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The insured sought damages and a declaration that the insurer should defend and indemnify for alleged wrongdoing regarding investments made on behalf of a client.  The insured had Errors and Omissions and Director and Officer coverage from a carrier, whom the insured’s agent thought was charging too much.  He used the application for renewal with this carrier to seek coverage from other insurance carries.

The insurer here agreed to use this application among other information to issue a quote.  The insurer received the application from insured which was signed by the insured’s CEO and Chairman.  The application had a warranty question which asked if the applicant or any of its partners, directors, officers, employees, or trustees had knowledge of any fact or circumstance which might give rise to a claim under the proposed policy.  The insured marked No.

Based on and in reliance on this application, attachments, and other representations, the insurer issued a quote for D&O and E&O insurance coverage.  The insured then sent the insurer an order to bind coverage in accordance with the terms and conditions of their quote.

Subsequently a suit was brought against the insured and the insured’s directors for mismanagement, negligent misrepresentation, breach of fiduciary duty and breach of contract by their client.  The insured provided the insurer with notice of this suit a few days later.  The insurer sent the insured a letter reserving its right to deny coverage based on the Application Warranty Exclusion and to rescind the Binder and Contemplated Policies because of the insured’s possible misrepresentations.

After one round of motions, an appeal and remand, both parties renewed summary judgment motions. The court found that the Warranty exclusion in the policy application unambiguously bars coverage to the insured. The insured subjectively as well as objectively knew of the problems which might give rise to a claim well before they completed the insurance application. Many facts and circumstances in the record showed the insured’s subjective knowledge of a potential claim.

The most compelling evidence the court found of the insured’s subjective knowledge was a board meeting in which all the insured’s parties were present where a discussion ensued regarding the potential liability of the client’s investment fund. Any reasonable person in the insured’s position would have recognized that the facts and circumstances might give rise to liability. however they answered the Warranty question in the negative.

In addition the insured’s CEO was convicted of fraudulent conduct prior to the time of the submission of the application therefore the court found this to be another basis for the Application Warranty Exclusion to apply.

The court also allowed rescission of the Investment Adviser coverage part of the policy because they found reverse bad faith by the insured..  The insurer proved by clear and convincing evidence that the prospective insured knowingly and in bad faith made a false material representation during the application process. If the insurer had known the true facts and circumstances of the insured’s situation they would not have issued the quote or conditional binder policy.

The court allowed the insurance policy to be rescinded based upon these material false representations that were made in bad faith and with knowledge of their falsities.  Therefore the court granted the insurer’s motion for summary judgment and denied the insured’s motion for summary judgment.

Date of Decision: July 25, 2008

MDL Capital Mgmt v. Fed Ins. Co., United States District Court for the Western District of Pennsylvania, No. 06-389, 2008 U.S. Dist. LEXIS 57089 (W.D. Pa. July 25, 2008)(Schwab, J.)