Why it matters

In another dispute involving underlying litigation initiated by a state attorney general, the title and escrow company faced charges of taking part in a scam targeting distressed homeowners that resulted in alleged ill-gotten gains. The insurance company successfully argued in the district court that because ill-gotten gains were expressly excluded, it had no duty to defend. The Fourth Circuit reversed, clarifying that the mere allegation of “ill-gotten” gains did not trigger the exclusion unless the policyholder itself obtained the improperly received monies. That distinction is an important refinement to arguments that insurance policies generally do not apply to ill-gotten gain, disgorgement, or other similar claims. As here, if the policyholder itself did not obtain the improper gain then a defense is.

Detailed Discussion

A scam targeting distressed homeowners was the basis for a lawsuit filed by the Maryland Attorney General in 2008. The AG named 11 parties to the suit, including Cornerstone Title & Escrow. According to the complaint, the defendants induced homeowners facing foreclosure to enter into a sale-leaseback agreement and then pocketed any equity in the home while renting it back to the homeowners.

Cornerstone was the settlement agent for the deals, the AG said, and failed to deliver the homeowners their checks, instead sending them to the other defendants. The suit also alleged that all of the defendants were jointly and severally liable for the conduct of the others. Because of the allegations and the AG’s joint and several claim – which encompassed the intentional, fraudulent actions of the other defendants – Cornerstone’s insurer Evanston Insurance Company denied any duty to defend.

Cornerstone eventually agreed to a $100,000 settlement with the AG.

The insured filed a breach of contract suit and a federal district court judge granted summary judgment for Evanston. But the Fourth Circuit reversed.

Finding that the “Service and Technical Professional Liability Insurance” policy applied, the federal appellate panel considered Evanston’s argument that the Maryland AG’s case implicated two of the policy’s exclusions: Exclusion (n), which applied to claims based on Cornerstone “gaining any profit or advantage” to which it was not legally entitled, and Exclusion (x), for theft or conversion.

The court dismissed Exclusion (n), as Cornerstone may have collected the settlement proceeds, but did not retain them. “The Attorney General’s complaint did not allege that any particular ‘profit’ or ‘advantage’ inured to Cornerstone’s benefit, as exclusion (n) requires,” the panel wrote. “To the contrary, the complaint alleged that all the relevant benefits and funds went” to the other defendants. As the settlement agent, Cornerstone was required to collect the settlement proceeds, but “those assets went to parties other than ‘the Insured’ under the terms of Cornerstone’s policy with Evanston,” the court said. And the complaint made no allegations that Cornerstone overcharged or failed to provide bona fide settlement services. “Under the plain terms of exclusion (n), Cornerstone’s receipt of legally justified funds does not defeat policy coverage.”

Turning to Exclusion (x), Evanston told the court that Cornerstone committed conversion by delivering the checks to the other defendants and not the homeowners. Even assuming an improper delivery, the insured’s actions did not amount to conversion under Maryland law, the court explained. To commit conversion in the state, the payee of the check – in this case, the homeowner – must first receive the check before he or she can bring a conversion action based on a misuse or improper delivery of it. Because the checks never went to the homeowners, a necessary element of conversion was not met.

Two additional exclusions – Exclusion (a), for “dishonest, deliberately fraudulent, malicious, willful or knowingly wrongful acts or omissions,” and Exclusion (cc), eliminating coverage for violations of the Real Estate Settlement Procedures Act or analogous state law – were raised by Evanston. As the federal district court did not consider the application of these provisions, the Fourth Circuit did not address them, but remanded the case for it to do so.

To read the order in Cornerstone Title & Escrow Inc. v. Evanston Ins. Co., click here.