 (7th Cir. 2016)
(citation omitted); see also Taco Bell Corp. v. Continental Casualty Co.,
388 F.3d 1069, 1073 (7th Cir. 2004) (insurer’s duty to defend is “determined by
the allegations of the complaint … rather than by what is actually proved”).
courts ordinarily apply the “eight-corners” rule: “the court ‘compares the four
corners of the underlying complaint with the four corners of the insurance
policy to determine whether facts alleged in the underlying complaint fall
within or potentially within coverage.’ ” American Alternative Ins. Corp. v.
Metro Paramedic Services, Inc., 829 F.3d 509, 513–14 (7th Cir. 2016)
(citation omitted); see also Taco Bell Corp. v. Continental Casualty Co.,
388 F.3d 1069, 1073 (7th Cir. 2004) (insurer’s duty to defend is “determined by
the allegations of the complaint … rather than by what is actually proved”).
89When an insurer brings a timely declaratory judgment
action, Illinois courts may look beyond the four corners of the underlying
complaint and consider extrinsic evidence, such as a separate but related
pleading. See Pekin Ins. Co. v. Wilson, 237 Ill.2d 446, 341 Ill.Dec.
497, 930 N.E.2d 1011, 1020 (2010) (“To require the trial court to look solely
to the complaint in the underlying action to determine coverage would …
greatly diminish a declaratory action’s purpose of settling and fixing the
rights of the parties.”) (emphasis and citation omitted). But where the insurer
fails to bring a timely declaratory judgment action and the question before the
court is whether the insurer breached its duty to defend, the court confines
its review to the insurance policy and the underlying complaint, absent unusual
circumstances. Compare Hilger, 838 F.3d at 824 (“[W]hen an insurer tries
to deny coverage without seeking a declaratory judgment or
defending under a reservation of rights … the relevant question is whether
the insurer justifiably refused to defend the action based solely on the
allegations in the complaint, so the court’s inquiry is necessarily limited to
those allegations.”), with Bartkowiak v. Underwriters at Lloyd’s, London,
395 Ill.Dec. 709, 39 N.E.3d 176, 179, 182 (2015) (trial court did not err in
taking account of tortfeasor’s primary insurance coverage that was not
specifically referenced in underlying complaint or in defendant’s policy but
that was known to defendant at the time it denied coverage, was the basis for
that denial, and was an objective, undisputed fact).
action, Illinois courts may look beyond the four corners of the underlying
complaint and consider extrinsic evidence, such as a separate but related
pleading. See Pekin Ins. Co. v. Wilson, 237 Ill.2d 446, 341 Ill.Dec.
497, 930 N.E.2d 1011, 1020 (2010) (“To require the trial court to look solely
to the complaint in the underlying action to determine coverage would …
greatly diminish a declaratory action’s purpose of settling and fixing the
rights of the parties.”) (emphasis and citation omitted). But where the insurer
fails to bring a timely declaratory judgment action and the question before the
court is whether the insurer breached its duty to defend, the court confines
its review to the insurance policy and the underlying complaint, absent unusual
circumstances. Compare Hilger, 838 F.3d at 824 (“[W]hen an insurer tries
to deny coverage without seeking a declaratory judgment or
defending under a reservation of rights … the relevant question is whether
the insurer justifiably refused to defend the action based solely on the
allegations in the complaint, so the court’s inquiry is necessarily limited to
those allegations.”), with Bartkowiak v. Underwriters at Lloyd’s, London,
395 Ill.Dec. 709, 39 N.E.3d 176, 179, 182 (2015) (trial court did not err in
taking account of tortfeasor’s primary insurance coverage that was not
specifically referenced in underlying complaint or in defendant’s policy but
that was known to defendant at the time it denied coverage, was the basis for
that denial, and was an objective, undisputed fact).
*5 1011In conducting its review, the court liberally
construes the underlying complaint and the insurance policy in the manner
reasonably most favorable to the insured. The court gives little weight to the
legal labels attached to the underlying allegations. Selective Ins. Co. of
South Carolina v. Target Corp., 845 F.3d 263, 270 (7th Cir. 2016). Because
the duty to defend usually depends on the contents of these written
documents—the insurance policy and the complaints against the insured—the issue
can often be decided on a motion for summary judgment. E.g., Metro Paramedic,
829 F.3d at 516 (affirming summary judgment for insured); Hartford Casualty
Ins. Co. v. Karlin, Fleisher & Falkenberg, LLC, 822 F.3d 358, 361 (7th
Cir. 2016) (affirming summary judgment for insurer).
construes the underlying complaint and the insurance policy in the manner
reasonably most favorable to the insured. The court gives little weight to the
legal labels attached to the underlying allegations. Selective Ins. Co. of
South Carolina v. Target Corp., 845 F.3d 263, 270 (7th Cir. 2016). Because
the duty to defend usually depends on the contents of these written
documents—the insurance policy and the complaints against the insured—the issue
can often be decided on a motion for summary judgment. E.g., Metro Paramedic,
829 F.3d at 516 (affirming summary judgment for insured); Hartford Casualty
Ins. Co. v. Karlin, Fleisher & Falkenberg, LLC, 822 F.3d 358, 361 (7th
Cir. 2016) (affirming summary judgment for insurer).
12The rule of Illinois law most important here is that if
the underlying complaint alleges several theories of recovery, the insurer’s
duty to defend arises “even if only one such theory is within the potential
coverage of the policy.” Santa’s Best Craft, LLC v. St. Paul Fire &
Marine Ins. Co., 611 F.3d 339, 346 (7th Cir. 2010) (citation omitted); see
also Nat’l American Ins. Co. v. Artisan & Truckers Casualty Co., 796
F.3d 717, 723 (7th Cir. 2015) (insurer must defend against covered claims
despite presence of “proscribed theory of recovery”); Wilson, 341
Ill.Dec. 497, 930 N.E.2d at 1015 n.2 (where insurer has duty to defend against
at least one count of underlying lawsuit, it must then defend against all
counts).
the underlying complaint alleges several theories of recovery, the insurer’s
duty to defend arises “even if only one such theory is within the potential
coverage of the policy.” Santa’s Best Craft, LLC v. St. Paul Fire &
Marine Ins. Co., 611 F.3d 339, 346 (7th Cir. 2010) (citation omitted); see
also Nat’l American Ins. Co. v. Artisan & Truckers Casualty Co., 796
F.3d 717, 723 (7th Cir. 2015) (insurer must defend against covered claims
despite presence of “proscribed theory of recovery”); Wilson, 341
Ill.Dec. 497, 930 N.E.2d at 1015 n.2 (where insurer has duty to defend against
at least one count of underlying lawsuit, it must then defend against all
counts).
B. Prior Knowledge Provision
13Before digging into the exclusions that TIAC relied upon
in its denial letters, we must address an argument that TIAC raised for the
first time in federal court—that the prior knowledge provision in the policy’s
insuring agreement and in a related question on the insurance application barred
coverage of the underlying claims. The prior knowledge provision stated that
TIAC would cover damages relating to wrongful acts occurring “prior to the
policy period provided that on the effective date of th[e] policy the Insured
has no knowledge of such wrongful act[s].”
in its denial letters, we must address an argument that TIAC raised for the
first time in federal court—that the prior knowledge provision in the policy’s
insuring agreement and in a related question on the insurance application barred
coverage of the underlying claims. The prior knowledge provision stated that
TIAC would cover damages relating to wrongful acts occurring “prior to the
policy period provided that on the effective date of th[e] policy the Insured
has no knowledge of such wrongful act[s].”
