When facing allegations of intentional harm that, once proven, might preclude coverage, policyholders should keep in mind that insurers must afford a defense until the allegations are proven and fall within an express, unambiguous exclusion to coverage.  In certain circumstances, such as in the recent case described below, in which the insurer attempted to rely upon a form of a “prior knowledge” provision, policyholders should feel reassured that even “groundless, false or fraudulent” allegations will not jeopardize coverage for  their defense. Also, insureds should keep in mind that courts may sometimes look to other policy provisions to limit or bar coverage entirely. This can result in traps for the unwary. Policyholders should therefore fully scrutinize their insurance policies to locate and account for any potential limitations or restrictions to coverage.

A Pennsylvania federal court recently ruled that a professional liability insurer must defend its policyholders in the face of allegations that, if proven, would preclude coverage. Navigators Ins. Co. v. Resnick Amsterdam Leshner, P.C., No. 14­5158, 2015 WL 2366010 (E.D. Pa. May 18, 2015). The insurance policy in question, issued by Navigators Insurance Company (Navigators), contained a provision (not labeled as an exclusion) that operated to exclude coverage of claims the “insured had a basis to believe . . . might reasonably be expected to be the basis of a claim” prior to policy inception. The policy also required the insurer to defend the policyholder even if the allegations were groundless, false, or fraudulent, and required that a defense be provided until the “dishonest, intentionally wrongful, fraudulent . . . act or omission has been determined by any final adjudication, finding of fact or admission by the Insured.” A lawsuit filed against Resnick Amsterdam  Leshner,  P.C. (Resnick), the policyholder in this case, alleged that an employee covered by the policy had emailed confidential client information to third parties prior to the inception of the policy period. Navigators initially defended the policyholder, but  subsequently  filed  a  declaratory  judgment  action  asserting  that  the  insured  must  have  had reason to expect – prior to policy inception – that the alleged conduct would be the basis for a subsequent lawsuit.  All parties filed cross motions for summary judgment.

The court construed the “prior knowledge” provision as an exclusion even though it did not appear  in  the exclusions section of the policy. Slip op. at 4. Accordingly,  the  insurer  had  the  burden  to  prove  that  the provision barred coverage based on the policyholder’s prior knowledge. The insurer was unable to meet this burden because the allegations of unlawful conduct remained unproven and in dispute.  The  district  judge reasoned that the mere allegation of illegal conduct does not establish that the insured had reason to believe that any of its acts or omissions could give rise to a claim.

The court pointed to a policy exclusion for intentional conduct, which also imposed a duty to defend upon the insurer, as additional support for finding a duty to defend under the circumstances.  As  stated  above,  the exclusion required Navigators to defend claims based on intentionally wrongful conduct “unless and until such dishonest, intentionally wrongful, fraudulent, criminal or malicious act or omission has been determined by any final adjudication, finding of fact or admission by the Insured.” Slip op. at 5. Because there had been no final adjudication of the facts in the underlying suit, the insurer had to fulfill its duty to defend. The court further held that the insurer must defend all allegations in the underlying suit because “[i]f a single claim in a multiple claim complaint is potentially covered, the duty to defend attaches until the underlying plaintiff can no longer recover on a covered claim.”  Slip op. at 4.

The court also ruled that Navigators would have no duty to indemnify, regardless of the outcome of the underlying suit. The court reasoned that, if the policyholders prevail, there will be no damages and therefore no need for indemnification. Alternatively, a final adjudication finding Resnick liable would require the factfinder to have determined that Resnick engaged in the wrongful conduct alleged. Such a determination  would  preclude coverage under both the “prior knowledge” and the “intentional conduct” exclusions. It is somewhat rare for a court to find the existence of a duty to defend while, at the same time, ruling that there are no circumstances that could trigger the insurer’s duty to indemnify. But here, the court found no obstacle to such a holding, primarily based on the specific policy wording at issue – both the coverage provision and the exclusion that, itself, imposed a broad duty to defend any  allegations  of  intentional  wrongdoing  through  an  express  “carve back.” The court relied upon longstanding Pennsylvania law recognizing that the duty to defend and to indemnify are separate and independent duties bargained for by the policyholder at the time of policy inception.

The district judge’s reasoning in this case offers several insights for policyholders.   Most notably, it illustrates courts’ reluctance to infer prior knowledge of a potential claim based on mere accusations of wrongful conduct. The court’s holding that “[t]he insurer can sustain its burden only by establishing uncontradicted facts in the record”  suggests  that  the  outcome  of  its  analysis  turned  on  whether  the  allegations  were  rebutted  in  the underlying action.  Slip op. at 4.  This logic underscores the importance for policyholders to challenge allegations by  not  only  denying  their  veracity  but  also  introducing  evidence  of  their  groundlessness.   See  slip  op.  at  5 (“Resnick and Felderstein have not only denied the allegation, they have presented evidence demonstrating that the emails were fabricated.”).  So long as the allegations are contradicted in the record, the insurer must afford a defense until the final adjudication of those allegations, because the claim “could possibly be covered by the policy.”  Slip op. at 3.

Finally, the opinion serves as a prime example of the willingness of some courts to treat provisions as limiting or precluding coverage even if they are not labeled as exclusions. Here, the court reasoned that the  “prior knowledge” proviso – despite not having been “listed as an exclusion” – should be treated as a policy exclusion because “it operates as one.” Slip op. at 4. This finding demonstrates that policyholders must carefully read all provisions of a policy, not just the exclusions, before determining whether coverage may be limited, or non­ existent, for certain circumstances. By holding that the prior knowledge provision operated as an exclusion, however, the court properly placed the burden of proof on the insurer to establish that the provision bars coverage for the underlying claim.