In its recent decision in Am. Auto. Ins. Co. v. Sec. Income Planners & Co., 2012 U.S. Dist. LEXIS 39444 (E.D.N.Y. Mar. 22, 2012), the United States District Court for the Eastern District of New York had occasion to consider exclusions in a professional liability applicable to commingling and/or conversion of client funds, and whether these exclusions applied to the named insured’s negligent failure to prevent an employee from committing such conduct.

American Auto Insurance Company (“AAIC”) insured Security Income Planners & Co., LLC (“SIPCOLLC”), and others, under a life insurance agents errors and omissions policy.  SIPCOLLC and its president and CFO, Jay Hoffman, were named as defendants in an underlying suit alleging that Mr. Hoffman concerning his fraudulent conduct as an insurance broker.  Mr. Hoffman had, in fact, previously pled guilty to twenty-four (24) counts of criminal activity committed in his capacity as a broker during the period 1989 through 2009.  Among other things, Mr. Hoffman testified that he had “engaged in a scheme constituting a systematic ongoing course of conduct with the intent to defraud ten or more people by false or fraudulent pretenses, representations or promises, and obtained property from one or more such persons.”  Among these defrauded persons were plaintiffs in the underlying action, who alleged causes of action against SIPCOLLC and Hoffman for unjust enrichment, misrepresentation and failure to pay amounts owed.  Plaintiffs later amended their complaint to allege causes of action against SIPCOLLC for negligence, negligent training and supervision and breach of fiduciary duty.

AAIC argued that it had no duty to defend or indemnify its insureds in light of a policy exclusion stating

We shall not be liable to make any payment for Loss in connection with any Claim:

K. Based upon, arising out of . . . 3. Any commingling, misappropriation or conversion of funds.

AAIC also relied on a policy exclusion stating:

We shall not be liable to make any payment for Loss in connection with any Claim:

B. Based upon or arising out of any Insured gaining in fact any personal profit or advantage to which such Insured was not legally entitled.

Citing to Bistricer v. Fed. Ins. Co., 2003 U.S. Dist. LEXIS 17227 (S.D.N.Y. Sept. 30, 2003), a case in which the Southern District of New York held that an improper profit exclusion in a directors and officers policy did not apply to a negligent supervision claim, SIPCOLLC, and plaintiffs in the underlying action, argued that the exclusions in the AAIC policy did not apply to the negligence supervision claim.  The court agreed, citing to numerous cases cited under New York law, under a variety of policies including professional and general liability policies, holding that a negligent supervision claim against the named insured triggers at least a duty to defend even if the conduct alleged against an individual insured falls within a policy exclusion.  As the court explained, “because New York courts hold that negligence or negligent supervision claims arising from fraudulent or intentional acts are not excluded by insurance policies similar to the policy at issue, the negligent supervision allegation set forth in Gross and Cerulli's amended complaint suggests a ‘reasonable possibility’ of coverage” and thus a duty to defend was triggered.