1415The Claimants argue that TIAC waived its right to rely
on the prior knowledge provision by failing to cite that provision in its
letters denying coverage. Those letters said nothing about Chicago Abstract’s
prior knowledge. In fact, it was not clear that TIAC intended to rely on the
prior knowledge provision until it filed its motion for summary judgment in
this untimely declaratory judgment action (though TIAC did allude to the
provision in its answer to Coastal Funding’s counterclaim). Federal notice
pleading requires only a “short and plain statement of the claim showing that
the pleader is entitled to relief,” Fed. R. Civ. P. 8(a)(2), so TIAC’s failure
to refer to the prior knowledge provision in its declaratory judgment complaint
is not fatal. However, Illinois substantive law controls in this diversity
dispute. Illinois courts recognize that a “long delay in asserting a policy
defense … may constitute a waiver of that defense,” though the party
asserting waiver must prove that it has been prejudiced by the delay. E.g., Rosalind
Franklin Univ. of Medicine & Science v. Lexington Ins. Co., 380
Ill.Dec. 89, 8 N.E.3d 20, 44 (2014). Illinois courts also recognize the
“mend-the-hold” doctrine, which “preclude[s] insurers from denying a claim on
one basis and then changing [the] basis for denial during litigation” if there
is evidence of unfair surprise or arbitrariness. E.g., FHP Tectonics Corp.
v. American Home Assurance Co., 404 Ill.Dec. 816, 57 N.E.3d 575, 587
(2016); Grinnell Mutual Reinsurance Co. v. LaForge, 369 Ill.App.3d 688,
309 Ill.Dec. 235, 863 N.E.2d 1132, 1140 (2006).
on the prior knowledge provision by failing to cite that provision in its
letters denying coverage. Those letters said nothing about Chicago Abstract’s
prior knowledge. In fact, it was not clear that TIAC intended to rely on the
prior knowledge provision until it filed its motion for summary judgment in
this untimely declaratory judgment action (though TIAC did allude to the
provision in its answer to Coastal Funding’s counterclaim). Federal notice
pleading requires only a “short and plain statement of the claim showing that
the pleader is entitled to relief,” Fed. R. Civ. P. 8(a)(2), so TIAC’s failure
to refer to the prior knowledge provision in its declaratory judgment complaint
is not fatal. However, Illinois substantive law controls in this diversity
dispute. Illinois courts recognize that a “long delay in asserting a policy
defense … may constitute a waiver of that defense,” though the party
asserting waiver must prove that it has been prejudiced by the delay. E.g., Rosalind
Franklin Univ. of Medicine & Science v. Lexington Ins. Co., 380
Ill.Dec. 89, 8 N.E.3d 20, 44 (2014). Illinois courts also recognize the
“mend-the-hold” doctrine, which “preclude[s] insurers from denying a claim on
one basis and then changing [the] basis for denial during litigation” if there
is evidence of unfair surprise or arbitrariness. E.g., FHP Tectonics Corp.
v. American Home Assurance Co., 404 Ill.Dec. 816, 57 N.E.3d 575, 587
(2016); Grinnell Mutual Reinsurance Co. v. LaForge, 369 Ill.App.3d 688,
309 Ill.Dec. 235, 863 N.E.2d 1132, 1140 (2006).
*6 16The Claimants rely on the doctrines of both waiver and
“mend-the-hold,” arguing that TIAC’s late assertion of the prior knowledge
provision prejudiced them because they “did not engage in any discovery related
to ‘prior knowledge’ or alleged misrepresentations in the renewal application.”
While the Claimants have not made an especially strong showing of prejudice,
TIAC has offered no justification for its delay. “[S]trong proof is not
required to show a waiver of a policy defense, but only such facts as would
make it unjust, inequitable or unconscionable to allow the defense to be
interposed.” Rosalind Franklin Univ., 380 Ill.Dec. 89, 8 N.E.3d at 44
(citation omitted).
“mend-the-hold,” arguing that TIAC’s late assertion of the prior knowledge
provision prejudiced them because they “did not engage in any discovery related
to ‘prior knowledge’ or alleged misrepresentations in the renewal application.”
While the Claimants have not made an especially strong showing of prejudice,
TIAC has offered no justification for its delay. “[S]trong proof is not
required to show a waiver of a policy defense, but only such facts as would
make it unjust, inequitable or unconscionable to allow the defense to be
interposed.” Rosalind Franklin Univ., 380 Ill.Dec. 89, 8 N.E.3d at 44
(citation omitted).
17Moreover, even if TIAC’s late assertion of the prior
knowledge provision could be excused, the assertion would fail on its merits.
Chicago Abstract’s errors and omissions policy became effective July 24, 2008.
Nothing in the complaints tendered to TIAC implicated Chicago Abstract or its
principals (the defendants in the underlying suits) in any misconduct occurring
before that date.
knowledge provision could be excused, the assertion would fail on its merits.
Chicago Abstract’s errors and omissions policy became effective July 24, 2008.
Nothing in the complaints tendered to TIAC implicated Chicago Abstract or its
principals (the defendants in the underlying suits) in any misconduct occurring
before that date.
To support its denial decision, TIAC points to a letter that
Chicago Abstract received from First American and forwarded to TIAC before it
denied coverage. In that letter, First American warned that Chicago Abstract
might “have liability for numerous matters stemming from the activities within
[its] operation,” involving transactions “during a period of time from
approximately May 2008–October 2008.” First American’s early guesstimate as to
the date range during which problem transactions may have occurred is not a
useful measure for determining the point at which Chicago Abstract and its
agents were on notice of any wrongful acts. At most, First American’s letter
might have prompted TIAC to investigate whether its Insured had advance
knowledge of a potential claim. The letter could not justify TIAC’s flat
refusal to defend its Insured.
Chicago Abstract received from First American and forwarded to TIAC before it
denied coverage. In that letter, First American warned that Chicago Abstract
might “have liability for numerous matters stemming from the activities within
[its] operation,” involving transactions “during a period of time from
approximately May 2008–October 2008.” First American’s early guesstimate as to
the date range during which problem transactions may have occurred is not a
useful measure for determining the point at which Chicago Abstract and its
agents were on notice of any wrongful acts. At most, First American’s letter
might have prompted TIAC to investigate whether its Insured had advance
knowledge of a potential claim. The letter could not justify TIAC’s flat
refusal to defend its Insured.
In rejecting TIAC’s reliance on the prior knowledge
provision, we do not decide whether the outcome might be different if the
summary judgment record contained concrete evidence to support a finding that,
as of the policy’s effective date, Chicago Abstract and its principals were on notice
of a claim or of conduct likely to result in a claim. The record contains no
such concrete evidence. Coastal Funding’s fourth amended complaint—the pleading
that precipitated TIAC’s late entry in the underlying litigation—includes a few
vague allegations suggesting that Chicago Abstract’s principals may have
suspected trouble was afoot during the summer of 2008. But that pleading does
not allege—and there is certainly no evidence in the summary judgment record to
support a finding—that the principals knew about a Ponzi scheme or any missing
funds at that time.
provision, we do not decide whether the outcome might be different if the
summary judgment record contained concrete evidence to support a finding that,
as of the policy’s effective date, Chicago Abstract and its principals were on notice
of a claim or of conduct likely to result in a claim. The record contains no
such concrete evidence. Coastal Funding’s fourth amended complaint—the pleading
that precipitated TIAC’s late entry in the underlying litigation—includes a few
vague allegations suggesting that Chicago Abstract’s principals may have
suspected trouble was afoot during the summer of 2008. But that pleading does
not allege—and there is certainly no evidence in the summary judgment record to
support a finding—that the principals knew about a Ponzi scheme or any missing
funds at that time.
