Known Circumstances Exclusion Examined

 November 10, 2014

 The insured brought an action against its insurer seeking defense costs and indemnity under a directors and officers liability insurance policy. This case is Clark School for Creative Learning, Inc. v. Philadelphia Indem. Ins. Co., 734 F.3d 51 (1st Cir. 2013).

 The Clark School is a non-profit, independent K-12 school and was struggling financially. The Valentis, parents of children that attended the school, donated $500,000 to the school, based on a promise by the school to convey a security interest in the land and to use the funds to construct a new facility for the high school. Later, the Valentis sued the school for failure to follow through on its promises.

 The school notified its insurer, Philadelphia Indemnity, of the lawsuit, but the insurer denied coverage, stating that the costs associated with the Valentis' lawsuit were losses excluded from coverage by the known circumstances exclusion. The school defended itself and ultimately settled with the Valentis. The school then filed this action seeking indemnification for the costs of defending itself and in settling the lawsuit.

 The U.S. District Court ruled in favor of the insurer, and this appeal followed.

 The U.S. Court of Appeals noted that the parties both agreed that the losses would be covered except for the known circumstances exclusion. So, it is the interpretation of that exclusion that was at issue. The exclusion precludes losses based upon, arising out of, or in any way involving any matter, fact, or circumstance disclosed in connection with notes in the financial statement. One matter disclosed in the notes pertains to the gift given by the Valentis. The court said that the loss and defense costs certainly involve that gift since the loss and costs were incurred in defending and settling litigation about that gift. Thus, the plain language of the known circumstances exclusion excludes from coverage the losses from the lawsuit brought by the Valentis about their gift.

 The insured argued that the exclusion was intended to exclude only those losses that would result from a future stoppage in the school's operations due to financial problems. The school said that if the parties had intended for the exclusion to apply to the Valentis' gift, they would have referenced a separate note in the financial statement that discusses the gift in greater detail. However, the court said that the language here plainly is not limited to losses caused by financial difficulties. The language explicitly references the gift.

 The school also argued that the ejusdem generis canon required the phrase "in any way involving" to be interpreted in light of the earlier phrases in the list: "based upon, arising out of, or in consequence of." The insured said that these earlier clauses include a notion of causation, so, "any way involving" must include a causal element as well. The court rejected that construction, saying that the "or in any way involving" clause is a mop-up clause intended to exclude anything not already excluded by the other clauses.

 The final argument put forth by the insured was that the plain language reading of the known circumstances exclusion deprives the insured of coverage it reasonably expected. The school argued that it would not have expected the exclusion to reach the Valentis' lawsuit because the exclusion focused on the school's financial difficulties and because the lawsuit had not yet been filed and therefore could not have been a known circumstance. The court ruled that this argument fails on its own terms. The court said that when a contract is not ambiguous, a party can have no reasonable expectation of coverage when that expectation would run counter to the unambiguous language of an insurance policy. There was no uncertainty as to the meaning of the terms in this instance.

 The decision of the district court was affirmed.

 Editor's Note: The U.S. Court of Appeals, First Circuit, discussed the known circumstances exclusion and ruled that the clear and unambiguous wording of the exclusion means the insured did not have coverage for its claim. The insured argued that the plain language of the exclusion must give way to its reasonable expectation of coverage. The court did not agree. The court said that when a contract is not ambiguous, a party can have no reasonable expectation of coverage when that expectation would run counter to the unambiguous language of an insurance policy.