Prior Knowledge Clause Prevents Coverage for Embezzlement Losses
The insured accounting firm sued a professional liability insurer, alleging a breach of contract, and seeking a declaration that the insurer was obligated to cover claims related to embezzlement by an insured employee. This case is Bryan Brothers Incorporated v. Continental Casualty Company, 2011 WL 1058851 (C.A.4, Va. ). Note that this opinion was not selected for publication in the Federal Reporter.
Continental Casualty issued a professional liability insurance policy effective from July 1, 2008 to July 1, 2009 to cover certain liabilities arising from Bryan Brothers' accounting services. The policy applied to all sums that the named insured became legally obligated to pay as damages by reason of an act or omission in the performance of professional services by the named insured or by any person for whom the named insured is legally liable. The insuring agreement went on to state that “this coverage is applied provided that prior to the effective date of the policy, none of you had a basis to believe that any such act or omission might reasonably be expected to be the basis of a claim”.
In February 2009, Bryan Brothers discovered that Whitworth, the firm's account clerk from 1999 to 2009, had stolen funds from eight clients' accounts. Whitworth's thefts began in 2002 and the last theft occurred sometime after July 1, 2008 during this policy period. The victims asserted tort claims against Bryan Brothers. The insured filed for coverage of the claims but the insurer denied coverage. The insurer stated that Whitworth fit within the policy's definition of “you” because she committed the thefts as an employee performing professional services for Bryan Brothers, and because she had reason to believe that as early as 2002, before the inception of the policy, that her acts might be the basis of a claim, the terms of the insuring agreement were not met. Coverage is thus precluded under the prior knowledge provision.
The insured settled the claims with the clients and then sued the insurer for breach of contract. The district court granted summary judgment to the insurer and this appeal followed.
The United States Court of Appeals, Fourth Circuit, noted the arguments. The insured argued that it is entitled to coverage because it did not share prior knowledge of Whitworth's thefts and so, the firm was an innocent insured under the terms of the policy. Bryan Brothers claimed that the prior knowledge provision is an exclusion and the innocent insureds provision saves coverage for the firm. The insurer stated that the prior knowledge provision is a condition precedent that precludes coverage if it is unsatisfied. The court agreed with the insurer.
The court declared that the plain language and structure of the policy convinced it that the prior knowledge provision is a condition precedent to coverage. The insuring agreement in the policy said that liability was covered “provided that none of you had a basis to believe that an act or omission might reasonably be expected to be the basis of a claim”. The court rephrased this language to say that if any defined “you” knew prior to the effective date of the policy that an act or omission might be the basis for a claim, any claims arising from that act or omission are not covered. Because Whitworth had prior knowledge, there was a failure to fulfill a condition upon which the obligation of the insurer is dependent.
The court said that its interpretation melds with the concept of fortuity, a fundamental premise of insurance law. In this case, the prior knowledge provision essentially makes fortuity a condition of coverage. The prior knowledge provision indicates in clear and unambiguous language the insurer's unwillingness to cover liability arising from prior acts or omissions that any insured might reasonably expect to result in a claim. The innocent insureds provision in the policy was not implicated at all in this instance.
The decision of the district court was affirmed. The prior knowledge provision was held to be a condition precedent to coverage and because Whitworth had prior knowledge of her thefts, a condition precedent was unfulfilled. The insuring agreement was not triggered.
Editor's Note: The policy in question in this case had an innocent insured provision that would afford coverage to “any of you who did not personally commit, have knowledge of, or participate in criminal, dishonest, illegal, fraudulent, or malicious acts”. The insured based its claim for coverage on this provision, but the court of appeals looked to the insuring agreement first and found no coverage.
The court stated that “it is elemental that exclusions and exceptions and conditions in an insurance policy cannot expand the scope of agreed coverage”. In other words, read the insuring agreement first before exploring any exclusions or exceptions, because if the terms of the insuring agreement are not met, the policy does not provide coverage.