Mere suspicion of questionable transactions does not trigger
the prior knowledge provision. That provision requires, well, knowledge. There
is no evidence that Chicago Abstract and its principals had such knowledge as
of July 24, 2008.2 We therefore do not decide whether, if
after-acquired evidence showed that Chicago Abstract or its principals actually
knew about wrongful acts and/or looming claims when they applied for coverage,
the ordinary estoppel rules would give way. TIAC points to no authority that
would require that result, though the equities and policy arguments might
support that conclusion. That is not this case, so we decline to predict how
the Illinois Supreme Court would decide that issue. With neither
contemporaneous nor after-acquired evidence that would trigger the prior
knowledge provision, TIAC’s argument fails on its merits.
the prior knowledge provision. That provision requires, well, knowledge. There
is no evidence that Chicago Abstract and its principals had such knowledge as
of July 24, 2008.2 We therefore do not decide whether, if
after-acquired evidence showed that Chicago Abstract or its principals actually
knew about wrongful acts and/or looming claims when they applied for coverage,
the ordinary estoppel rules would give way. TIAC points to no authority that
would require that result, though the equities and policy arguments might
support that conclusion. That is not this case, so we decline to predict how
the Illinois Supreme Court would decide that issue. With neither
contemporaneous nor after-acquired evidence that would trigger the prior
knowledge provision, TIAC’s argument fails on its merits.
C. TIAC’s Bases for Denying Coverage
1. Exclusion (a)
*7 18We turn now to the provisions TIAC invoked in denying
coverage back in 2009. Exclusion (a) withheld coverage for any claim relating
to “any dishonest, fraudulent, criminal, malicious or intentional wrongful acts
committed by or at the direction of the Insured.” Exclusion (a) does not
justify TIAC’s refusal to defend against the tendered suits.
coverage back in 2009. Exclusion (a) withheld coverage for any claim relating
to “any dishonest, fraudulent, criminal, malicious or intentional wrongful acts
committed by or at the direction of the Insured.” Exclusion (a) does not
justify TIAC’s refusal to defend against the tendered suits.
Later-filed pleadings and subsequent developments show that
the Claimants’ damages were attributable at least partly to fraud by someone.
But the complaints as tendered did not compel that conclusion. At most
they placed TIAC on notice that one or more of the underlying claims might be
subject to exclusion (a). The presence of a theory excluded from coverage
simply does not excuse an insurer from its duty to defend its insured. Artisan
& Truckers, 796 F.3d at 723; see also Santa’s Best, 611 F.3d at
346 (where underlying complaint presents several theories of recovery, “the
duty to defend arises even if only one such theory is within the potential
coverage of the policy”) (citation omitted).
the Claimants’ damages were attributable at least partly to fraud by someone.
But the complaints as tendered did not compel that conclusion. At most
they placed TIAC on notice that one or more of the underlying claims might be
subject to exclusion (a). The presence of a theory excluded from coverage
simply does not excuse an insurer from its duty to defend its insured. Artisan
& Truckers, 796 F.3d at 723; see also Santa’s Best, 611 F.3d at
346 (where underlying complaint presents several theories of recovery, “the
duty to defend arises even if only one such theory is within the potential
coverage of the policy”) (citation omitted).
Most of the allegations in the tendered complaints had no
obvious relationship to a fraud claim, though just one path toward a covered
claim would have been enough to trigger the duty to defend. First American’s
complaint accused Chicago Abstract of breach of contract, and it alleged a host
of errors and omissions that could arise as easily from negligence as from
intentional wrongdoing. The complaint also alleged “irregular and suspicious”
real estate transactions and suggested that Chicago Abstract’s agents may have
misappropriated escrow funds. Those nebulous allegations did not indisputably
remove the complaint from coverage, which is what would have been required to
avoid the duty to defend. 1st Funding settled and has not appeared in TIAC’s
federal case, but nothing in 1st Funding’s complaint changes our analysis. 1st
Funding alleged that Chicago Abstract disbursed loan proceeds before all
conditions were met. It accused Chicago Abstract of negligence and breaches of
contract and fiduciary duty. It did not accuse Chicago Abstract of fraud.
obvious relationship to a fraud claim, though just one path toward a covered
claim would have been enough to trigger the duty to defend. First American’s
complaint accused Chicago Abstract of breach of contract, and it alleged a host
of errors and omissions that could arise as easily from negligence as from
intentional wrongdoing. The complaint also alleged “irregular and suspicious”
real estate transactions and suggested that Chicago Abstract’s agents may have
misappropriated escrow funds. Those nebulous allegations did not indisputably
remove the complaint from coverage, which is what would have been required to
avoid the duty to defend. 1st Funding settled and has not appeared in TIAC’s
federal case, but nothing in 1st Funding’s complaint changes our analysis. 1st
Funding alleged that Chicago Abstract disbursed loan proceeds before all
conditions were met. It accused Chicago Abstract of negligence and breaches of
contract and fiduciary duty. It did not accuse Chicago Abstract of fraud.
1920The Coastal Funding complaint presents a somewhat closer
question, but the result is the same. Coastal Funding accused Chicago Abstract
of misappropriating and/or converting $1,370,000. Conversion is an intentional
tort, but conversion does not include as an element the intent to defraud. It
does not require proof of a criminal or otherwise culpable mental state.
Rather, the tortfeasor must simply act intentionally in a manner that exercises
dominion over the property of another without authorization. Whether he does so
maliciously or by innocent mistake, the action is still conversion. See Longo
Realty v. Menard, Inc., 405 Ill.Dec. 708, 59 N.E.3d 1, 11 (2016) (
“Conversion requires the plaintiff establish by a preponderance of the
evidence: (1) the defendant’s unauthorized and wrongful assumption of control,
dominion, or ownership over the plaintiff’s personal property; (2) the
plaintiff’s right in the property; (3) the plaintiff’s right to immediate
possession of the property, absolutely and unconditionally; and (4) the
plaintiff’s demand for possession of the property.”); Martel Enterprises v.
City of Chicago, 223 Ill.App.3d 1028, 164 Ill.Dec. 945, 584 N.E.2d 157, 159
(1991) (“Although conversion is considered an intentional tort because it
requires ‘an intentional exercise of dominion or control over a chattel,’ it
does not require proof of malice, culpability, or conscious wrongdoing.”)
(citations omitted).
question, but the result is the same. Coastal Funding accused Chicago Abstract
of misappropriating and/or converting $1,370,000. Conversion is an intentional
tort, but conversion does not include as an element the intent to defraud. It
does not require proof of a criminal or otherwise culpable mental state.
Rather, the tortfeasor must simply act intentionally in a manner that exercises
dominion over the property of another without authorization. Whether he does so
maliciously or by innocent mistake, the action is still conversion. See Longo
Realty v. Menard, Inc., 405 Ill.Dec. 708, 59 N.E.3d 1, 11 (2016) (
“Conversion requires the plaintiff establish by a preponderance of the
evidence: (1) the defendant’s unauthorized and wrongful assumption of control,
dominion, or ownership over the plaintiff’s personal property; (2) the
plaintiff’s right in the property; (3) the plaintiff’s right to immediate
possession of the property, absolutely and unconditionally; and (4) the
plaintiff’s demand for possession of the property.”); Martel Enterprises v.
City of Chicago, 223 Ill.App.3d 1028, 164 Ill.Dec. 945, 584 N.E.2d 157, 159
(1991) (“Although conversion is considered an intentional tort because it
requires ‘an intentional exercise of dominion or control over a chattel,’ it
does not require proof of malice, culpability, or conscious wrongdoing.”)
(citations omitted).
*8 21Coastal Funding’s allegations of misappropriation and
conversion were factually threadbare, amounting to little more than legal
conclusions. That’s not surprising, given the urgency with which the complaint
had to be prepared. Legal conclusions standing alone will not justify an insurer’s
refusal to defend its insured. See Cincinnati Ins. Co. v. Eastern Atlantic
Ins. Co., 260 F.3d 742, 745 (7th Cir. 2001) (“What is important is not the
legal label that the plaintiff attaches to the defendant’s … conduct, but
whether that conduct as alleged in the complaint is at least arguably within
one or more of the categories of wrongdoing that the policy covers.”); International
Ins. Co. v. Rollprint Packaging Products, Inc., 312 Ill.App.3d 998, 245
Ill.Dec. 598, 728 N.E.2d 680, 688 (2000) (“The question of coverage should not
hinge on the … whims of the plaintiff in the underlying action.”).3
conversion were factually threadbare, amounting to little more than legal
conclusions. That’s not surprising, given the urgency with which the complaint
had to be prepared. Legal conclusions standing alone will not justify an insurer’s
refusal to defend its insured. See Cincinnati Ins. Co. v. Eastern Atlantic
Ins. Co., 260 F.3d 742, 745 (7th Cir. 2001) (“What is important is not the
legal label that the plaintiff attaches to the defendant’s … conduct, but
whether that conduct as alleged in the complaint is at least arguably within
one or more of the categories of wrongdoing that the policy covers.”); International
Ins. Co. v. Rollprint Packaging Products, Inc., 312 Ill.App.3d 998, 245
Ill.Dec. 598, 728 N.E.2d 680, 688 (2000) (“The question of coverage should not
hinge on the … whims of the plaintiff in the underlying action.”).3
22Coastal Funding did plead one fraud count that was more
factually robust, but that count named only Donnel Thomas, a third party whose
association with Chicago Abstract was unexplained. TIAC could not reasonably
have construed the allegations against Thomas as somehow excluding coverage for
its Insured. This is particularly so in light of the policy’s condition (1),
which provided that the fraud exclusion would not bar coverage for any Insured
who neither participated in nor knew about the fraud, provided the Insured
notified TIAC upon learning of the misconduct.
factually robust, but that count named only Donnel Thomas, a third party whose
association with Chicago Abstract was unexplained. TIAC could not reasonably
have construed the allegations against Thomas as somehow excluding coverage for
its Insured. This is particularly so in light of the policy’s condition (1),
which provided that the fraud exclusion would not bar coverage for any Insured
who neither participated in nor knew about the fraud, provided the Insured
notified TIAC upon learning of the misconduct.
The decisive point is that the underlying complaints,
whether read individually or together, did not compel the conclusion that the
Claimants’ losses were attributable to intentional wrongdoing by Chicago
Abstract and its agents. See U.S. Fidelity & Guaranty Co. v. Wilkin
Insulation Co., 193 Ill.App.3d 1087, 140 Ill.Dec. 907, 550 N.E.2d 1032,
1036 (1989) (“[S]ince the underlying claims arise from the same set of
circumstances, the allegations in any single complaint can be inferred in the
other complaints.”), aff’d, 144 Ill.2d 64, 161 Ill.Dec. 280,578 N.E.2d
926 (1991). The undisputed facts show that exclusion (a) could not justify
TIAC’s refusal to defend its Insured at the time of tender.4
whether read individually or together, did not compel the conclusion that the
Claimants’ losses were attributable to intentional wrongdoing by Chicago
Abstract and its agents. See U.S. Fidelity & Guaranty Co. v. Wilkin
Insulation Co., 193 Ill.App.3d 1087, 140 Ill.Dec. 907, 550 N.E.2d 1032,
1036 (1989) (“[S]ince the underlying claims arise from the same set of
circumstances, the allegations in any single complaint can be inferred in the
other complaints.”), aff’d, 144 Ill.2d 64, 161 Ill.Dec. 280,578 N.E.2d
926 (1991). The undisputed facts show that exclusion (a) could not justify
TIAC’s refusal to defend its Insured at the time of tender.4
2. Exclusion (j)
23TIAC also denied coverage based on exclusion (j), which
withheld coverage from any claim relating to “any defalcation, commingling of,
or failure to pay any funds.” Exclusion (j) also does not justify TIAC’s denial
of coverage.
withheld coverage from any claim relating to “any defalcation, commingling of,
or failure to pay any funds.” Exclusion (j) also does not justify TIAC’s denial
of coverage.
Defalcation is an undefined term in the policy. The term is
commonly used in the bankruptcy context, where it describes a “culpable state
of mind” involving “knowledge of, or gross recklessness in respect to, the
improper nature of … relevant fiduciary behavior.” Bullock v.
BankChampaign, N.A., 569 U.S. ––––, ––––, 133 S.Ct. 1754, 1757, 185 L.Ed.2d
922 (2013). More generally, the term connotes fraud or embezzlement, though
broader usages also have been recognized. See Defalcation, Black’s
Law Dictionary 506 (10th ed. 2014). As discussed above, TIAC could not
refuse to defend its Insured on the basis of a fraud exclusion.
commonly used in the bankruptcy context, where it describes a “culpable state
of mind” involving “knowledge of, or gross recklessness in respect to, the
improper nature of … relevant fiduciary behavior.” Bullock v.
BankChampaign, N.A., 569 U.S. ––––, ––––, 133 S.Ct. 1754, 1757, 185 L.Ed.2d
922 (2013). More generally, the term connotes fraud or embezzlement, though
broader usages also have been recognized. See Defalcation, Black’s
Law Dictionary 506 (10th ed. 2014). As discussed above, TIAC could not
refuse to defend its Insured on the basis of a fraud exclusion.
*9 As for commingling, only one underlying pleading—the
First American complaint—included such an allegation, and commingling was not
an essential aspect of First American’s lawsuit. As for the undefined phrase
“failure to pay,” the Claimants argue that they alleged the very opposite in
state court: they alleged that Chicago Abstract did pay (i.e., disburse)
escrow funds under circumstances in which it should not have done so. TIAC
perhaps could have countered that “failure to pay” should be read broadly to
encompass Chicago Abstract’s failure to return funds to the lenders, but
neither exclusion (j) nor the state court complaints were clear enough to
establish that no claim could possibly fall within the scope of coverage. TIAC
might have been able to assert a successful defense to coverage during litigation,
but even if that were true, it would not follow that TIAC was entitled to
abandon its Insured at the outset of litigation.5
First American complaint—included such an allegation, and commingling was not
an essential aspect of First American’s lawsuit. As for the undefined phrase
“failure to pay,” the Claimants argue that they alleged the very opposite in
state court: they alleged that Chicago Abstract did pay (i.e., disburse)
escrow funds under circumstances in which it should not have done so. TIAC
perhaps could have countered that “failure to pay” should be read broadly to
encompass Chicago Abstract’s failure to return funds to the lenders, but
neither exclusion (j) nor the state court complaints were clear enough to
establish that no claim could possibly fall within the scope of coverage. TIAC
might have been able to assert a successful defense to coverage during litigation,
but even if that were true, it would not follow that TIAC was entitled to
abandon its Insured at the outset of litigation.5
3. Northbrook Property and “Wholly Independent” Acts
24TIAC argues that the district court should have enforced
exclusion (a) and/or exclusion (j) on the ground that the underlying complaints
included some allegations that, if proved, might have fallen outside the scope
of coverage. According to TIAC, “where a claim alleges injuries caused by both
excluded acts and non-excluded acts,” the insurer must defend only if the
non-excluded acts were “wholly independent” of the excluded acts. TIAC’s
proposition is difficult to square with the settled principle of Illinois law
that if the “underlying complaints allege several theories of recovery … the
duty to defend arises even if only one such theory is within the potential
coverage of the policy.” Santa’s Best, 611 F.3d at 346 (citation
omitted). In fact, the cases TIAC cites for its “wholly independent” argument
are readily distinguishable from this case and illustrate the narrow
application of that rule.
exclusion (a) and/or exclusion (j) on the ground that the underlying complaints
included some allegations that, if proved, might have fallen outside the scope
of coverage. According to TIAC, “where a claim alleges injuries caused by both
excluded acts and non-excluded acts,” the insurer must defend only if the
non-excluded acts were “wholly independent” of the excluded acts. TIAC’s
proposition is difficult to square with the settled principle of Illinois law
that if the “underlying complaints allege several theories of recovery … the
duty to defend arises even if only one such theory is within the potential
coverage of the policy.” Santa’s Best, 611 F.3d at 346 (citation
omitted). In fact, the cases TIAC cites for its “wholly independent” argument
are readily distinguishable from this case and illustrate the narrow
application of that rule.
TIAC relies principally on Northbrook Property &
Casualty Co. v. Transportation Joint Agreement, 194 Ill.2d 96, 251 Ill.Dec.
659, 741 N.E.2d 253 (2000), where a general liability policy excluded injuries
stemming from “ownership, maintenance, use or entrustment” of a vehicle. Id.,
251 Ill.Dec. 659, 741 N.E.2d at 254. The underlying complaints alleged that
students were injured when a train collided with the insured school district’s
school bus. Those complaints “utterly fail[ed] to state facts which either
actually or potentially” brought the complaints “within the policy’s coverage.”
Id. While the claimants attempted to argue around the vehicle exclusion
by characterizing the students’ injuries as resulting from the school
district’s failure to select safe bus routes, those allegations were “nothing
more than rephrasings of the fact that the students’ injuries arose from the
school districts’ use or operation of a motor vehicle.” Id. The students
were harmed in an excluded bus accident. Causation was not in dispute, and
state of mind was irrelevant. No set of facts consistent with the allegations
in the underlying complaints could have brought those complaints within the
scope of coverage.6
Casualty Co. v. Transportation Joint Agreement, 194 Ill.2d 96, 251 Ill.Dec.
659, 741 N.E.2d 253 (2000), where a general liability policy excluded injuries
stemming from “ownership, maintenance, use or entrustment” of a vehicle. Id.,
251 Ill.Dec. 659, 741 N.E.2d at 254. The underlying complaints alleged that
students were injured when a train collided with the insured school district’s
school bus. Those complaints “utterly fail[ed] to state facts which either
actually or potentially” brought the complaints “within the policy’s coverage.”
Id. While the claimants attempted to argue around the vehicle exclusion
by characterizing the students’ injuries as resulting from the school
district’s failure to select safe bus routes, those allegations were “nothing
more than rephrasings of the fact that the students’ injuries arose from the
school districts’ use or operation of a motor vehicle.” Id. The students
were harmed in an excluded bus accident. Causation was not in dispute, and
state of mind was irrelevant. No set of facts consistent with the allegations
in the underlying complaints could have brought those complaints within the
scope of coverage.6
*10 In this case, when the Claimants filed their initial
pleadings, the circumstances surrounding their injuries or possible injuries
were murky at best. Records were missing. Transactions were unaccounted for.
Chicago Abstract’s escrow account was short of cash, but it was not clear who
or what was responsible for the shortage. The Claimants sought emergency
judicial intervention to preserve the status quo and to avoid further losses
while they sorted through the facts. Their vague pleadings reflected their
uncertainty. Many of the allegations related to one another only generally, and
at least one theory—in fact, most theories—fell outside exclusions (a)
and (j).
pleadings, the circumstances surrounding their injuries or possible injuries
were murky at best. Records were missing. Transactions were unaccounted for.
Chicago Abstract’s escrow account was short of cash, but it was not clear who
or what was responsible for the shortage. The Claimants sought emergency
judicial intervention to preserve the status quo and to avoid further losses
while they sorted through the facts. Their vague pleadings reflected their
uncertainty. Many of the allegations related to one another only generally, and
at least one theory—in fact, most theories—fell outside exclusions (a)
and (j).
First American alleged that Chicago Abstract had engaged in
“irregular and suspicious” transactions and that its agents appeared to have
commingled and misappropriated escrow funds. But First American also accused
Chicago Abstract of failing to account for the funds, failing to turn over
records, issuing unauthorized insurance policies, neglecting to supervise its
employees, and wrongfully holding itself out as an agent of First American. 1st
Funding intervened in the First American action, citing a series of incidents
in which Chicago Abstract allegedly disbursed loan proceeds before all
conditions were satisfied. Coastal Funding filed a separate complaint in which
it speculated that Chicago Abstract may have converted its funds. But in that
same complaint, Coastal Funding alleged that it had fallen prey to a Ponzi
scheme orchestrated by Donnel Thomas, a third party whose association with
Chicago Abstract was unclear.
“irregular and suspicious” transactions and that its agents appeared to have
commingled and misappropriated escrow funds. But First American also accused
Chicago Abstract of failing to account for the funds, failing to turn over
records, issuing unauthorized insurance policies, neglecting to supervise its
employees, and wrongfully holding itself out as an agent of First American. 1st
Funding intervened in the First American action, citing a series of incidents
in which Chicago Abstract allegedly disbursed loan proceeds before all
conditions were satisfied. Coastal Funding filed a separate complaint in which
it speculated that Chicago Abstract may have converted its funds. But in that
same complaint, Coastal Funding alleged that it had fallen prey to a Ponzi
scheme orchestrated by Donnel Thomas, a third party whose association with
Chicago Abstract was unclear.
We now know that Thomas had an inside man at Chicago
Abstract: Juan Orozco, the employee who was eventually convicted of wire fraud
for his part in Thomas’s Ponzi scheme. But the Claimants did not know that or
allege that when they filed their complaints in 2008. Nor is there any
indication that anyone at TIAC was aware of Orozco’s crimes when it denied
coverage in 2009. Even if TIAC had known about Orozco, a fraud claim—unlike a
motor vehicle tort, see Northbrook Property, 251 Ill.Dec. 659, 741
N.E.2d at 254—requires the finder of fact to ascertain the tortfeasor’s state
of mind. Before undertaking fact discovery, TIAC could not possibly have known
whether its Insured, defined to include not only Chicago Abstract but also its
members and employees acting within the scope of their employment, were in on
the scheme, aware of the scheme, or innocent victims of the scheme. TIAC could
not preemptively refuse to defend its Insured on the basis of facts it did not
and could not then know.
Abstract: Juan Orozco, the employee who was eventually convicted of wire fraud
for his part in Thomas’s Ponzi scheme. But the Claimants did not know that or
allege that when they filed their complaints in 2008. Nor is there any
indication that anyone at TIAC was aware of Orozco’s crimes when it denied
coverage in 2009. Even if TIAC had known about Orozco, a fraud claim—unlike a
motor vehicle tort, see Northbrook Property, 251 Ill.Dec. 659, 741
N.E.2d at 254—requires the finder of fact to ascertain the tortfeasor’s state
of mind. Before undertaking fact discovery, TIAC could not possibly have known
whether its Insured, defined to include not only Chicago Abstract but also its
members and employees acting within the scope of their employment, were in on
the scheme, aware of the scheme, or innocent victims of the scheme. TIAC could
not preemptively refuse to defend its Insured on the basis of facts it did not
and could not then know.
The search for Northbrook Property‘s “wholly
independent” cause of injury is futile when the primary cause of injury is
unknown. Based on the “eight corners” of the tendered complaints and the
insurance policy, see Metro Paramedic, 829 F.3d at 513–14, the
undisputed facts show no sufficient basis for TIAC to deny coverage.
independent” cause of injury is futile when the primary cause of injury is
unknown. Based on the “eight corners” of the tendered complaints and the
insurance policy, see Metro Paramedic, 829 F.3d at 513–14, the
undisputed facts show no sufficient basis for TIAC to deny coverage.
D. The Consequences of TIAC’s Breach
2526When TIAC breached its duty by denying a defense in
2009, it left its Insured high and dry. TIAC complains that Chicago Abstract
did not “contest or object to TIAC’s coverage declination.” At oral argument,
TIAC took the point one step further, suggesting that because Chicago Abstract
did not challenge its denial decision, TIAC was unaware “that there was any
suggestion that there might be coverage under the policy.” Nonsense. Chicago
Abstract placed TIAC on notice of its claim for coverage when it tendered the
underlying complaints. TIAC cites no authority for the proposition that an
insured must lodge an exception to a denial decision or follow up, begging for
reconsideration. On the contrary, Illinois courts even excuse insureds from
complying with otherwise non-negotiable policy duties after receiving denial
letters. E.g., Owners Ins. Co. v. Seamless Gutter Corp., 356 Ill.Dec.
137, 960 N.E.2d 1260, 1271 (2011) (“[A]n insurer should not be allowed to
assert a blanket denial of coverage and then assert the insured’s failure to
provide proof of loss, since the law does not require the insured to perform
what appeared to be a useless act.”); Jones v. Universal Casualty Co.,
257 Ill.App.3d 842, 196 Ill.Dec. 397, 630 N.E.2d 94, 101 (1994) (same).
2009, it left its Insured high and dry. TIAC complains that Chicago Abstract
did not “contest or object to TIAC’s coverage declination.” At oral argument,
TIAC took the point one step further, suggesting that because Chicago Abstract
did not challenge its denial decision, TIAC was unaware “that there was any
suggestion that there might be coverage under the policy.” Nonsense. Chicago
Abstract placed TIAC on notice of its claim for coverage when it tendered the
underlying complaints. TIAC cites no authority for the proposition that an
insured must lodge an exception to a denial decision or follow up, begging for
reconsideration. On the contrary, Illinois courts even excuse insureds from
complying with otherwise non-negotiable policy duties after receiving denial
letters. E.g., Owners Ins. Co. v. Seamless Gutter Corp., 356 Ill.Dec.
137, 960 N.E.2d 1260, 1271 (2011) (“[A]n insurer should not be allowed to
assert a blanket denial of coverage and then assert the insured’s failure to
provide proof of loss, since the law does not require the insured to perform
what appeared to be a useless act.”); Jones v. Universal Casualty Co.,
257 Ill.App.3d 842, 196 Ill.Dec. 397, 630 N.E.2d 94, 101 (1994) (same).
*11 When an insurer learns of a claim against its insured,
the ball is in the insurer’s court. It may defend under a reservation of
rights, or it may seek judicial input as to its obligations under the policy.
But if it refuses to defend, it cannot then blame the insured for failing to
win it over, particularly where—as here—the insured faces significant exposure
and must make prompt and difficult decisions regarding litigation or
settlement. Cf. Waste Management, Inc. v. Int’l Surplus Lines Ins. Co.,
144 Ill.2d 178, 161 Ill.Dec. 774, 579 N.E.2d 322, 334 (1991) (estoppel did not
apply where insurers did not abandon insureds but instead (1) sent letters
expressing concerns about coverage, (2) evaluated claims under express
reservation of rights, and (3) subsequently sought declaratory judgment).
the ball is in the insurer’s court. It may defend under a reservation of
rights, or it may seek judicial input as to its obligations under the policy.
But if it refuses to defend, it cannot then blame the insured for failing to
win it over, particularly where—as here—the insured faces significant exposure
and must make prompt and difficult decisions regarding litigation or
settlement. Cf. Waste Management, Inc. v. Int’l Surplus Lines Ins. Co.,
144 Ill.2d 178, 161 Ill.Dec. 774, 579 N.E.2d 322, 334 (1991) (estoppel did not
apply where insurers did not abandon insureds but instead (1) sent letters
expressing concerns about coverage, (2) evaluated claims under express
reservation of rights, and (3) subsequently sought declaratory judgment).
27Though TIAC did appear in the Coastal Funding action and
file for declaratory relief in federal court five years later, those
long-overdue actions cannot excuse its breach of duty back in 2009. By the time
TIAC saw fit to intervene, 1st Funding had settled its claims against Chicago
Abstract, which had also defaulted on multiple counts in the Coastal Funding
case. “Where an insurer waits to bring its declaratory judgment action until
after the underlying action has been resolved by a judgment or a settlement,
the insurer’s declaratory judgment action is untimely as a matter of law.” Ehlco
Liquidating Trust, 237 Ill.Dec. 82, 708 N.E.2d at 1138; cf. Korte
Construction Co. v. American States Ins., 322 Ill.App.3d 451, 255 Ill.Dec.
847, 750 N.E.2d 764, 770 (2001) (“[T]he insurer must take some action to
adjudicate the issue of coverage or undertake to defend the insured under a
reservation of rights, and it must take that action within a reasonable time
of a demand by the insured.”) (emphasis added).
file for declaratory relief in federal court five years later, those
long-overdue actions cannot excuse its breach of duty back in 2009. By the time
TIAC saw fit to intervene, 1st Funding had settled its claims against Chicago
Abstract, which had also defaulted on multiple counts in the Coastal Funding
case. “Where an insurer waits to bring its declaratory judgment action until
after the underlying action has been resolved by a judgment or a settlement,
the insurer’s declaratory judgment action is untimely as a matter of law.” Ehlco
Liquidating Trust, 237 Ill.Dec. 82, 708 N.E.2d at 1138; cf. Korte
Construction Co. v. American States Ins., 322 Ill.App.3d 451, 255 Ill.Dec.
847, 750 N.E.2d 764, 770 (2001) (“[T]he insurer must take some action to
adjudicate the issue of coverage or undertake to defend the insured under a
reservation of rights, and it must take that action within a reasonable time
of a demand by the insured.”) (emphasis added).
“The world is a dangerous and litigious place. People and
businesses buy liability insurance in large part for peace of mind—the
knowledge that if one is sued, the insurer will provide a legal defense….” CE
Design Ltd. v. King Supply Co., 791 F.3d 722, 727 (7th Cir. 2015)
(Hamilton, J., concurring). When an insurer breaches its duty to defend, “it’s
not just any breach of contract. An insurer’s breach abandons its insured and
deprives it of the peace of mind it has bought.” Id.; see also Pompa
v. American Family Mutual Ins. Co., 520 F.3d 1139, 1146 (10th Cir. 2008) (“
‘By purchasing insurance, the insured reasonably expects that he will not be
required to furnish the cost of defending actions that facially fall within the
terms of his policy.’ The insured will be deprived of the peace of mind that
insurance promises if the insurer can refuse to defend the case, await
developments, and then decide to reimburse the insured for defense costs only
once it is clear that there was coverage.”) (citations omitted); Cates Construction,
Inc. v. Talbot Partners, 21 Cal.4th 28, 86 Cal.Rptr.2d 855, 980 P.2d 407,
416 (1999) (“In general, insurance policies are not purchased for profit or
advantage; rather, they are obtained for peace of mind and security in the
event of an accident or other catastrophe.”).
businesses buy liability insurance in large part for peace of mind—the
knowledge that if one is sued, the insurer will provide a legal defense….” CE
Design Ltd. v. King Supply Co., 791 F.3d 722, 727 (7th Cir. 2015)
(Hamilton, J., concurring). When an insurer breaches its duty to defend, “it’s
not just any breach of contract. An insurer’s breach abandons its insured and
deprives it of the peace of mind it has bought.” Id.; see also Pompa
v. American Family Mutual Ins. Co., 520 F.3d 1139, 1146 (10th Cir. 2008) (“
‘By purchasing insurance, the insured reasonably expects that he will not be
required to furnish the cost of defending actions that facially fall within the
terms of his policy.’ The insured will be deprived of the peace of mind that
insurance promises if the insurer can refuse to defend the case, await
developments, and then decide to reimburse the insured for defense costs only
once it is clear that there was coverage.”) (citations omitted); Cates Construction,
Inc. v. Talbot Partners, 21 Cal.4th 28, 86 Cal.Rptr.2d 855, 980 P.2d 407,
416 (1999) (“In general, insurance policies are not purchased for profit or
advantage; rather, they are obtained for peace of mind and security in the
event of an accident or other catastrophe.”).
28Under Illinois law, an insurer that breaches its duty to
defend and abandons its insured is estopped from later invoking policy defenses
to indemnity. See Panfil v. Nautilus Ins. Co., 799 F.3d 716, 719 (7th
Cir. 2015); Philadelphia Indemnity Ins. Co. v. Chicago Title Ins. Co.,
771 F.3d 391, 400 n.6 (7th Cir. 2014). This Illinois rule of estoppel is strong
stuff, but it is intended to protect insureds’ reasonable expectations of
coverage when they most need it. Because TIAC breached its duty to its Insured,
it is barred from asserting any policy defenses to coverage that might have
applied otherwise. As a practical matter, this means TIAC is on the hook for
the judgment or any reasonable settlement amount that the Claimants ultimately
recover against TIAC’s Insured. See Delatorre v. Safeway Ins. Co., 370
Ill.Dec. 880, 989 N.E.2d 268, 276 (2013) (“When an insurer wrongfully refuses
to defend [its insured], it is liable … for breach of contract. The measure
of damages for such a contractual breach is generally the amount of the
judgment against the insured.”), citing Fidelity & Casualty Co. of New
York v. Mobay Chemical Corp., 252 Ill.App.3d 992, 192 Ill.Dec. 191, 625
N.E.2d 151, 155 (1992); see also Guillen v. Potomac Ins. Co. of Illinois,
323 Ill.App.3d 121, 256 Ill.Dec. 51, 751 N.E.2d 104, 114 (2001) (“The measure
of damages for … a breach is generally the amount of the judgment against the
insured or of a reasonable settlement, plus any expenses incurred.”), aff’d
as modified, 203 Ill.2d 141, 271 Ill.Dec. 350, 785 N.E.2d 1 (2003). In the
end, TIAC’s hasty abandonment of its Insured may cost it far more than it would
have spent if it had simply honored its duty to defend. The judgment of the
district court is
defend and abandons its insured is estopped from later invoking policy defenses
to indemnity. See Panfil v. Nautilus Ins. Co., 799 F.3d 716, 719 (7th
Cir. 2015); Philadelphia Indemnity Ins. Co. v. Chicago Title Ins. Co.,
771 F.3d 391, 400 n.6 (7th Cir. 2014). This Illinois rule of estoppel is strong
stuff, but it is intended to protect insureds’ reasonable expectations of
coverage when they most need it. Because TIAC breached its duty to its Insured,
it is barred from asserting any policy defenses to coverage that might have
applied otherwise. As a practical matter, this means TIAC is on the hook for
the judgment or any reasonable settlement amount that the Claimants ultimately
recover against TIAC’s Insured. See Delatorre v. Safeway Ins. Co., 370
Ill.Dec. 880, 989 N.E.2d 268, 276 (2013) (“When an insurer wrongfully refuses
to defend [its insured], it is liable … for breach of contract. The measure
of damages for such a contractual breach is generally the amount of the
judgment against the insured.”), citing Fidelity & Casualty Co. of New
York v. Mobay Chemical Corp., 252 Ill.App.3d 992, 192 Ill.Dec. 191, 625
N.E.2d 151, 155 (1992); see also Guillen v. Potomac Ins. Co. of Illinois,
323 Ill.App.3d 121, 256 Ill.Dec. 51, 751 N.E.2d 104, 114 (2001) (“The measure
of damages for … a breach is generally the amount of the judgment against the
insured or of a reasonable settlement, plus any expenses incurred.”), aff’d
as modified, 203 Ill.2d 141, 271 Ill.Dec. 350, 785 N.E.2d 1 (2003). In the
end, TIAC’s hasty abandonment of its Insured may cost it far more than it would
have spent if it had simply honored its duty to defend. The judgment of the
district court is
*12 AFFIRMED.
Footnotes
*The Honorable Pamela Pepper, United States District Judge
for the Eastern District of Wisconsin, sitting by designation.
for the Eastern District of Wisconsin, sitting by designation.
1 Coastal Funding’s
fourth amended complaint alleges a fraudulent scheme involving Chicago Abstract
employee Juan Orozco and Donnel Thomas (the individual defendant named in
Coastal Funding’s first complaint). In 2010, Orozco, Thomas, and their
associates were charged with federal wire fraud in connection with a real
estate Ponzi scheme spearheaded by Thomas. Orozco pled guilty several years
later.
fourth amended complaint alleges a fraudulent scheme involving Chicago Abstract
employee Juan Orozco and Donnel Thomas (the individual defendant named in
Coastal Funding’s first complaint). In 2010, Orozco, Thomas, and their
associates were charged with federal wire fraud in connection with a real
estate Ponzi scheme spearheaded by Thomas. Orozco pled guilty several years
later.
2 There is no
dispute, of course, that Juan Orozco was aware of his own misdeeds. TIAC points
out that the prior knowledge provision is triggered when the “Insured” has
knowledge of a prior wrongful act. “Insured” is defined to include not only the
entity but also its employees acting within the scope of their duties. TIAC
argues that “Orozco’s participation in and knowledge of the Ponzi scheme is
sufficient to trigger the prior knowledge provision.” TIAC assumes (without
developing the point) that Orozco was acting within the scope of his employment
in facilitating a Ponzi scheme, a dubious proposition. In any event, TIAC’s
argument proves too much. When viewed as a whole, the errors and omissions
policy included important protections for innocent Insureds. Condition (1), in
particular, preserved coverage for claims relating to fraud for any Insured
“who did not personally commit or personally participate in committing” the
fraud and who had “neither notice nor knowledge” of the fraud, provided that
the Insured “upon receipt of notice or knowledge … immediately notifies the
Company.” That protection for innocent Insureds would be nullified if a single
employee’s wrongdoing were enough to nullify coverage. We decline to read the
policy so as to undermine that important protection.
dispute, of course, that Juan Orozco was aware of his own misdeeds. TIAC points
out that the prior knowledge provision is triggered when the “Insured” has
knowledge of a prior wrongful act. “Insured” is defined to include not only the
entity but also its employees acting within the scope of their duties. TIAC
argues that “Orozco’s participation in and knowledge of the Ponzi scheme is
sufficient to trigger the prior knowledge provision.” TIAC assumes (without
developing the point) that Orozco was acting within the scope of his employment
in facilitating a Ponzi scheme, a dubious proposition. In any event, TIAC’s
argument proves too much. When viewed as a whole, the errors and omissions
policy included important protections for innocent Insureds. Condition (1), in
particular, preserved coverage for claims relating to fraud for any Insured
“who did not personally commit or personally participate in committing” the
fraud and who had “neither notice nor knowledge” of the fraud, provided that
the Insured “upon receipt of notice or knowledge … immediately notifies the
Company.” That protection for innocent Insureds would be nullified if a single
employee’s wrongdoing were enough to nullify coverage. We decline to read the
policy so as to undermine that important protection.
3 Coastal Funding’s
first amended complaint, which it filed on July 27, 2009, added some spare
factual content pertaining to Chicago Abstract’s alleged misconduct. There is
no indication TIAC received, let alone reviewed, that amended complaint before
denying coverage four days later.
first amended complaint, which it filed on July 27, 2009, added some spare
factual content pertaining to Chicago Abstract’s alleged misconduct. There is
no indication TIAC received, let alone reviewed, that amended complaint before
denying coverage four days later.
4 TIAC’s brief
includes an extended discussion of Gulf Underwriters Ins. Co. v. KSI
Services, Inc., 233 Fed.Appx. 239 (4th Cir. 2007). We are not sure why.
Apart from being non-precedential even in its home circuit, Gulf
Underwriters is inapposite. In that case, the claimant—whose funds were
embezzled by the insured’s bookkeeper—filed the underlying suit after the
bookkeeper’s fraud came to light and after she pled guilty. The Claimants here,
aware only of funds missing under fishy circumstances, rushed to the courthouse
to preserve the status quo long before they had a clear sense of the cause and
extent of their damages. Their broad and vague pleadings reflect legal triage
in a crisis, not definitive grounds for concluding that Chicago Abstract had
engaged in intentional wrongdoing that would defeat coverage.
includes an extended discussion of Gulf Underwriters Ins. Co. v. KSI
Services, Inc., 233 Fed.Appx. 239 (4th Cir. 2007). We are not sure why.
Apart from being non-precedential even in its home circuit, Gulf
Underwriters is inapposite. In that case, the claimant—whose funds were
embezzled by the insured’s bookkeeper—filed the underlying suit after the
bookkeeper’s fraud came to light and after she pled guilty. The Claimants here,
aware only of funds missing under fishy circumstances, rushed to the courthouse
to preserve the status quo long before they had a clear sense of the cause and
extent of their damages. Their broad and vague pleadings reflect legal triage
in a crisis, not definitive grounds for concluding that Chicago Abstract had
engaged in intentional wrongdoing that would defeat coverage.
5 To support its
argument about exclusion (j), TIAC relies on Bethel v. Darwin Select Ins.
Co., 735 F.3d 1035 (8th Cir. 2013), which applied Minnesota law to uphold
denial of a defense under a title insurer’s errors and omissions policy. The
exclusion at issue in that case was broader than exclusion (j) here, as it
reached claims relating to “loss, disappearance … or shortage” of funds, as
well as commingling and misappropriation. Also, the underlying complaint was
narrower, alleging intentional wrongdoing and leaving no room for innocent
mistake. Id. at 1037, 1040. Those differences were critical to the
Eighth Circuit’s decision.
argument about exclusion (j), TIAC relies on Bethel v. Darwin Select Ins.
Co., 735 F.3d 1035 (8th Cir. 2013), which applied Minnesota law to uphold
denial of a defense under a title insurer’s errors and omissions policy. The
exclusion at issue in that case was broader than exclusion (j) here, as it
reached claims relating to “loss, disappearance … or shortage” of funds, as
well as commingling and misappropriation. Also, the underlying complaint was
narrower, alleging intentional wrongdoing and leaving no room for innocent
mistake. Id. at 1037, 1040. Those differences were critical to the
Eighth Circuit’s decision.
6 TIAC’s other cases
parallel the analysis in Northbrook Property. See State Farm Fire
& Casualty Co. v. Perez, 387 Ill.App.3d 549, 326 Ill.Dec. 580, 899
N.E.2d 1231 (2008) (injury caused by automobile accident excluded; insurer had
no duty to defend against negligent modification claim relating to modified
seats); Massachusetts Bay Ins. Co. v. Unique Presort Services, Inc., 287
Ill.App.3d 741, 223 Ill.Dec. 291, 679 N.E.2d 476 (1997) (injury caused by
automobile accident excluded; insurer had no duty to defend against
“inextricably intertwined” claim for violation of drug testing regulation); Oakley
Transport, Inc. v. Zurich Ins. Co., 271 Ill.App.3d 716, 208 Ill.Dec. 177,
648 N.E.2d 1099 (1995) (injury caused by automobile accident excluded; insurer
had no duty to defend against “inextricably intertwined” claim for negligent
supervision of driver); see also Nautilus Ins. Co. v. 1452–4 N. Milwaukee
Avenue, LLC, 562 F.3d 818 (7th Cir. 2009) (damages caused by faulty
contractor work excluded; insurer had no duty to defend against “intertwined”
negligence and statutory claims). In each of these cases, the gravamen of the
underlying claim was an excluded injury. The courts refused to allow claimants
and insureds to avoid unambiguous exclusions with artful labeling.
parallel the analysis in Northbrook Property. See State Farm Fire
& Casualty Co. v. Perez, 387 Ill.App.3d 549, 326 Ill.Dec. 580, 899
N.E.2d 1231 (2008) (injury caused by automobile accident excluded; insurer had
no duty to defend against negligent modification claim relating to modified
seats); Massachusetts Bay Ins. Co. v. Unique Presort Services, Inc., 287
Ill.App.3d 741, 223 Ill.Dec. 291, 679 N.E.2d 476 (1997) (injury caused by
automobile accident excluded; insurer had no duty to defend against
“inextricably intertwined” claim for violation of drug testing regulation); Oakley
Transport, Inc. v. Zurich Ins. Co., 271 Ill.App.3d 716, 208 Ill.Dec. 177,
648 N.E.2d 1099 (1995) (injury caused by automobile accident excluded; insurer
had no duty to defend against “inextricably intertwined” claim for negligent
supervision of driver); see also Nautilus Ins. Co. v. 1452–4 N. Milwaukee
Avenue, LLC, 562 F.3d 818 (7th Cir. 2009) (damages caused by faulty
contractor work excluded; insurer had no duty to defend against “intertwined”
negligence and statutory claims). In each of these cases, the gravamen of the
underlying claim was an excluded injury. The courts refused to allow claimants
and insureds to avoid unambiguous exclusions with artful labeling.